Last June, I told investors to buy shares of Starbucks (SBUX 0.27%) instead of McDonald's (MCD -0.15%). At the time, I noted Starbucks faced fewer competitors than McDonald's, had more growth opportunities in China, and locked in more customers with a stronger digital ecosystem.
The market seemed to agree with me. Starbucks' stock has risen roughly 50% since, while McDonald's stock has advanced only 25%. But will Starbucks continue to outperform McDonald's for the rest of the year?
Comparing their core businesses
Starbucks ended its most recent quarter, which ended on Dec. 27, with 32,938 stores worldwide. Its two largest markets are the U.S., with 15,340 stores, and China, with 4,863 stores.
Nearly half of Starbucks' stores are licensed, but the company generated only 9% of its revenue from licensed locations last quarter. Those locations pay Starbucks licensing fees to display its logo and sell its products, but they aren't franchisees that need to follow Starbucks' official business model.
McDonald's operated and franchised 39,198 restaurants at the end of 2020. It generated 56% of its revenue from its franchisees, which accounted for 93% of all stores. These franchisees pay McDonald's fees -- including rent and a cut of their sales -- and are tethered to much-tighter corporate rules than Starbucks' licensees.
Starbucks, which started accepting mobile payments more than a decade ago, has a head start in the digital race against McDonald's. It generated 25% and 30% of its transactions in the U.S. and China, respectively, from its mobile app last quarter. That growth feeds its "digital flywheel" strategy, which locks in its users with rewards, digital payments, and mobile orders.
McDonald's only got serious about upgrading its digital platforms four years ago with its "Experience of the Future" plan, which aimed to renovate its stores, install in-store digital kiosks, and expand its online ordering and digital delivery capabilities. Those accelerated efforts enabled McDonald's to generate nearly 20% of its systemwide sales from digital channels in 2020.
Comparing their growth rates
Starbucks' revenue declined 11% in fiscal 2020, which ended last September, as its global comparable-store sales fell 14%.
That decline was caused by the pandemic, which had led to a comps decline in the second, third, and fourth quarters. Adjusted earnings plunged 59% as the costs of dealing with the pandemic soared.
However, Starbucks cushioned the blow by providing more delivery options, relying more on drive-thru windows and entryway pickups, and gradually reopening its stores with social distancing measures. It also continued to open new stores, which indicated its core business was still healthy.
Starbucks' revenue fell 5% year over year in the first quarter, with a 5% drop in its global comps, as its adjusted earnings fell 23%. U.S. comps declined 5%, but Chinese comps increased 5% -- which indicated the rest of the world could eventually follow China's recovery as the pandemic gets under better control.
Starbucks expects its U.S. business to fully recover in the second quarter, and analysts expect its revenue and earnings to rise 21% and 143%, respectively, against easy year-over-year comparisons.
McDonald's revenue declined 10% in fiscal 2020, which aligns with the calendar year, as its global comps fell 7.7%. Its U.S. comps increased 0.4%, but that growth was offset by a 15% decline in its international comps.
The pandemic severely disrupted McDonald's business throughout the year, but the company also leaned more heavily on drive-thru and delivery options to partly offset its loss of dine-in customers.
This year, McDonald's expects new menu items -- including spicy Chicken McNuggets, a new chicken sandwich, and new McCafe items -- to lure back diners. It also plans to keep investing in its "three Ds" (digital, delivery, and drive-thru) to streamline its business.
Analysts expect McDonald's a 15% boost to revenue and a 39% increase in earnings this year. Like Starbucks, McDonald's will likely increase its store count again this year -- as it has done every year in recent history.
The valuations and verdict
Starbucks and McDonald's should both recover over the next few quarters. However, Starbucks stock now trades at 33 times forward earnings, much higher than McDonald's forward P/E ratio of 25.
Starbucks' forward dividend yield of 1.6% is also lower than McDonald's forward yield of 2.2% and the 10-year Treasury yield of 1.7%. That higher valuation and lower yield could make Starbucks less appealing than McDonald's this year, especially as rising bond yields spark a rotation from growth to value stocks.
Starbucks and McDonald's are both solid long-term investments. But if I had to pick one over the other, I'd choose McDonald's this time around instead of Starbucks because it's significantly cheaper and pays a higher dividend.