McDonald's (NYSE:MCD) and Yum! Brands (NYSE:YUM) are arguably the two leading contenders when it comes to size and global dominance in the fast-food business. In addition, both companies are quite popular among dividend stocks investors because of their succulent capital distributions. Let's compare McDonald's and Yum! Brands to find out which one may be the best choice for dividend-hungry investors.
Both McDonald's and Yum! Brands are facing considerable challenges lately. Consumers are increasingly conscious about the health implications of the food and drinks they consume, and the fast-food market in the U.S. is quite saturated. In addition, fast-casual organic burrito maker Chipotle Mexican Grill is stealing customers away at an amazing speed, while generating truly exceptional growth rates over the past several years.
Making things worse, both companies are facing declining sales in China because of food safety concerns. An investigative report from Chinese TV in late July showed that food supplier Shanghai Husi, a division of OSI Group, was repackaging expired meat and supplying it to both McDonald's and Yum! Brands.
Yum! Brands and McDonald's have closed any commercial ties with Shanghai Husi since then, and they are working on increasing their oversight when it comes to supply chain and food quality in China. However, the scandal is dragging on performance in the middle term.
McDonald's announced a 2.5% decline in global comparable sales for July. Sales in the U.S. were quite weak, with a 3.2% decline versus the same month in 2013. Europe did relatively better, although nothing to get too excited about, with a 0.5% increase in comparable sales. Comparable sales in the Asia-Pacific, Middle East, and Africa region were particularly bad, with a big 7.3% decline in July.
Yum! Brands was recovering from previous food safety scandals in China before the incident with Shanghai Husi broke out. The company had announced a big 21% systemwide increase in sales in China during the second quarter of 2014. Worldwide system sales increased 6% during the quarter, so Yum! Brands was clearly benefiting from its big global exposure and outgrowing McDonald's by a considerable margin.
However, Yum! Brands recently announced that it expects comparable sales in China to decline by approximately 13% during the quarter ended in August. According to the company, "While sales are beginning to rebound, they continue to be negative."
McDonald's is facing considerable difficulties when it comes to generating sales growth, but this fast-food powerhouse is still a very profitable business, producing tons of cash flow on a recurrent basis. The House of Ronald has raised its dividends each and every year since making its first distribution in 1976.
McDonald's pays a generous 3.5% dividend yield, and the payout ratio is quite safe, in the area of 58% of earnings estimates for 2014. The company plans to return between $18 billion and $20 billion to shareholders via dividends and stock buybacks between 2014 and 2016, representing an increase of 10% to 20% versus the cash distributed in the 2011 to 2013 period.
Yum! Brands pays a smaller 2.1% dividend yield, and it started paying dividends in 2004, so it has a shorter dividend growth track record than McDonald's. On the other hand, Yum! Brands beats McDonald's when it comes to dividend growth, as the company has increased payments at double-digit rates over the past nine years. That's quite a remarkable dividend growth trajectory for a company as big as Yum! Brands that operates in a mature industry.
The payout ratio is comfortably low, in the area of 43% of earnings estimates for the current year. Even factoring in that financial performance will most likely take a hit because of problems in China, cash flow distributions from Yum! Brands are clearly sustainable.
Yum! Brands has made missteps when it comes to its suppliers in China on multiple occasions, so management really needs to implement the right strategies and systems to make sure it finds a definitive solution to these problems. Assuming the company gets back on track in the middle term, dividend growth prospects look quite exciting for Yum! Brands, since its huge emerging-market presence should be a major growth driver in the coming years.
Tastier dividends: McDonald's or Yum! Brands?
McDonald's pays a higher yield, and the company lacks the level of exposure to China that Yum! Brands enjoys, so it will be affected by the food safety concerns to a lesser degree. Yum! Brands, on the other hand, makes a big 35% of its operating profits from China, which means higher uncertainty in the coming months, but also superior potential for growth if the company can effectively control its suppliers in the country.
While McDonald's provides more income, Yum! Brands offers superior growth prospects when considering both earnings and dividends. From a total return perspective, Yum! Brands could be the right choice for investors with a strong enough stomach to withstand the short-term uncertainty.
Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.