Fast-food behemoths McDonald's(NYSE:MCD) and Yum! Brands (NYSE:YUM) are both caught in difficult situations. In the United States, sales are struggling due to shifting consumer habits. As consumers in developed markets become more health-conscious, they're slowly shying away from fast food. This presents a problem, because the United States is still the largest market for McDonald's and Yum.
Internationally, emerging economies present a real opportunity for future growth. However, McDonald's and Yum (operator of KFC, Taco Bell, and Pizza Hut) can't seem to get out of their own way, and recent food safety scandals have put a dent in their foreign growth.
Still, McDonald's and Yum can be counted on to deliver decent dividends, and both companies continue to generate solid cash flow. In a matchup of two fast-food giants, let's look at which might be a better buy for income investors.
Foreign growth hits a speed bump
McDonald's and Yum have each targeted emerging economies across the world to fuel growth. As McDonald's announced earlier this year as part of its Plan to Win initiative, the company will spend $3 billion in 2014 to open at least 1,500 new restaurants, the majority of which will be located in faster-growing economies in places like Asia, the Middle East, and Africa.
McDonald's operations abroad did the heavy lifting last quarter, while its U.S. business fell behind. Comparable sales, which measure sales at locations open at least one year, rose 1.1% in the company's Asia-Pacific, Middle East, and Africa (APMEA) segment. Overall comparable sales were flat last quarter, and McDonald's produced just 1% growth in earnings per share. Most of the blame fell on its U.S. operations, where comparable sales fell 1.5% in the last quarter.
Unfortunately, McDonald's emerging market business is now under pressure partly as a result of a public relations mess when workers at one of its suppliers were seen on video repacking expired meat. As you might expect, this has caused customers to flee in droves.
McDonald's comparable sales in its APMEA segment fell 7.3% in July and 14.5% in August. Clearly this is a troubling situation, since McDonald's has invested heavily in expanding into these countries.
Yum is also counting on expanding in China. Total sales there jumped 21% last quarter, driven by 15% same-store sales growth. Restaurant margin in China grew by 6 percentage points, and operating profit more than doubled year over year. This was the primary driver for Yum's 30% earnings growth last quarter.
Yum management expects at least 20% earnings growth this year. This will be achieved partly by significant new restaurant openings in China. The company opened 104 new restaurants in China just last quarter, and expects as many as 700 openings for the year in the market.
McDonald's dividend feeling the effects
McDonald's financial performance is weighing significantly on its ability to increase its dividend. The company's rate of dividend growth has slowed in recent years. Over the past five years, McDonald's has increased its payout by 10% compounded annually. But its most recent 5% dividend increase was a disappointment and well below its average raises. This reflects the multiple headwinds the company faces. McDonald's is due to increase its payout once again, since it has been a full year since its last dividend bump. It will be interesting to see what kind of increase investors receive.
McDonald's yields 3.5%, which gives it an edge over Yum's 2% yield. But Yum has grown its dividend by 14% compounded annually over the past five years, which it's able to do because of much-higher earnings growth.
Yum is also on schedule to announce what investors expect will be a dividend increase in the near future. If it decides on a 15% dividend increase, Yum's yield would suddenly rise to about 2.3%, if the share price doesn't change. While that would still be below McDonald's yield, if the Golden Arches can't right the ship, Yum could catch up to it in the dividend yield realm.
Given Yum's superior operating performance and much stronger dividend growth prospects, it looks like the better fast-food stock for income investors right now.
Bob Ciura owns shares of McDonald's. The Motley Fool recommends McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.