Fast-food restaurants have sprung up all over the world.
According to IBISWorld, an industry market research company, there are 536,825 fast-food restaurants globally.
Among all these restaurants, two companies stand out: McDonald’s (NYSE: MCD) and Yum! Brands (NYSE: YUM).
With over 41,000 locations worldwide, the Golden Arches need no introduction.
On the other hand, many may not be familiar with Yum! Brands.
Yum! Brands is the world’s largest restaurant company, operating over 59,000 restaurants.
The company is best known for owning KFC and Pizza Hut, which are popular in Singapore.
Apart from KFC and Pizza Hut, Yum! Brands also owns Taco Bell and The Habit Burger Grill, both of which have a large presence in the US.
Many people are regular customers of McDonald’s or the chains under Yum! Brands.
Hence, investors may be interested to invest in these two iconic companies.
This raises the question, which of these fast-food behemoths is more worthy of your investment?
Financial performance
Let’s delve into the latest financial results of these two companies.
For the second quarter of 2024 (2Q 2024), Yum! Brands reported a 4.5% year on year increase in revenue to US$1.8 billion.
On the other hand, net profit fared worse, declining by 12.2% year on year to US$367 million.
However, investors should not worry too much. Profit before taxes saw a slight increment of 1.8% to US$487 million, with lower net income explained by higher taxes paid.
The company also generated a positive free cash flow of US$606 million for the quarter.
Meanwhile, for 2Q 2024, McDonald’s net revenue stood flat at US$6.5 billion.
Net profit dipped by 12.5% year on year, totalling US$2.0 billion.
The business generated a positive free cash flow of US$1.1 billion.
Both fast-food companies reported solid financial performances despite a tough environment attributed to inflationary and consumer demand pressures.
However, a curious point arises: Despite Yum! Brands operating over 18,000 more restaurants, how is McDonald’s able to generate over three times more revenue?
Analysing their business models
The reason McDonald’s earns significantly more lies in its business model.
First and foremost, both McDonald’s and Yum! Brands do not operate most of their restaurants.
Both companies franchise a majority of their restaurants, collecting franchising fees and royalties.
McDonald’s directly operates only about 5% of its restaurants.
Likewise, 98% of the Yum! Brands’ restaurants are franchisee-owned and operated.
What sets McDonald’s apart is its substantial property holdings.
In McDonald’s balance sheet for 2Q 2024, the company owns over US$43.8 billion in property, plant and equipment (PPE).
This allows McDonald’s to charge rent to franchisees on top of royalties, a model employed by 55% of its restaurants.
In contrast, Yum! Brands’ PPE stands at US$1.4 billion as of 30 June 2024.
In 2023, Yum! Brands recorded US$115 million in property revenue.
In contrast, McDonald’s generated a staggering US$9.8 billion in rental income last year.
McDonald’s business model has been so effective that the previous CEO, Harry J. Sonneborn, famously described the company as a real estate business rather than a fast food chain.
However, McDonald’s has outperformed Yum! Brands in almost all aspects, achieving higher revenues for both organic company sales and revenue from franchisees.
This might be attributed to the fact that the Golden Arches is simply the more popular brand.
According to QSRMagazine, for 2022, McDonald’s was ranked the first in sales for fast food in the US, far eclipsing the chains from Yum! Brands, with Taco Bell performing the best at fourth.
In fact, Yum! Brands’ CEO, David Gibbs, has acknowledged the decline in popularity of KFC to other competitors.
Which company should I invest in?
From an earnings perspective, it seems that McDonald’s appears superior to Yum! Brands.
However, we should not completely disregard Yum! Brands.
In terms of valuation, both companies are trading at a comparable price to earnings (P/E) ratio.
Currently, McDonald’s P/E ratio is at 23.6x, while Yum! Brands’ P/E ratio is slightly higher at 24.8x.
This small difference suggests that the market values both companies similarly.
Over a longer timeframe, McDonald’s has seen its net revenue and net profit grow at a five-year compound annual growth rate (CAGR) of 4.0% and 5.9% respectively.
In comparison, Yum! Brands has exhibited a slightly higher net revenue CAGR at 6.1%, but a lower net profit CAGR at 4.9%.
The reason behind Yum! Brands’ higher revenue growth rate is due to some of the chain’s popularity abroad.
While brands like KFC and Pizza Hut are underperforming in the US, they are gaining considerable traction in emerging nations, particularly Latin America, Africa, and India.
These countries represent significant growth opportunities and are pivotal to Yum! Brands’ long-term strategic outlook.
Despite more robust revenue growth, margins have been a key challenge for Yum! Brands.
To illustrate, operating margins for 2Q 2019 were at 36.0% but have since decreased to 34.4% in 2Q 2024.
Acknowledging these challenges, the company has initiated measures to improve efficiency and profitability.
In 2021, Yum! Brands announced the acquisition of Dragontail Systems.
The Dragontail platform is an innovative system that seeks to optimise the entire food preparation process using artificial intelligence (AI).
Apart from Dragontail, Yum! Brands has also integrated other technologies into its operations, such as Poseidon, a cloud platform for order and cash management.
Investors are hopeful that Yum! Brands’ operating margins will improve as the company continues to adopt high-end technology.
Dividends galore
For investors who value a consistent business model with a history of solid profitability, McDonald’s might be more suitable.
Conversely, Yum! Brands may appeal to growth-hungry investors who have a higher risk tolerance.
Regardless of your investment style, both companies are good dividend payers.
For 2Q 2024, McDonald’s declared a quarterly dividend of US$1.67, an increase from the previous year’s US$1.52.
Similarly, Yum! Brands announced a quarterly dividend of US$0.67, up from last year’s US$0.605.
This results in trailing dividend yields of 2.5% for McDonald’s and 2.0% for Yum! Brands respectively.
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Disclosure: Aw Kai Rui does not own any of the stocks mentioned in this article.
