Why Yum May Outperform McDonald’s This Year

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Fast food is big business, and there are no bigger players than McDonald’s Corp. (NYSE: MCD) and Yum! Brands Inc. (NYSE: YUM), parent company of KFC, Taco Bell and Pizza Hut. McDonald’s enjoyed buoyant 2015, while Yum was stagnant, but both are in the process of implementing growth initiatives aimed at replicating their 2015 performance this year. Of the two options, which looks more attractive?

Yum began 2015 well, outperforming McDonald’s up through October. Since then though, McDonald’s pulled away and had the stronger 2015, with its stock gaining 25% while Yum went nowhere. Yum was outpacing McDonald’s all year, but a host of health scares reversed its fortunes and the company ended up giving back practically all of its 2015 gains.

Yum’s revenues, a better indication of the company’s health, grew steadily each quarter during 2015, coming in at $2.6 billion, $3.1 billion and $3.4 billion for the first, second and third quarters, respectively, and analysts expect the fourth quarter to continue this trend. Gross profit margin dipped slightly year over year during first and second quarters of 2015, but the third quarter beat out its comparable 2014 quarter, coming in at 27.22%, versus 25.34% for 2014.

McDonald’s saw an almost identical pattern, albeit not to the same degree. The company grew revenues between the first and third quarter by 11%, from $5.9 billion to $6.6 billion, versus Yum’s 30% gains across the same period. McDonald’s outshone Yum from a gross margin perspective though, not only beating the numbers from a quantitative perspective but also maintaining margin growth across the period.

What about the restaurants themselves? McDonald’s started offering all-day breakfasts in November last year, to much praise from customers, and this likely will impact its fourth-quarter financials, to be reported on January 25. Some studies put the impact of this extended offering as high as 30% increased sales, and if this proves valid, it should help the burger chain get off to a strong 2016 start. One thing to keep in mind though is that its breakfast menu is lower priced and carries lower margins than the dinner menu, but a boost is a boost.

Yum is looking to expand its already huge Asian operations through an absolute franchise model in China. All Yum restaurants in the region will be franchised, and this should help the company reduce its overhead into 2016 and push up margins. The move comes on the back of the company’s decision to separate its core and Chinese operations last year.

So which company wins out? Yum’s potential in China is intriguing but dangerous as China’s economy is a big unknown. As Yum recovers from its health scare sales dip, its market capitalization should recover to at least pre-scare levels. McDonald’s is expanding, but at its current price just 3% off all-time highs, it may be overbought. Both companies look like long-term buys, but Yum’s discount gives it the higher risk, considering China, and the higher upside as well.