According to the Department of Agriculture, 15% of Americans use food stamps. It’s such a large number that Yum Brands (NYSE:YUM) is lobbying for its restaurants to be permitted to accept food stamps. If you’re an investor in Yum Brands, this might seem like a huge opportunity because three states already have pilot programs under way. However, Yum Brands already is a major contributor to childhood and adult obesity. Accepting food stamps would only increase this.
This is just one reason why investors ought to ditch Yum Brands and buy Darden Restaurants (NYSE:DRI). Read on and I’ll explain some others:
China is a popular choice for many American companies looking for growth outside their own country’s borders. Yum Brands is opening stores there at an amazing rate, and business is strong. In the third quarter, YUM opened 138 units in China, and it expects to open 600 in 2011. At the end of Q3, it had 4,187 restaurants open in China with 83% under its KFC brand. Year to date, the China division’s same-store sales are up 17% on the top line and its operating profit YTD is up 20% on the bottom line.
It’s no wonder Yum Brands is pushing hard into China. Its U.S. segment saw operating profits and revenues decline 20% and 10%, respectively, in the first half of the year with little hope for near-term improvement. China must perform, because YUM’s stock isn’t cheap right now, trading at a forward P/E of 16 — almost identical to McDonald’s (NYSE:MCD) but with a smaller dividend. If China slows, the impact is much less severe for McDonald’s than for Yum Brands. Therefore, if you believe China’s growth is slowing or will do so, holding YUM stock carries too much risk compared to its potential return.
China’s labor costs are rising substantially, as are its food costs. This will continue to put margin pressure on Yum Brands’ business there. During the past decade, while China has grown by double digits, its inflation rate has increased by just 2% annually. If growth continues, the inflation rate is expected to increase to between 3% and 5% annually.
Combine this with labor inflation of 20% for Yum Brands in the third quarter alone, and its low-prices initiative in China appears under pressure. It recently raised its prices by 2%; it will continue raising them until its costs catch up with inflation. That might not happen until the middle of 2012. By then, YUM’s booming revenue growth might be a fading memory if Chinese customers decide to eat at McDonald’s and elsewhere instead. If you’re fixated on quick-service restaurants, McDonald’s is a better play. However, for those investors willing to give full-service restaurants a look, Darden Restaurants is your best bet. Here’s why: