Yum! Brands, Chipotle and Domino’s — A Recipe for Investor Indigestion

by Peter Cohan | October 4, 2011 11:15 am

Fast-food companies are doing well thanks to global growth and popular store concepts. But we’ll know just how well they’re doing when Yum! Brands (NYSE:YUM[1]) reports its results Tuesday after the market closes. But YUM is far from the only restaurant stock out there — for example, there’s Chipotle (NYSE:CMG[2]) and Domino’s (NYSE:DPZ[3]). Will any of these companies fatten your net worth?

Yum! Brands is a tale of two regions — a slumping U.S., and a booming China and rest of the world. YUM operates 38,000 restaurants globally, many of those under the Taco Bell, Pizza Hut and KFC brands. But thanks to growth overseas, Yum! Brands is expected to report higher revenue and profit in its third-quarter report. Almost three-quarters of Yum! Brands’ operating profit comes from China[4] and other foreign countries — even though they account for a relatively meager 50% of its total restaurant count.

But one of the downsides of the growth in China is the risk that inflation — in the form of higher labor and commodity costs — will take a bite out of YUM’s profits. Meanwhile, Yum Brands’ U.S. operations are flagging. In the second quarter, its operating profit there fell 28% in all three of its core brands. Its biggest problem has been with Taco Bell, which accounts for 60% of its U.S. profit.

FactSet-polled analysts expect Yum! Brands to report 82 cents a share of adjusted earnings on $3.08 billion in revenue — that would be an EPS increase of 12.3% and a revenue rise of 73 cents per share on revenue of 7.1% compared to the third quarter of 2010.

Chipotle’s growth could accelerate if its new newly opened ShopHouse Southeast Asian Kitchen can do for Asian noodles what Chipotle already has done for Mexican food. Based on the popularity of its Washington, D.C., store[5], opened recently, ShopHouse’s prospects look good.

And while Domino’s was dogged for years for its low-quality pizza, it made wholesale changes to its base pie in 2010, and the company recently introduced a new “artisan” line[6] that features feta cheese and so-called Tuscan salami that may help boost public perception of its quality.

But is any of this enough to justify an investment in Yum! Brands, Chipotle or Domino’s? I would skip them all for now, as they are too expensive when compared to their earnings growth. Here’s my reasoning:

• Yum: Growing, profitable company; overpriced stock. Yum revenues were up 4.7% to $11.7 billion in the past year, and its net income grew 8.1% to $1.2 billion, yielding a solid 10.3% profit margin. But its price/earnings-to-growth ratio is an overvalued 1.61 (where 1.0 is considered fairly valued) on a P/E of 19.5 on earnings forecast to grow 12.1% to $3.19 in 2012[7].
• Chipotle: Rapidly growing, highly profitable company; overpriced stock. Chipotle’s revenues are up 21% in the past year to $2 billion, and its net income climbed 41% to $192 million, yielding a solid 9.6% net profit margin. And its PEG is a high 1.77 on a P/E of 48.4 on earnings forecast to grow 27.3% to $8.67 in 2012[8].
• Domino’s: Growing, decently profitable company; pricey stock. Domino’s revenues are up 11.9% in the last year to $1.6 billion, and its net income exploded 10.2% to $93 million, yielding a slim 5.8% net profit margin. And its PEG is a high 2.05 with a P/E of 26.5 on earnings forecast to grow 12.9% to $1.83 in 2012[9].

The market is overestimating the growth prospects for these fast-food purveyors. Avoid them for now, as they could unsettle your portfolio.

Peter Cohan has no financial interest in the securities mentioned.

Source URL: https://investorplace.com/2011/10/yum-brands-chipotle-and-dominos-restaurant-stock/

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