InvestorPlace contributor Vince Martin recently discussed Yum! Brands, Inc. (NYSE:YUM) and how the company’s franchise model has helped boost YUM stock in recent years.
In 2016 and 2017, YUM stock has seen calendar-year gains of 24% and 31%, respectively, outperforming its restaurant peers by a significant amount.
“How are the stock prices of fast-food restaurant concepts rising at the same time that fewer customers are visiting those restaurants?” Martin asked January 2. “One clear reason is that brand-owners like YUM operate a franchise model. And that model has become a favorite of investors.”
YUM’s Franchising Model
It’s become especially attractive in recent years as companies like YUM refranchise former company-owned locations, reducing the restaurant-level expenses that typical franchisees face in their businesses.
Which would you rather own? A restaurant company that earns franchise fees and royalties on sales without having to get your hands dirty, or a business that has minimum-wage hikes and all kinds of other labor-related issues?
The problem, as Martin points out, is that the franchising model is only as successful as its franchisees. If the franchisor keeps offloading costs onto the franchisee without raising prices, the business ultimately fails due to a lack of profits at the store level.
YUM Isn’t a Bad Business
The company delivered fourth-quarter 2017 earnings February 8. They were pretty good.
Earnings per share excluding special items — $752 million from refranchising gains at restaurants in several countries, including the United States, increased by 20% to $0.96 from $0.80. Same-store sales were positive across all three of the company’s concepts with KFC leading the way with 3% comp growth.
So, to say the business is facing imminent disaster is the farthest thing from the truth. There’s a lot to like about YUM.
However, of the three concepts, Pizza Hut had the least attractive results with just 1% comps. Before buying YUM stock, investors might want to consider the company’s pizza rival, Domino’s Pizza, Inc. (NYSE:DPZ).
DPZ Outperforms YUM
Last April, I discussed a chart making the rounds that showed DPZ stock hammering Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) since both went public in the summer of 2004.
How was it possible that a low-tech company like Domino’s could outperform Larry Page and company? By operating a well-run business, that’s how.
So, let’s consider DPZ versus YUM stock.
Over the past five years, Domino’s has outperformed YUM stock by 200% on an annualized basis. In 2018, DPZ is up 12% through February 7 while YUM is down 2%.
Over at Domino’s, you don’t hear much chatter about refranchising — despite the fact it owns just 399 stores in the U.S. out of 14,434 globally. It probably should get rid of them, but I suspect it’s hanging on to them to use as testing grounds for new technology and products.
That’s what innovators do. Not what’s best for short-term results, but what will help the business five and 10 years down the line.
Consider Domino’s same-store sales growth.
In the third quarter ending September 10, it increased 8.4% in the U.S. and 5.1% excluding currency internationally. It opened 217 new stores in Q3 2017, about three-quarters of which were outside the U.S.
If the U.S. can support almost 5,500 Domino’s locations, think how many the company can open internationally.
Bottom Line on YUM vs. DPZ
As Vince said, Yum’s not a bad business.
However, this isn’t a popularity contest. It’s about making money and in that regard, there is no comparison between the two companies.
If you want to buy YUM stock — don’t. Buy DPZ instead. You’ll thank me in five to 10 years.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
