The Real Reason Yum! Brands Is Outperforming McDonald's Stock

Key Points

• Corporate greed may have overtaken the fast food industry, as menu item inflation has outpaced restaurants and the U.S. economy.
• Investors can spot the 'greed index' and how it has developed over the pandemic months by looking at McDonald's and Yum! Brands.
• If the industry remains where it is, markets may keep rewarding Yum! stock over McDonald's.

Some may call it corporate greed, and some may buy the media message, but the truth is that fast food isn’t cheap or quick. This CNBC short documentary covered some of the factors behind fast food price increases. However, it only covered one side of the equation, and investors should have access to the whole picture.

The whole picture includes some corporate greed factors, as the issue doesn’t just lie with wage increases and commodity costs; it goes way beyond that. Investors—and consumers—should know that brands like McDonald’s Co. NYSE: MCD keep taking advantage of today’s environment to bloat the bottom line, which is also a benefit of having such a strong brand moat.

On the other hand, the corporate greed index (proxied by net income margins) did not reach stocks like Yum! Brands Inc. NYSE: YUM, and that is why markets have been rewarding the stock over McDonald’s. Before investors find the truth behind Yum! Brands’ outperformance in detail, here’s where the fast food industry is headed.

Understanding Why Fast Food Inflation Is Surpassing Overall Inflation Rates

Investors were told it was because of wage increases, as remote and hybrid work outcompeted the demanding shifts behind a burger and fry station. However, because fast food margins are already pretty thin, boosting wages means these added costs must be made up somehow.

This is where rising prices come to fix the issue. Over the past 12 months, fast food inflation has outpaced not only restaurant inflation but overall U.S. inflation. Readings of 5.2% stood over 3.8% for restaurants and roughly the same for national core inflation rates.

Chicken and beef prices, the primary proteins used in fast food, have declined over the past 12 months. So, suppose commodity inputs can’t be blamed for price increases. What else could these companies point to to justify these accelerating price increases?

The answer is corporate greed or the net profit margin rate. If net income margins rise, it cannot be due to higher input costs like commodities and wages. If item prices rise at a similar pace to input costs, then net income margins should stay the same; that’s not the case at McDonald’s.

McDonald's Brand Moat: The Secret Behind Price Hikes Exceeding Cost Increases

Suppose there is no corporate greed factor to this issue. In that case, net income margins should increase yearly at a rate that roughly matches inflation. McDonald’s financials show a net income margin of 24.6% in 2020. Then, a sudden jump to 32.5% in 2021 is far from a behavior expected from rising wages and food costs.

These elevated margins remained at these levels until 2023, when the net income margin reached 33.2%. 2023 saw a roughly 8.6% jump in margins, crystalizing the possibility of corporate greed beyond any wage or commodity cost increase.

Focused on these financial ratios, Wall Street analysts were happy to slap a $316.2 a share price target for McDonald’s stock, calling for a 23.7% upside from where it trades today. However much upside there may be for this stock, the market doesn’t like greed that much.

How can investors tell? McDonald’s stock has fallen behind over the past 12 months compared to the consumer discretionary sector. The Consumer Discretionary Select Sector SPDR Fund NYSEARCA: XLY pushed out a 9% annual performance, while McDonald’s stock actually fell by 11.4%.

Applying the same analysis to Yum! Brands will show investors a different story, one that favors Main Street over Wall Street. Here are the facts.

Markets Favor Yum! Brands Stock for Maintaining Prices in Line with the Economy

For Yum! Brands' financials, investors can see the company’s net income margin remains relatively steady. Before the COVID pandemic, Yum! Brands saw a net income margin of 23.1% in 2019, which didn’t jump as aggressively as McDonald’s.

Fast forwarding to 2023, net income margins stood at 22.6% despite the wage increases and commodity input costs. As the company never pushed its luck by squeezing the situation into a profit margin expansion, analysts saw no need to reward it with a rising valuation.

This is why Wall Street analysts only see a $143.8 price target for Yum! Brands, implying a mere 4.2% upside from where it trades today, far from the double-digit run proposed for McDonald’s stock.

Despite the lack of Wall Street enthusiasm, markets noticed how Yum! keeps its situation realistic with the economy. Over the past 12 months, Yum! Brands stock outperformed McDonald’s stock by over 12%.

If the fast food industry's current state remains the same and corporate greed stays at the helm of restaurant stocks, considerate brands like Yum! could see another winning round in the next couple of quarters.