Tuesday, October 04, 2011

Yum, Chipotle, and Dominos Could Give Your Portfolio Indigestion

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) reports its results Tuesday after the market closes. But YUM is not the only one out there -- for example, there's Chipotle Mexican Grill (NYSE: CMG) and Dominos (NYSE: DPZ) – will any of these companies fatten your net worth?

Yum 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. Among the brands of the former PepsiCo (NYSE: PEP) restaurant division are Taco Bell, Pizza Hut, and KFC. But thanks to growth overseas, Yum is expected to report higher revenue and profit in its third-quarter report.

Almost 75% of Yum's operating profit comes from China 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's 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 that accounts for 60% of its U.S. profit. And Yum blames a lawsuit regarding claims of insufficient beef in its tacos for a sales drop at Taco Bell.

FactSet-polled analysts expect Yum 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.

Would that be enough to justify an investment in Yum? Should you buy Chipotle or Dominos instead? I would skip them all for now since they are too expensive when compared to their earnings growth. Here's my reasoning:
  • Yum: growing, profitable company; over-priced stock. Yum revenues were up 4.7% to $11.7 billion in the last year while its net income grew 8.1% to $1.2 billion yielding a solid 10.3% profit margin. But its Price-earnings-to-growth ratio (PEG) -- 1.0 is fair value -- is a slightly over-valued 1.61 on a P/E of 19.5 on earnings forecast to grow 12.1% to $3.19 in 2012.
  • Chipotle: rapidly growing, highly profitable company; over-priced stock. Chipotle revenues are up 21% in the last year to $2 billion and its net income climbed 41% to $192 million while it earned 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.
  • Dominos: growing, decently profitable company, pricey stock. Dominos revenues are up 11.9% in the last year to $1.6 billion and its net income exploded 10.2% to $93 million while it earned 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.
The market is over-estimating the growth prospects for these fast food purveyors. They could give your portfolio indigestion.


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