Fast food companies are feeling the squeeze.

On one hand, sales are growing in the emerging markets abroad. At the same time, however, the quick-service restaurants also are wrestling with a slowdown in their home U.S. market, and a backlash from media-fueled concerns about the spread of obesity.

In a saturated U.S. market, fast food firms have had to find a delicate balance between soaring raw ingredient prices and a penurious U.S. consumer who is increasingly feeling the pinch of high gasoline prices and a slowing U.S. economy.

Many of the names that have long been associated with the American market have turned to growing overseas markets to compensate for lagging domestic sales.

The Original, But Still the Best?

McDonald’s Corp. (MCD) has been around for more than 50 years and, for better or worse, the company’s familiar Golden Arches logo has become synonymous with America. With the purchase of the McDonald brothers’ San Bernardino, California restaurant in 1954, the late Ray Kroc started a fast food powerhouse that now has over 31,000 restaurants in over 100 countries worldwide, which serve 56 million customers daily.

Unlike its rival, Yum! Brands Inc. (YUM), McDonald’s has been going back to basics in recent years. It has divested controlling interests in its other brands, which once included Boston Market, Chipotle, Donatos Pizzeria and Fazoli’s.

Revenue for full-year 2007 reached a record $22 billion on the back of a 6.8% increase in sales, but net income dropped to $2.4 billion from $3.5 billion the year before. Earnings per share also declined, dropping to $1.98 per share last year from $2.83 in 2006.

Sales in Europe and Asia, helped by a currency boost from the weak greenback, are outpacing U.S. growth, but McDonald’s feels it is well positioned to face a downturn in the U.S. economy.

"We acknowledge that the general retail industry here seems to be impacted by the current economic environment," Chief Executive Officer Jim Skinner said during a fourth quarter earnings conference call. "Historically, though, McDonald’s has not been as affected by a slowdown in consumer spending as other retailers because of our everyday affordability. We offer great value for the money and we have a convenience advantage."

In a bid to increase domestic market share – and to swallow some of the $60 billion spent on beverages every year – McDonald’s will be expanding its specialty drink offerings in 2008. Through co-investment with franchisees, McDonald’s restaurants will add smoothies, frappes, and a variety of other fountain and bottle beverages to its existing iced-coffee and sweet-tea offerings. There are even plans to go head to head with Starbucks Corp. (SBUX), by offering espresso drinks at a much lower price.

McDonald’s has also been selected as the Official Restaurant of the Beijing 2008 Olympic Games. The fast food giant has plans to build four restaurants in Beijing that will cater to the athletes, the news media and spectators. McDonald’s also will run a Champion Kids promotion to give 300 children a chance to attend the Olympic games.

McDonald’s has done quite well in the past by targeting children in its advertising – offering kid-friendly finger foods, playgrounds inside its restaurant, and The Walt Disney Co. (DIS) movie toys in its ubiquitous Happy Meals. But the kid-friendly strategy has also received widespread criticism, given that childhood obesity has been on the rise for years.

McDonald’s has tried to combat that image by offering healthier choices and smaller portions.  

More Than Just Burgers

If someone asked: What fast-food company is the world leader in terms of total restaurant locations? While most consumers would probably guess McDonald’s, the actual leader is fast-food rival Yum! Brands Inc., with 34,000 locations.

Yum is the proprietor of such well-known brands as KFC, Pizza Hut, Taco Bell, Long John Silver’s and A&W All-American Food Restaurants. Yum also has East Dawning, an Asian-markets chain operated by its Yum! Restaurants International (YRI) division.

For the full-year ended Dec. 29, operating profit growth in China and within YRI helped offset a 3% decline in the United States. In addition to its already strong overseas performance, favorable currency exchange rates helped to boost earnings per share (EPS) by an additional six cents.

As was the case with McDonald’s, Yum! Brands’ domestic-market performance was the weak spot in an otherwise strong earnings report. The increase in same-store sales open a year was not enough to boost operating profit, down 1% from the prior year, due to higher commodity and labor costs.

"In all candor, the best thing I can say about our weak U.S. performance in 2007 is that it sets us up for growth in 2008," President and CEO David C. Novak said.

Yum has done exceptionally well in China, where most consumers think of KFC when they think of chicken. But now the company is planning to expand further into India, which hasn’t proven to be a successful market for rival McDonald’s, whose cash flows finally broke even in 2007, 17 years after opening it’s first Indian locations.

Yum plans to open several Taco Bell locations in India in the latter half of 2008. India’s Economic Times reported that Yum, which already has KFC and Pizza Hut locations in India, plans to double its revenues from India in the next three years, with most of this growth coming from Taco Bell.

Yum also has been pushing to increase domestic sales by revamping U.S. menus, increasing breakfast options, and reducing company ownership through a re-franchising program of its KFC and Pizza Hut brands, The Associated Press reported. And it looks like that hard work is starting to pay off.

UBS AG (UBS) recently upgraded Yum shares to a "Buy" from "Neutral." In a note to clients, analyst David Palmer said that "while some investors have expressed concerns that the U.S. re-franchising appeared to slow versus company guidance in 2007, we expect to see that trend reverse in 2008 and 2009."

"We believe the end result for Yum will be a faster-growing, more-international, higher-return company by 2010 – with 40% or more of its enterprise value coming from its rapidly growing China business," Palmer added.

Rounding Out the Pack

Burger King Holdings Inc. (BKC) and Wendy’s International (WEN) are the No. 2 and No. 3 American hamburger chains behind McDonald’s.

Burger King has more than 11,000 locations in 69 countries and Wendy’s boasts more than 6,500 locations in 20 countries and territories. While neither fast food firm has made the big push into the foreign markets that larger rivals McDonald’s and Yum have engineered, the two junior partners are facing the same domestic challenges – soaring prices and rising labor costs.

Despite these setbacks, Burger King has been able to post strong same-store domestic sales gains. For the quarter-ended Dec. 31, the firm’s second fiscal quarter of 2007, Miami-based Burger King reported $49 million in net income, up from $38 million in the first quarter.

Total revenue increased 10% to reach $613 million on the strength of a 4.5% sales increase in stores open at least a year in the United States and Canada, a sharp contrast to the declining domestic results posted by McDonald’s and Yum. And the company’s outlook for the rest of the fiscal year is strong.

"The momentum is expected to remain throughout the second half of the year as we continue to promote our value menu and premium products, satisfying both cost-conscious consumers and guests seeking indulgence," CEO John Chidsey said.

Wendy’s outlook, however, isn’t quite so bullish. The hamburger chain that is known for using fresh meat – never frozen – has been under increasing pressure from key investor Nelson Peltz to either boost profits or expect a takeover.

Peltz, non-executive chairman of holding company Triarc Companies Inc. (TRY), owns the Arby’s restaurant chain and has offered to add Wendy’s to his holdings.  Peltz already controls about 9.8% of Wendy’s outstanding shares and has made moves to try to take over the board of directors and remove Chief Executive Officer Kerrii B. Anderson. 

The company has struggled to find a successful advertising campaign since the death of founder Dave Thomas in 2002, but executives hope that a menu overhaul will supercharge customer traffic, which has been in decline for the past five years.

 "We have to grow the top line," Anderson told Reuters in an interview at the company’s headquarters, referring to sales. "We are very focused on driving traffic."

With the current board in turmoil and pressure from Peltz, Anderson can’t embark upon an aggressive international expansion initiative or a domestic re-franchising strategy right now. However, the company does plan to make some menu changes, including introducing a spicy version of the popular Baconator sandwich to appeal to men, while offering value-priced chicken wraps to appeal to female customers.

News and Related Story Links:

• Reuters:
  McDonald’s U.S. sales rebound

• The Economic Times:
  Yum! Taco Bell to tickle Indian taste buds

• MarketWatch:
  Burger King profit up on same-store sales growth

• Reuters:
  Peltz to seek control of Wendy’s board

• Reuters:
  Wendy’s CEO hopes new items will spur sales

• Forbes:
  Yum Brands Move Higher on Stock Upgrade

Global Titan Yum! Brands Inc. (YUM) will buy back another $1.25 billion of its stock over the next 12 months, the latest part of a $4 billion stock repurchase plan announced last October.

Yum Brands operates the Taco Bell, KFC and Pizza Hut casual-dining restaurant chains.
The company said this authorization, which lasts over the next 12 months, is part of its overall plan to buy back a total of up to $4 billion in stock over a two-year period.

As of late last week, Yum said there was about $450 million left under the prior authorization.

Since Yum began its repurchase program in 1999, it has bought back about 250 million shares for about $5.4 billion at an average price of $21.73 per share through Jan. 23, according to a report by CNNMoney.com.

The company said its regular share-repurchase program has reduced average diluted share count by 9% over the past two years.

Yum had about 508.6 million shares outstanding as of Oct. 15.

As so-called "Global Titans," companies such as Yum Brands combine the safety of the U.S. financial system [with its transparency, regulatory oversight and detailed financial reporting], with the long-term growth promise of emerging Asia and Europe. For that reason, Yum and firms such as PepsiCo Inc. (PEP), MGM Mirage (MGM), The Coca-Cola Co. (KO), General Electric Co. (GE), and The Boeing Co. (BA) are "best-of-both-worlds" investment.

When it reported its third-quarter profits back in October, the Louisville-based Yum boosted its profit growth projections for the entire year from 12% to 13%. When a company has to raise earnings projections, that’s usually a bullish sign. And it’s even better when a company says it’s using the flush times to buy back its own stock. When the company announced those earnings, it said it would buy back the $4 billion worth of its shares, a move that would reduce its outstanding stock by a hefty 20%.

Yum also said it was adding new debt, using borrowed funds to help fund the buyback.

Research studies have demonstrated time and again that companies that buy back shares, as a group, tend to outperform the broader market. And adding some debt can actually be good for a company, creating what’s known as an "optimal capital structure." That means the company’s mix of stock and debt has enabled the company to achieve the lowest possible average cost of capital needed to fuel growth.

When a company buys back stock, its profits are apportioned across fewer shares, meaning it experiences earnings per share growth even if its actual profits don’t increase. But when a company is building profits as Yum Brands is doing through organic growth – and is also buying back shares at the same time – the impact on earnings per share growth can be both remarkable and substantial.

And that usually bodes very well for the company’s stock price, too.

The China Factor

For the third quarter alone, Yum Brand’s China Division – which includes mainland China, Thailand and KFC Taiwan – operating profit rose a stunning 28% to $135 million. At the international division, which excludes China, operating profit rose 21% to $127 million. U.S. operating profit rose 1% to $187 million, but profit margin at company restaurants fell because of higher labor and dairy (cheese) costs.

For the year, sales in China soared 26%. International sales advanced 9%, and U.S. sales skidded 6%.

But the company is revamping its U.S. operations, including its menu offerings. And its overseas growth potential is massive.

Here’s an interesting trivia question: What fast-food company is the world leader in terms of total restaurant outlets? Did you guess McDonald’s Corp. (MCD)?

Close, but no cigar… McDonald’s has 31,045. But Yum beats that easily, boasting 34,000 global locations – including 20,000 in the United States market.

The message is clear: There’s still plenty of untapped growth potential abroad. Yum executives actually see the day when the restaurant firm has 20,000 locations in China alone.

And that means the overseas growth potential is huge, especially in China. [As we've noted in other articles, Yum's management is shrewdly adapting its menu and service to each market. Pizza Hut caters to "tea time" in China, restaurants offer favorite local desserts and even serve smaller portions.]

In China, when consumers think of chicken, they think of KFC. When they think of Mexican food, they think of Taco Bell. And when they think of pizza, Pizza Hut springs to mind. KFC is one of the most popular restaurant destinations in all of China.

According to recent reports in food-industry trade journals, Yum says it will open at least 425 new restaurants in mainland China, during the next several years. The move includes 310 KFCs, 85 Pizza Hut "casual dining" restaurants, 20 Pizza Hut "Home Service" restaurants, and 10 East Dawning restaurants.

On the international level, the company has plans to open at least 750 new restaurant sites overall. Those plans include 450 new KFCs, 250 new Pizza Huts and about 15 Taco Bells in at least 50 countries around the world.

The company also says there will be U.S.-market changes, too. Yum will expand its U.S. "re-franchising" efforts by reducing company ownership from its current 20% of the restaurants to potentially less than 10% by the end of 2010.

In a report earlier this month, Standard & Poor’s Corp. analysts said they "continue to see further gains for Yum shares in 2008, following a 30% increase in 2007."

S&P says it is raising its earnings estimate for this year by another nickel a share to $1.95, citing the decline in the dollar versus China’s yuan as a key reason.

S&P’s target price for Yum: $45. From Friday’s closing price of $36.24, that would represent an investment gain of 24% – and that’s even before factoring in Yum’s dividend yield of 1.7%.

The shares are trading at 18.8 times projected earnings. That compares favorably with 16 times for McDonald’s, especially given Yum’s more-favorable global-growth potential.

If these two stocks were valued like peer global-growth companies, both companies would see their share prices experience a significant advance.

We’ve written a lot about U.S.-based Global Titans that are positioned to benefit from China’s substantial long-term growth. If you want a mini-portfolio of U.S. firms that will benefit from China, buy shares of Pepsi, Coke, McDonald’s, MGM, GE, Boeing and Yum Brands.

News and Related Story Links:

• Money Morning Investment Research Report:
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• Dow Jones News Service:
  Yum Brands OKs Additional Share Buyback

• Pork Magazine:
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• Business Week Magazine:
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McDonald’s Corp. (NYSE:MCD) announced plans to invest $76.44 million (3 billion rupees) over the course of the next three to five years in efforts to triple its India operations.

The first phase of its plan is to ramp up its presence in cities and major airports in Delhi, Mumbai, Kolkata and Chennai. All totaled, McDonald’s has 123 restaurants in India.

The elephant in the room here is obviously the cow, the animal that McDonald’s built its empire on, but not a popular source of meat in India. To fight this, McDonald’s fuses its India menu with local flavors – McCurry Pan, Pizza McPuff (basically a Hot Pocket), and India’s Big Mac, the Chicken Maharaja Mac – a strategy shared by its other international restaurants. [Want to check out the 'full menu' of McDonald's India? Just click here.]

And this represents a major difference between expanding restaurant operations in India, versus China. One can say this is McDonald’s way of striking first in India because, judging by the menus, the upper hand would go to Yum! Brands Inc. (YUM), owner of KFC, Pizza Hut and Taco Bell. In fact, it has been going toe-to-toe with Domino’s in India for nearly a decade.

It might seem easier for Yum! to carry its success over to India because it doesn’t have to substitute its core products out of the menu. And its success in China could give the company some much-needed momentum. Yum’s better-than-expected third quarter earnings were attributed to international growth. The same factors favor PepsiCo. Inc. (PEP), which reported a 17% gain in third-quarter net income.

It’s also worth mentioning that McDonald’s India operation is a 50-50 joint venture partnership between McDonald’s and two Indian businessmen. Amit Jatia’s Hardcastle Restaurants Pvt. Ltd. owns and operates McDonald’s restaurants in Western India. Vikram Bakshi’s Connaught Plaza Restaurants Pvt. Ltd owns and operates the Northern operations.

McDonald’s might have an earlier start in the race to feed India’s growth, but its successes (or failures) won’t make as large as a mark on its overall earnings as a company fully vested in overseas growth.

That said, McDonald’s is doing great earnings-wise. The company is expected to post big third-quarter earnings on Friday morning. Last week, as the company posted its September sales, it said that total sales were up 12% and predicted earnings-per-share of 89 cents, up from EPS of 68 cents in 2006.

The company also announced last month that it plans to increase its already beefy dividend by 50%, and more may be on the way. Overall, the company’s stock is up more than 34% in the past year.

News and Related Story Links:

• Fortune:
  India’s Pizza Wars.

• Money Morning:
  Yum Brands Shares Soar For Second Day on China-Fueled Earnings Surprise.

• Money Morning:
  Pepsi’s Stellar 3Q Gains Fueled By International Growth and Falling Dollar.

• MarketWatch:
  Expect another red-hot quarter from McDonald’s.

• Money Morning News:
  Deutsche Bank Boosts YUM Brands Target Price to $43.

• Money Morning Investment Analysis:
  How to Profit on an Earnings Surprise From China’s Rise.

• Money Morning Investment Analysis:
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• Money Morning Investment Analysis:
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• McDonald’s India:
  Full Menu.