SBUX vs. YUM: Which Stock is Poised for Better Q3 Earnings?

We are in the thick of the Q3 earnings season with results seemingly on solid ground given the positive momentum on the revenue front. Apart from maintaining the above-average proportion of positive earnings surprises, the estimate revision trend for the December quarter is quite palpable.

According to our latest Earnings Preview, 64.2% of the total market capitalization of S&P 500 is already out. As of Oct 27, 2017, total earnings for the 272 S&P 500 members are up 8.7% year over year on 6.7% higher revenues. Of these, 75.7% surpassed earnings estimates, while 66.2% beat revenue expectations.

A Look at the Restaurant Industry

We note that the performance of the restaurant industry, under the broader Retail-Wholesale sector, has been mixed so far this earnings season. Among the restaurant stocks that have reported, Domino’s Pizza Inc. DPZ posted robust results, beating earnings and revenue estimates.

McDonald’s Corporation MCD posted mixed third-quarter 2017 results. While earnings surpassed the Zacks Consensus Estimate, revenues fell short of the same. However, Chipotle Mexican Grill, Inc. CMG lagged on both fronts.

Soft consumer spending environment in the U.S. restaurant space along with rising costs continue to haunt restaurant chains. Also, the recent hurricanes seem to have negatively impacted results of a number of restaurant companies this earnings season, which includes the likes of BJ’s Restaurants, Inc. BJRI that reported lower-than-expected results in third-quarter fiscal 2017.

Nonetheless, innovative operators with strong fundamentals are continuing to exhibit strength even in a not-so-favorable environment.

Let’s have a sneak peek at two major restaurant stocks scheduled to report earnings tomorrow to see how things are shaping before the announcement.

Starbucks Corporation SBUX is set to report fourth-quarter fiscal 2017 results.

We expect Starbucks’ revenues to increase on the back of an addition of new restaurants and positive global comparable store sales or simply comps growth. Starbucks also projected global comps growth at 3-4% for the quarter. Comps in the fiscal fourth quarter are likely to be driven by significant menu innovations like new and improved Bistro Boxes, Seared Steak and Egg Wrap.

Starbucks’ digital offering, Mobile Order and Pay, is also witnessing increased usage and could prove to be a key growth driver in the to-be-reported quarter as well as in 2017. Again, growth in Starbucks reward members is expected to contribute to its revenue growth in the to-be-reported quarter.

The company had earlier revealed that it expects stronger revenue growth in the second half of the fiscal year, driven by mid-single digit comps including accelerating comps in the United States. Overall, for the fiscal fourth quarter, the Zacks Consensus Estimate for revenues stands at $5.73 billion, implying 0.4% year-over-year growth.

With respect to the company’s bottom line, Starbucks’ EPS is likely to witness a decline in the third quarter due to a rise in cost of sales and higher goodwill and other asset impairment expenses for the closing of 379 Teavana stores. Hence, despite a revenue-growth expectation, the coffee giant’s margins are likely to narrow due to higher cost of sales as a result of commodity inflation. These headwinds, however, are likely to be offset by lower general and administrative (G&A) expenses.

That said, a challenging environment in the United States restaurant space might be a cause for concern for investors in the near term.

For the fiscal fourth quarter, the Zacks Consensus Estimate for earnings is pegged at 55 cents a share, reflecting a decrease of 2.5% year over year.

Meanwhile, our proven model does not conclusively show that Starbucks is likely to beat earnings this quarter as it does not possess the key components.

For the impending quarter, the company has an Earnings ESP of -0.08%. Starbucks currently has Zacks Rank #3 (Hold), making an earnings prediction uncertain. A stock needs to have both a positive Earnings ESP and a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 for a likely earnings beat. You can see the complete list of today’s Zacks #1 Rank stocks here.

(Read: Will Higher Costs Impact Starbucks' Q4 Earnings?)

Yum! Brands, Inc. YUM is scheduled to report third-quarter 2017 numbers before the opening bell.

Post China business separation, Yum! Brands endeavors to drive growth by employing greater focus on the development of its three iconic global brands, increasing its franchise ownership, and creating a leaner and more efficient cost structure bodes well. This, in turn, is likely to bolster third-quarter results.

Particularly, augmented pace of unit development along with increased investments in technology-driven initiatives is anticipated to somewhat drive top-line growth in the quarter.

Coming to the Pizza Hut brand, while the international division might continue doing well, Pizza Hut U.S. is expected to post soft results for the quarter despite numerous strategic efforts similar to the last few quarters. Notably, a soft consumer-spending environment in the U.S. restaurant space is likely to continue restricting revenue growth.

Meanwhile, KFC’s efforts to revamp outlets, focus on its operational excellence, delivery services, innovation and convenience, are expected to continue boosting comps.

However, Yum! Brands is likely to witness a decline in company sales due to the impact of its strategic refranchising initiative, which, in turn, will lower the company’s revenues in the third quarter. A slowdown in emerging markets is likely to further hamper the quarter’s performance.

Overall, the Zacks Consensus Estimate for third-quarter earnings of 66 cents implies a year-over-year decline of 39.5%. The same for revenues is pegged at $1.39 billion, 58.2% lower than the prior-year quarter figure.

Meanwhile, our proven model does not conclusively show that Yum! Brands is likely to beat earnings this quarter as it does not possess the key components. For the impending quarter, the company has an Earnings ESP of -1.37%. The company currently has Zacks Rank #3, making an earnings prediction uncertain. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

(Read: What's in the Cards for Yum! Brands in Q3 Earnings?)

Our Take

Earnings beat for both the companies remain uncertain. Starbucks and Yum! Brands have delivered positive surprises in the trailing four quarters. However, Yum! Brands’ average beat of 7.01% steers past Starbucks’ level of 0.46%.

From the sales growth perspective, Starbucks is well positioned to report better quarterly results.

Meanwhile, both the companies are expected to report a decline in earnings. However, Yum! Brands’ rate of decline of earnings is more than the Starbucks’ (-39.5% Vs. -2.5%).

Stay tuned! Check back on our full write-up on earnings releases of these stocks.

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