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Yum! Brands Has Superb Management and Growth Stories
Posted by: Federico Flom (IP Logged)
Date: December 9, 2011 01:45PM
Yum! Brands Inc, a Kentucky-based company, is a firm that owns, operates and franchises more than 37,000 food concepts including KFC, Pizza Hut and Taco Bell.
Yum! is present in more than 100 countries with these brands and offers consumers more choice and convenience. This multi-branding company includes three segments:
United States, the China Division, consisting only of mainland China, and Yum Restaurants International (YRI).
Internationally speaking, markets comprise Asia (excluding mainland China), Australia, Continental Europe, Latin America, Middle East, France, Russia, India and the UK.
Yum! is present almost everywhere and there are a few reasons worth pointing out about why it is an interesting pick:
· The China division offers spectacular growth potential in its two leading brands, KFC and Pizza Hut. A 15% growth is expected from this segment in the next five years according to the last YUM investors conference. Yum! has more than 97% of its restaurants in China under near-record operational performance.
· Yum! is expecting to attract an emerging middle-class in China. The deal with Little Group Limited to purchase the Chinese chain of hot pot restaurants will leverage its presence in the country.
· Apart from China, the company is looking for opportunities in other markets such as India, Russia, France and Africa.
· 75% of its operating profit will be coming from China by 2015.
· It has a key growth driver: overseas expansion in emerging economies.That driver will continue for many years because emerging markets growth is a secular story.
· Yum! has restarted with its franchising program. This is based on a de-risking strategy it is putting in place to provide low-risk opportunities to boost returns.
· The company is very interested in enhancing shareholders' return. Actually, its target involves a dividend payout ratio of 35% on average.
· Unique and capable management with proven experience in China and other emerging markets economies.
Sara Senatore, restaurant industry analyst with Bernstein Research says, “Yum reflects its intent to be the leading brand in every significant category among restaurants in China and across the world with its expansion program.”
Of course, every move has its risks and Yum is not unfamiliar with them.
One of the major risks that may challenge Yum is the increase in food costs, thus bringing general commodity inflation.
Although management has acknowledged that the YRI division may not suffer from this rise due to the fact that it is mostly franchised, margins will still be under pressure.
Another risk that Yum is prepared to face is high wage inflation in China and a decrease in U.S. sales. Furthermore, many of the brands will suffer a decline in sales, even Taco Bell, the most profitable one. In this case in particular, Taco Bell has been affected by a lawsuit brought on the content and quality of beef products. Although the plaintiff voluntarily dismissed the allegation, consumers may have a negative perception of the brand.
The periods to come will be hard, but nothing beyond Yum's control. Actually, last quarter’s results clearly show that Yum can handle this.
In terms of sales, they increased by 29% in Yum Restaurants International in China and 13% in the other emerging markets, particularly in Russia.
Taco Bell has recovered from the negative view it has had with the publicity issues, although management has recorded a store sale decline of 2%. Something similar has happened with Pizza Hut and KFC U.S., where sales contracted 3%.
Management considers that it needs to implement more aggressive measures to put the company on the right path in the U.S..
As it has been mentioned before, Yum is likely to face food cost increases next year, thus putting pressure on operating margins. Nevertheless, its presence in emerging market economies will surely enable Yum to achieve high-teens operating margins over the next decade.
Management is extremely focused on how Yum will perform in the years to come, particularly considering all the efforts and improvements it has achieved to date. David Novak, CEO and chairman of Yum has always had growth and profitability as the company’s cornerstone.
The advantage is that he knows the company very well. Indeed he has been involved since 1997.
Speaking about management in general, senior executives and board members collectively only own 3% of the fully diluted outstanding shares. This is sufficient to match their interests with those of shareholders.
An interesting tip about management is that it has adopted several shareholder-friendly stewardship practices in the past years.
Generally speaking, I consider YUM fair value estimate is $57 per share, which represents P/E multiple of 17 times, value/EBITDA of 11 times and free cash flow yield of 5%. YUM is not cheap on a valuation perspective but if markets deteriorate from the European situation and emerging markets sell-off, the stock could offer attractive entry levels between the 50-48 level.
Despite the macro inflation headwinds and the fact that management foresees a slowing growth if emerging markets economies decelerate, Yum is in sound financial shape. Furthermore, with the refranchising efforts in the U.S. and the expansion strategy in China, operating margins will improve to nearly 18% which will allow for improving operational results in the medium term.
These are the current Guru holdings:
It seems that almost every Guru thought that YUM trading in the mid/high 50s is not cheap if I guide from the evidence that Steve Mandel, Mason Hawkins and Ruane Cunniff reduced their YUM position in the last quarter. Other Gurus did that too in the Second Quarter, for example, George Soros and Andreas Halvorsen sold all their positions in the quarter ended in 06/30/2011.
The Yum! story is very interesting and I will add to my positions if the stock corrects to the low $50s, as it did some months ago. As Buffett always says, it is important what you buy and the price you pay. Both quality and good price must be in tandem.