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Don’t Dunk into Yum! Yet

October 14, 2013 | About:
Strong insider activity has been registered at Yum! Brands (YUM) lately. Several people related to the company have purchased its stock following the third quarter earnings call, which took place last week. The acquisitions also coincided with the announcement of a quarterly dividend, scheduled for Friday, Nov. 1 (applicable to investors of record on Friday, Oct. 11). The company will yield about 2% of the current stock price, rewarding those who bet on the company.

However, Oct. 11 is already past and thus, new stockholders will not receive the upcoming dividend. So, is Yum still a worthy investment for the long term? Are these insider purchases worth following? Or are there better choices in the restaurant industry?

International Expansion Is Key

Yum is the world´s largest restaurant company and, as such, has attracted many investors over the years. However, the business´ last quarterly results have failed to meet its expectations. Yum missed revenues and earnings consensus estimates last quarter, mainly due to weak results in China and a tax increase. Nevertheless, these problems should only impact on short-term results, as they can be mostly attributed to macro-related issues. So, one question remains: What about the long-term?

Yum´s exposure to international markets, especially emerging economies, where penetration is low and consumers´ discretionary spending power continues to rise, provides it with plenty of growth opportunities. Furthermore, increasing urban population should drive results even further.

Holding some of the strongest brand names in the world, like KFC, Pizza Hut and Taco Bell, and a good level of international presence, analysts calculate that 50,000 Yum locations are possible by 2020 (Morningstar). This would mean an increase in its store base of more than 25% over the next six years. Nevertheless, growth projections are substantially more conservative among other analysts. Consensus estimates point towards average annual EPS growth rates around 11% for the next five years.

Although analysts cannot reach an agreement with respect to Yum´s prospects, one thing is for sure: In terms of valuation, the company looks quite attractive. Trading at 21.9 times its earnings, it carries a 7% discount to the industry average.

In addition, U.S. segments are rebounding slowly, while a refranchising strategy increasingly safeguards Yum's earnings.

Size Is Not Everything

Dunkin Brands (DNKN) is not nearly as big as Yum is (its market cap is about one-sixth that of Yum’s), but its prospects are still very interesting. As Morningstar analysts clearly put it, “Dunkin' Brands offers investors one of the more compelling domestic and international growth stories in consumer cyclicals with an exceptionally strong free cash flow profile. We've awarded it a narrow economic moat rating because of its intangible asset in the form of the Dunkin' Donuts brand and a cohesive franchisee system, particularly in the Northeastern U.S.”

The company’s strong brand equity should help it expand in the U.S. going forward, as there are plenty of underpenetrated areas and a highly fragmented market to capture. Furthermore, the improvement of franchisee returns over the last few years bodes very well for Dunkin’s future. With cash-on-cash returns running at 25% to 30%, store base expansion should not be an issue for a decade, at least.

Outside the U.S., Dunkin’s situation also looks quite promising. Holding the fourth-largest overseas restaurant business, behind Yum, McDonald's (MCD), and Subway, but ahead of Starbucks (SBUX), expansion potential in emerging markets abounds, and its brand name recognition should certainly help it achieve this goal.

Although its valuation at 39 times its earnings makes the stock slightly less attractive, its industry-leading margins, above 40%, make up for it. Moreover, Dunkin faces better growth projections than Yum analysts expect Dunkin to deliver average annual EPS growth rates around 16% over the next five years. Finally, a 1.66% dividend yield makes the deal even sweeter.

What About Returns?

One efficient way to compare both firms would be looking at their returns on equity. While Yum offers a 65.4% return on equity, more than double its peers´ mean, Dunkin only boasts 23.2%. Although this wide difference should concern Dunkin investors, I still believe that the company offers compelling growth prospects, based on an asset-light model and plenty of expansion opportunities, both domestically and internationally.

Just like me, Jim Simons seems to be placing his bets on Dunkin, as he has reduced his participation at Yum substantially over the last few months, while increasing his stake at Dunkin. In addition, other big investors like Steven Cohen’s SAC Capital Advisors, are also betting strong on the company, and have already perceived plenty of stock price upside.

Disclosure: Damian Illia holds no position in any stocks mentioned.

About the author:

Damian Illia
A fundamental analyst at Lonetreeanalytics.com constantly looking for value and income investments.

Visit Damian Illia's Website


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