YUM! Brands Inc. (YUM, Financial) operates quick service restaurants in the U.S. and internationally. The company's largest competitors include Burger King, Subway and McDonald's Corp. (MCD). Turning our attention to the future direction of the stock, let's take a look at the intrinsic value of this company and try to explain to investors the reasons why it is a good buy or not.
Valuation
In stock valuation models, dividend discount models (DDM) define cash flow as the dividends to be received by the shareholders. Extending the period indefinitely, the fundamental value of the stock is the present value of an infinite stream of dividends, using the John Burr Williams´ original DDM formula:
Let´s estimate the inputs for modeling:
- Required Rate of Return (r)
The capital asset pricing model (CAPM) estimates the required return on equity using the following formula: required return on stock j = risk-free rate + beta of j x equity risk premium.
Assumptions
- Risk-Free Rate: Rate of return on LT Government Debt: RF = 2.67%
- Beta: β =0.68
- GGM equity risk premium = (1-year forecasted dividend yield on market index) +(consensus long-term earnings growth rate) – (long-term government bond yield) = 2.13% + 11.97% - 2.67% = 11.43%[1]
rCAT = RF + βCAT [GGM ERP]
= 2.67% + 0.68 [11.43%]
= 10.44%
- Dividend growth rate (g)
The sustainable growth rate is the rate at which earnings and dividends can grow indefinitely assuming that the firm´s debt-to-equity ratio is unchanged and it doesn´t issue new equity.
g = b x ROE
b = retention rate
ROE can be estimated using Dupont formula:
The growth rates are:
| Year | Value | g(t) |
| 1 | g(1) | 47,73% |
| 2 | g(2) | 37,89% |
| 3 | g(3) | 28,04% |
| 4 | g(4) | 18,20% |
| 5 | g(5) | 8,36% |
G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).
- Calculation of Intrinsic Value
| Year | Concept | Amount | Present value |
| 0 | Div 0 | 1,41 | Â |
| 1 | Div 1 | 2,08 | 1,89 |
| 2 | Div 2 | 2,87 | 2,35 |
| 3 | Div 3 | 3,68 | 2,73 |
| 4 | Div 4 | 4,35 | 2,92 |
| 5 | Div 5 | 4,71 | 2,87 |
| 5 | Terminal Value | 244,57 | 148,84 |
| Intrinsic value | Â | Â | 161,60 |
| Current share price | Â | Â | 73,21 |
Final Comment
When the stock price is lower than the intrinsic value, the stock is said to be undervalued and it makes sense to buy the stock. I would advise fundamental investors to consider adding this stock according to our estimations.
The Hedge fund Manning & Napier Advisors Inc added the stock and holds 3,310,016 shares.
Disclosure: Victor Selva holds no position in any stocks mentioned.
[1] These values were obtain from Bloomberg´s CRP function.
