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Yummy Yum? A Stock on the Watch

February 27, 2014 | About:

Yum! Brands (YUM) is one of the largest global quick-service restaurant companies, and includes the brands KFC with 18,400 units, Pizza Hut with 13,000 and Taco Bell with 5,600. Yum operates in several countries, and continues to expand with a staggering rate of five new restaurants per day. It is expected to open 1,850 more restaurants during 2014 and spend over $1.2 billion as capital expenditures. China has been a key player in the company’s growth story, and Yum has indeed a strategic focus on the country, but the Indian market is also being boosted.

This food giant is expected to generate $43 billion in system sales in 2013 and $2.2 in operating profit before corporate expenses. Still, the company’s top-line was missed due to lower same-store sales at both U.S. and China divisions. Yum Brands will indeed have to face some setbacks and overcome the difficulties this industry always poses, but still the company with its intangible assets is one of the more compelling global growth opportunities.

Chinese Hustle

Being the Chinese market crucial for the company’s growth, the negative publicity during 2012 regarding the quality of chicken supplied to KFC in China affected Yum’s top line during 2013. Despite the management’s expectations of double earnings growth for 2014, the Chicken-China hustle is not completely over and may loom large during this year.

The recent fourth quarter had a mixed performance for Yum, as the revenues were short but the EPS of $0.86 beat analysts’ estimates. During 2013 the firm's consolidated revenue decreased by 4%, partly due to Yum’s international division, which had a negative revenue growth of 6%.

The Chines market, caught in the middle of this hustle regarding the safety of the KFC poultry suppliers, had negative impact in growth. The Chinese market is indeed these days one of the most promising expansion areas for restaurant and quick-service firms such as Yum’s, but the concern about the safety of food is growing every day in this country. This challenge will have to be faced by all the companies that decide to bet on this emerging market.

In order to clear the image of KFC’s food safety, CEO David C. Novak announced the Operation Thunder, which consists in strengthening its supply chain and regulating food safety. Yum competes toe-to-toe with McDonald's (MCD) at the eastern markets, making it crucial for the firm to protect its brand image from erosion. Approximately 40% of total operating profits come from the China division, thus Yum is more sensitive to fluctuations in the region than its peers.

Petit Café Brings Big Competition

At home competition is also intense. Not only does the firm have to compete with biggies such as McDonald's, but also face the increasing competition from fast-casual restaurants, which promote healthier food and provide a more warm experience. The customer traffic has grown very little in the past years for traditional quick-service restaurant firms, while fast-casual restaurants such as Chipotle Mexican (CMG) or Panera Bread (PNRA) are increasing their revenue growth almost every day.

The U.S. quick-service restaurant industry is mature, and players will increasingly fight each other for market share. Yum will have to deal with an uneven spending environment, aggravated by wage inflation and volatile commodity costs. Although the company did under-perform the past fourth quarter, the EPS is expected to increase 20% during 2014, and is determined to turn around their performance during 2013.

Yum! Brands Is in the Game

The firm still has growing markets to explore, and will keep up with its international expansion strategy during the next years. Nevertheless, Yum will have to take extra care of its brands’ image, as healthier food is definitely not falling off the menu.

Some analysts think the strong bet Yum is putting on the Chinese market should be regarded with caution, as its economy might be slowing on the near-term. Also, the quick-service restaurant industry is pushing forward with its competition, which implies switching to customers' preferences.

Despite those bearish statements, other analysts stand on the opposite side of the road, and hold that the expectancy of growth for the China division and other emerging markets is pretty high. Average unit sales of $1.7 million in China actually surpass most other restaurant chains in the region. The population is growing, and the consumers’ solvency is increasing as well, with 50,000 Yum locations possible by 2020.

Bottom Line

Yum Brands has been consistently enhancing shareholders return, with a 50.5 ROE. Dividends have increased every year since 2004, and each annual increase has been at a double-digit percentage rate. EPS of $0.86 beat the Zacks Consensus Estimate of $0.80, and in the fourth quarter, total revenue nudged up 1% year over year to $4.18 billion. Nevertheless, quarterly revenues weren’t has high as expected.

Yum indeed has promising expansion plans for emerging markets, but it will need to strengthen its position through a marketing strategy and meet the market’s requirements. The U.S. division, meanwhile, has a strong position among consumers, but will have to face many problems including the depressed customer spending and intense competition. The company’s performance during 2014 might reveal whether Yum overcomes the setbacks of the industry and changing consumers’ preferences with a new position, or still deals with the new problems the old way.

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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