Yum! Brands (YUM, Financial) recently posted its third quarter earnings, which was a mixed bag as revenue was considerably down while earnings were just able to meet analyst estimates by a notch. Investors around the globe are concerned with the company’s future prospects as its sales in China are facing headwinds that can ruin the company’s financials, going ahead. The management have taken a cautious stand and have essentially cut the fourth-quarter guidance, disappointing investors all the way. Let’s dive in to find out whether Yum Brands remains a safe investing option after the China crisis, but before that a summary of the third quarter results for the readers is essential. So, here it is.
Third-quarter synopsis
Yum! posted third quarter sales of $3.35 billion, a 3.2% decline compared to the last year. It was below analysts’ expectation of $3.48 billion. The company’s revenue saw a drop due to the softness witnessed in the results from its Chinese operations. The reported 3.2% decline in sales results from weak company sales that were down by 4.3% to $2.89 billion. As Yum! is incredibly dependent on China for nearly 55% of its total revenue, improvement of operating earnings in the country is vital for posting solid growth in the near future.
Earnings on a GAAP basis jumped from just $152 million last year to $404 million, resulting in diluted earnings of $0.89 per share. Adjusted earnings totaled around $0.87 a share, which marked a two-cent increase versus last year. Reported earnings were slightly better than anticipated, with analysts predicting earnings to be down by a penny. Earnings ended on an optimistic note as the effective tax rate was down significantly to 22.7% of earnings before tax, quite a bit below the 57.2% rate reported in the similar quarter last year.
While the company kept a lid on its operating expenses, the operating earnings took a hit as the company was charged around $300 million as closure and impairment charges last year. This has led to adjusted operating earnings to be down from $650 million reported in the similar quarter last year to $550 million in this fiscal quarter.
Looking into China’s fortunes
The shortfall in the revenue is obviously driven by China which has shown lackluster sales after the food scandal that took place this summer. This was followed by the improper handling of food at supplier OSI, for which the company severed all ties with the supplier, but it had a drastic effect on the sales chart for Yum!
Total sales from China were down by 9.5% to $1.84 billion compared to last year. Growth was chiefly aided by new store openings as comparable store sales were down a whopping 14%. The company opened 175 stores in China during the quarter, increasing its total restaurant count to 6,419 with growth tailored to mainly Pizza Hut store openings.
While Yum! was able to reduce overall costs in China by 3.5%, profits took a beating with operating earnings down 40% to $202 million. Taking such disappointing developments in China into account seems to be continuing for the long term, the top brass have lowered their full-year guidance, now forecasting earnings to increase by 6% to 10% compared to last year.
The cut in the annual earnings per share growth guidance reflects that the fourth quarter adjusted earnings could be anywhere between $0.72 and $0.84 per share, much lower than $0.87 expected by analysts. This does not bode well for a company like Yum! that has been competing with rivals like McDonald’s (MCD, Financial) to keep its sales growing at a steady pace.
Cash position and dividend pay-out remain strong
At the end of the quarter, Yum! held around $1.01 billion in cash, equivalents and other short-term investments while having some $3.39 billion in debt being apparent on the balance sheet. This debt position seems to be huge compared to the cash available at the end of the quarter, but this debt is manageable given the positive earnings and the reported EBITDA of around $3 billion on an annual basis.
The company has also managed to double its earnings towards $1.5 billion on an adjusted annual basis while having repurchased little over a quarter of its total outstanding share base which stands currently at 443 million outstanding shares.
While China is in troubled waters, the dividend yield of 2.3% seems sustainable, and the company has fueled shareholder returns with shares that have steadily risen from levels around $25 in 2005 to current levels of around $70.
Final word
Investors should keep in mind that, despite the trouble lingering in China, Yum! stock did hit a high of $83 a share earlier this year. This was, however, before the food scandal hit the Chinese market dynamics of Yum! But the management remains optimistic while taking a cautious note of the slowdown in China.
CEO David Novak remains upbeat about the long-term future, anticipating solid growth in top and bottom line in the upcoming fiscal year, irrespective of China’s woes. Yum!’s brand strength is expected to become better in China by early 2015. Though the company’s dividend pay-out still remains pretty appealing, investors’ should remain cautious with respect to their positions in the stock. But they should hold the shares, at least for some time, to find out if the stock can again get back to an all-time high within the next six to nine months timeline.
