China is a massively important markets for most food chains because of the immense potential it offers in terms of revenue growth. Yum! Brands (YUM, Financial), the iconic company behind big names like Taco Bell and KFC, might be understanding the significance of this market as the stock fell the most in five months after the company cut its profit forecast for 2014, hurt by health scare in China. Some analysts have categorized this decline as a lucrative buying opportunity and as such, it is wise to check if the stock has potential to deliver gains for investors.
Recently, Yum! Brands downgraded its full-year guidance for earnings-per share growth to mid-single digits from 6 to 10 percent estimate. Additionally, the company said that the same-store sales would be negative in China amid fallout from safety issues with a meat supplier. This tainted meat scare did not only hamper Yum’s prospects but also disrupted McDonald’s (MCD, Financial) business to a reasonable extent. McDonald’s has already encountered sizeable decline in its share price over the past months but Yum! Brands traded steadily as it convinced investors of a rebound. Alas, it seems that Yum! might have been propagating an erroneous picture.
Working to resolve the crisis
After this incident, both McDonald’s and Yum! immediately severed ties with the supplier in an effort to minimize the damage to its brand. In addition, the company has employed aggressive marketing measures to restore confidence in the brand. One of these measures include redesigning of stores to offer a rich dining experience. This measure has also been adopted by rival McDonald’s in order to improve its brand perception as well. However, the updated guidance from the company has made it clear that the recovery is going to take time and as such, the damage will be seen in this 2014’s results.
Considering that the management and investors have accepted the fact that 2014 results will see the negative impact of food scandal in China, the essential question is whether Yum! brands has become an attractive proposition after this fall. At the onset, let me point out that this fall has shed off Yum’s excessive valuation to an extent and currently, the stock is trading at about 21 times the earnings. In addition to that, Yum’s PEG ratio has also come down to 1.67, suggesting a better valuation than its earlier trading price. Compare this to Yum’s closest rival McDonald’s and one will find that for the product portfolio and presence that Yum! has, it is cheaper than MCD.
So, in terms of valuation, Yum! represents a reasonable buy when compared to its closest rivals. In addition to that, I am quite bullish on Yum!’s global strategy. In a bid to stretch its global footprint, the company plans to add 13000 international Taco Bell locations by the end of 2023. The roll out is targeted for the U.K., Korea, Chile, India, Poland, Japan, Thailand and Peru. Though the proportion of revenue from Taco Bell China is less as compared to KFC yet this global expansion will help the company in achieving lesser dependence on China.
Even in China, the company has announced aggressive expansion in order to beat the slowdown. Perhaps this is also a reason that Yum! has a brighter view in China for year 2015. The company anticipates that it will deliver earnings growth of 10% or more, depending on the sales recovery in China. Further, profit in the China division is expected to be at least 15%. Both the KFC and the Pizza Hut Divisions are expected to post operating profit growth of 10%, while the Taco Bell Division is expected to report 6%.
Final words
Certainly, Yum! Brands has cut down its forecast for 2014 and as we saw, it has resulted in a considerable decline of around 6 percent. In a panic reaction to this updated guidance, the market attempted to book profits ahead of any steep slide. However, investors need to acknowledge the fact that the long-term business model remains intact and this is more like a short-term hiccup, which should fade soon. Quite rightly, the company has undertaken expansion and menu innovation in order to revive growth in the Chinese region. Hence, the current price range provides a lucrative entry point as the stock is poised to gain in near future.
