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Panos Mourdoukoutas
Panos Mourdoukoutas
Articles (104) 

Yum China: A Good Franchise Selling at a Discount

The company is an excellent long-term buy, given its growth initiatives and relative valuation

February 12, 2021 | About:

Yum China Holdings Inc. (NYSE:YUMC) is a good franchise selling at a discount on Wall Street, according to Quo Vadis Capital President John Zolidis.

Last week, the operator of KFC, Pizza Hut and other fast-food brands in China reported fourth-quarter earnings of 35 cents per share that beat analysts' expectations of 24 cents per share.

But it warned of "significant headwinds" in the first quarter of 2021 due to a Covid-19 resurgence in some areas of China.

Wall Street took this warning seriously, sending the company's shares on a roller coaster following the report.

Still, Zolidis thinks Yum China is an excellent long-term buy, citing the company's growth initiatives and relative valuation.

"We would regard any dip as an opportunity to add or get involved," he said. He finds the shares "exceptionally cheap" relative to the company's plans to open 1,000 stores per year for the next five years and comparable to similar franchises like Chipotle (NYSE:CMG) or Starbucks (NASDAQ:SBUX).

"While investors over-pay for CMG at EV 5x 2022 revenues or SBUX at EV 4x 2022 revenues, YUMC can be bought at just 2x," he said.

Meanwhile, Yum China's recent economic profit stands at 3.81%, compared to -2.16% for Starbucks and -0.29% for Chipotle. Economic profit is a measure of how effectively a company manages capital raised from stockholders and debtholders and indicates the strength of the company's competitive advantage.




Economic Profit

3-year Average Revenue growth

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Still, investors should take Zolidis' enthusiasm for Yum China with a dose of skepticism for a couple of reasons. One of them is that the stock trades well above its intrinsic value, as are its two peers, which he uses in its relative valuation model.

Then there's the nature of the Chinese market, which isn't a homogeneous market, but a collection of three different segments:

The highly globalized segment, in which Chinese consumers display similar preferences and taste with consumers of highly developed countries. This segment extends over three eastern regions: The Pearl River Delta, which includes Hong Kong, Guangzhou and Shenzhen; the Yangtze River Delta, which includes Shanghai and nearby cities; and the Beijing-Tianjin region.

The highly localized segment, in which consumers maintain their local preferences and tastes. This segment extends in the most remote rural areas of central and western China.

The semiglobal market segment, in which consumers display a mix of global and local preference. This segment is a collection of "mega-cities" like Fuzhou, Zibo, Quingdao, Hantu, Dilian and Huizhou.

So far, Yum China has reached the easy target, opening up stores at a fast pace in the highly globalized segment, which requires little localization of the products sold in their home market.

The trouble with the highly globalized market segment is getting crowded with both overseas and domestic players.

So now here come the more difficult targets for the company -- the semiglobal and local market segments.

Will Yum China continue to expand to these market segments at the same pace with the same profit margins? It's too early to say.

Disclosure: I own shares of Yum China.

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About the author:

Panos Mourdoukoutas
I’m a Professor of Economics at LIU Post in New York. I also teach at Columbia University. I’ve published several articles in professional journals and magazines, including Forbes, Barron’s, The New York Times, Japan Times, Newsday, Plain Dealer, Edge Singapore, European Management Review, Management International Review, and Journal of Risk and Insurance.

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