Some Reasons Why I like Yum
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I think it is essential to pick solid companies that operate highly growth brands and are operated by proven management teams that do not only deliver top and bottom line growth but also are shareholder oriented and focus on execution. Yum Brands (NYSE: YUM) is one of these companies.
What I like about Yum is their company owned and franchise positions, in 2001, 84% of company-owned units operated in developed markets and 16% operated in emerging markets. By 2011, the company reported that 53% of company-owned units operated in emerging markets and that by 2014 that number is expected at approximately 70%. Currently, Yum is actively refranchising units in developed, low-growth markets in the U.S and in Western Europe, and plowing capital into high growth international markets, making it possible to capitalize to a greater degree from emerging market growth.
Yum adopted a less risky strategy by reducing its ownership of restaurants through its refranchising program. The company announced its U.S. refranchising initiative during the end of 2007. Refranchising provided Yum a low-risk opportunity to boost returns; this expects to retain only 5% ownership in Pizza Hut and KFC by the end of 2012 and plans to reduce Taco Bell ownership from 22% to 16% by the end of 2013. These streamlining efforts will benefit the company’s general and administrative expenses. In third-quarter 2011, Yum announced its decision to refranchise its entire Pizza Hut UK segment.
The organization plans to open up restaurants in about 20 fast growing African countries by the end of 2012 mainly through franchising. Yum acquired 70 restaurants in South Africa in 2011 taking full control of that region. They also find room for growth in Western European countries where Yum is still un-penetrable and facing competition from Mcdonald’s. Management views massive retailing potential and seeks opportunities to expand in other emerging markets like India, Russia and Africa as well. With a 2:1M ratio, meaning two restaurants per million people in the world's 10 largest emerging markets provides Yum the opportunity to grow in the future. Russia delivered stupendous performance in second-quarter 2012 with 44% system sales growth and 32% same-store sales growth.
I see the current financial position and sustainability strategies of Yum are focused on these aspects;
Supplier Relationship: Being the leading restaurant operator in China and the U.S., Yum has developed a narrow economic moat through its considerable advantage over suppliers and scale advantages. Suppliers are eager to collaborate with Yum and its significant growth potential, ensuring the best purchasing terms possible for raw materials. With incredible advertising resources and convenient, high-traffic locations, Yum's brands are among the most recognized in the world.
Investor Satisfaction: Yum consistently enhances investors return. Yum targets an annual dividend payout ratio of 35% to 40% of net income, which increases its dividend every year. According to management, Yum’s strong balance sheet and cash generation allowed the company to return more than $1 billion to shareholders in 2011. The company accelerated its buyback program. It repurchased $733 million of stock in 2011. Management recently stated that it planned the repurchase about $800 million in 2012 after a relatively low share repurchase activity of $371 million in 2010. The share buyback activities will likely favor 2012 EPS growth by 2 points. The company reiterated its target to deliver EPS growth for 2012 to at least 12%. In fact, around 97% of outlets in China are company operated. Currently, the company has also started accelerating its franchising activities there.
Better Pricing: Regardless of the depressed margins in second-quarter 2012, The company expects modest margin improvement in the latter half of 2012 and double-digit profit growth mainly backed by strong top-line growth. Further, moderating inflation and the imposition of pricing action will aid margin expansion. During the second-quarter 2012, Yum implemented pricing action in the range of 3-4% in China leading to 7% effective pricing in the third quarter.
Store Hours and Menu Variations: KFC and Pizza Hut did a tremendous job in international markets of leveraging assets throughout the day by offering a localized, robust, high-value menu of food and beverage products for breakfast, lunch, dinner, and everything in between. In China, KFC sells congee and PH Dine In draws customers for afternoon tea. Yum is also expanding delivery in China with Pizza Hut Home Service (135 units), and KFC is currently in the early stages of expanding delivery and 24-hour service. Their Delivery and Drive Thru’s are not that imprtant in emerging markets than in developed markets. However, it is expected to gain traction in the coming years.
Manpower Development: During the December 2011 investor conference three presentations were given by Yum China executives. The first, by President and COO Mark Chu, concentrate fully on how the company is developing local leaders to keep pace with the rapid speed of new unit development. He said that every store in China is a training store and that developing capable Restaurant General Managers (RGMs) is his number one goal; Chu boasts 4,000+ RGMs and counting. Focus on people’s growth and development is a competitive advantage that will gain dividends.
Yum trades at a similar P/E to McDonald's (NYSE: MCD) and a much lower earnings multiple than Chipotle Mexican Grill, Starbucks (NASDAQ: SBUX) and Arcos Dorados. While Starbucks has a 5 year growth rate that doubles that of Yum, I think that Yum offers investors a solid emerging markets growth picture while Starbucks is more dependant on developed economies. Something similar happens with McDonald's. I think that neither McDonald's nor Starbucks can match Yum's emerging markets growth strategy and positioning.
My fair value estimate is $70 per share, which is squarely in the middle of management's internal discounted cash flow analysis from its 2011 investor meeting (which pegs the intrinsic value of the stock at $65-$75 per share) and sum-of-the-parts valuation (which assigns multiple ranges of 18-20, 12-15, and 6-7 times to the adjusted EBITDA for Yum's company-owned China restaurants, global franchising fees and licensing revenue, and company-owned restaurants in the United States and other YRI markets, respectively). My fair value estimate represents a fiscal 2013 price/earnings multiple of 18 times, enterprise value/EBITDA multiple of 11 times, and a free cash flow yield of 5%.
For investors looking for a stable and proven company that will keep growing from emerging market economies in the mid term, Yum is the stock to research.
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