How Yummy is Yum!?
Rajesh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Fast Food restaurant chain Yum! Brands’ (NYSE: YUM) journey in China has been extremely rewarding for the company where it witnessed phenomenal growth. Though the company experienced a dip in its profitability for the China division in the recent quarter, it looks better positioned for the rest of the year. The operator of KFC, Pizza Hut and Taco Bell outlets across 120 nations experienced a 4 percent drop in the operating profit in the mainland. The wage inflation and commodity volatility has been troubling the company, and this is expected to continue in the foreseeable future.
Despite the current slowdown in China, this fast food company is expected to return to normalcy and get better in the second half of the year.
Yum Looks Poised
Margins are expected to improve for the Kentucky-based fast food chain for the second half of the year. The company is looking to expand its KFC and Pizza Hut brands particularly in emerging markets including Russia, Africa, China and India. Such growth markets have been the engine that drives the company’s revenue and profitability. In fact, analysts expect that in the next five years Yum’s China division would grow to twice as much as its US operation. As far as India is concerned, the company doesn’t expect this market to contribute an essential portion of the revenue in the next couple of years, but it surely smells huge potential in this untapped market. Currently there are 479 outlets in India and 100 more are expected to be added by this year end.
The company’s executives estimate that it could enjoy a 10 percent growth in its international division by this year end. It plans to increase its annual net openings to double in the next five years, most of which would be in Russia and Africa. However, Yum is not the only one eying the potential that the emerging economy of Russia offers, fellow player Burger King Worldwide (NYSE: BKW) has also showed interest to get traction and open additional outlets here. In addition, Yum has been a powerful brand. It consistently posted earnings over 10 percent in the past 10 years and expects to touch 12 percent growth in the current year. It continuously keeps innovating and adding new items to its menu card. It re-brands and reinvents itself to suit the local palette.
However, there are some challenges that the company needs to take care of.
The company faces competition from archrivals McDonald’s (NYSE: MCD), Wendy’s (NASDAQ: WEN) and Burger King for its KFC and Taco Bell outlets. McDonald’s presence in China is growing strong as the company has rigorous expansion plan in the mainland. However, even in the face of competition, Yum should get the first mover advantage from the development in China’s interior, as the company’s brand positioning is much stronger than McDonald’s and the latecomer coffeemaker Starbucks. On the other hand, Wendy’s 6,547 restaurants and outlets may be a very small number compared to Yum’s 37,000 outlets, but the second largest burger chain in the US has undertaken quite a number of initiatives to strengthen its competitive position. Its offerings are limited but of quality. This is precisely why it maintained an average sales growth rate of 14.4 percent in the last five years compared to Yum’s 5.7 percent.
Pizza Hut directly competes with Domino’s Pizza (NYSE: DPZ) and Papa John’s. Domino’s Pizza is the second largest pizza chain in the US, behind Pizza Hut, and targets the same market with similar demographic features offering a similar menu that includes pizza, pastas and other side dishes. Other than this, there are several regional players in various markets that give stiff competition to the company.
In addition, the company is exposed to the frequent fluctuations in food prices. Rising prices create pressure on the profitability margin of the company. Another concern that the company has is the slowdown in the Chinese economy which has been a major revenue driver in the past. The company is highly dependent on this emerging market which contributes around 44 percent of the company’s revenue and accounts for about 42 percent of the operating profits.
Though the slowdown in the Chinese market affected the company in the recent quarter, yet Yum looks poised. The untapped markets of the growth economies like China and India have a lot to offer to this fast food chain giant. The second half of the year might not be that impressive given the current scenario of the Chinese market. However, in the long run the company looks extremely promising with its international growth strategy.
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