Yum is Not Yummy in China!

Mihir is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The parent company of brands like KFC, Taco Bell, and Pizza Hut, Yum! Brands (NYSE: YUM) reported its fourth quarter results along with full-year 2012 review earlier this week. EPS, after adjustment of special items, came in at $0.72 per diluted share, a fall of almost 3% from the same period last year. The net income was also down by 5% to settle at $337 million. For the fiscal year 2012, however, net income rose by 21% at $1,597 million.

The results fell short of analyst estimates of $0.82 per share while beating street expectations on the revenue number. For the full-year 2012, EPS saw a growth of 13% (excluding special items), marking this as the 11th consecutive year with at least 13% growth. However, CEO David C. Novak pointed out that it might not be possible for the company to maintain this growth level in 2013 as its KFC brand image in China has taken a major hit owing to allegations in the Chinese media about usage of excessive level of antibiotics in chicken.

The last few weeks of December saw a sharp decline in KFC sales due to heightened media attention around the investigation by the Shanghai FDA into poultry supply management at Yum! China. The investigation was a result of a media report regarding excessive usage of antibiotics in chicken. This sparked negative customer perception towards poultry safety and significantly impacted KFC China’s sales. Even though no case has been brought against Yum!, this incident has had a negative impact on KFC’s brand image, which will take time to be restored.

As an investor, I am pretty curious to understand if it’s only the China factor that has impacted results or is there something else as well under the veil. The comparison of Yum!’s performance metrics to its major competitors in the fast food industry, i.e McDonald’s (NYSE: MCD) and Chipotle Mexican Grill (NYSE: CMG), will provide a better idea about the current and potential value of Yum!.

In terms of gross profit margins, Yum! has been quite ahead of its peers McDonald’s and Chipotle. Strong revenue and a systematic basis of cost management has helped Yum! to deliver higher profits to investors.

<img src="http://media.ycharts.com/charts/59b9532418c14c54e8dc83e985f84bb3.png" />

YUM Gross Profit Margin Quarterly data by YCharts

Yum! has grown has been growing its revenue at a reasonable rate of around 5%, whereas McDonald’s has a low revenue growth rate of around a percent (however, it has high absolute revenue)

<img src="http://media.ycharts.com/charts/592ac313783a7b3f896cfafc624efcbc.png" />

YUM Revenue TTM data by YCharts

Analysts and investors seem optimistic about McDonald’s share price movement especially after it announced an investment to the tune of around $457 million in recession-battered Italy. This might not be an advocated strategy; however, it shows McDonald’s confidence in its business model, which it believes will do well in such a challenging market. 

Chipotle Mexican Grill reported strong quarterly results earlier this week, meeting Street expectations with a net income of $61.4 million, or $1.95 per share. The company has done a commendable job in pushing up revenues amidst rising input costs and a sluggish economy.

The Bottom Line

The unfortunate incident in China had a highly significant impact on sales and income figures for KFC China to the extent that CEO David C. Novak showed skepticism regarding the achievement of target EPS in line with past performance. The company is doing well across the globe and especially the YRI markets; however, the turn of events in China has made investors and analysts doubtful about the overall sales of the company because China contributes nearly 50% to Yum’s overall sales. The company’s expectations of China’s potential is evidenced in the fact that it opened a record 889 units in the last year and are set to open around 700 more in the coming year.

Let us now take a look at the dividend history of Yum!, which will also be impacted by the China crisis. In the past year, the dividend has increased by approximately by 17%, which is a strong testimony of growing business revenue. However, as an implication of the crisis in China, the management has estimated a sharp decline of around 25% in store sales in China for the first quarter. This will have an adverse effect on the EPS for the first and perhaps second quarter as well, as it is difficult to estimate the time required to completely recover from this crisis. Hence, it is expected that dividend will take a hit in the first couple of quarters, which might prompt investors to go short on the stock in order to set off dividend loss.

<img src="http://media.ycharts.com/charts/fc493374a4c349324e58a4495bb200e9.png" />

YUM Dividend data by YCharts

2013 guidance also fails to provide any sense of satisfaction to investors and analysts, with a target EPS growth of 10%, which is lower than its performance standard. The company has clearly pointed out that time will abate the impact of China crisis and it would not be fruitful to increase advertising spending. In my opinion, this stock will entail higher risk and lower returns, and would not add value to your portfolio.

MihirMehta has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and McDonald's. The Motley Fool owns shares of Chipotle Mexican Grill and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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