The Story of Yum Brands and Chicken in China

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

Yum! Brands (NYSE: YUM) is a quick service restaurant company with 38,000 units in more than 120 countries. YUM generates revenue through company-owned restaurants, franchise fees, and licensing agreements. YUM's brands include KFC (17,400 units), Pizza Hut (12,100 units), and Taco Bell (5,500 units). While the market had been in rally mode, YUM decreased 2.20% since the beginning of 2012. This article will review what's happening for the company.

Major Highlight

All about Chicken and China: In December 2012 YUM was hit hard after high levels of antibiotics and chemicals were found in YUM's chicken supply. YUM later reported disappointing outlook on Chinese same-store-sales. On Jan. 25, 2013, the official Xinhua news agency reported that chicken sold to KFC's parent Yum! Brands Inc. in China contained excessive levels of chemicals, escalating a month-long scare that his hit YUM's sales in China. YUM had apologized to customers in China over its handling of the food scare. On Jan. 30, 2013, YUM's share price rebounded with the positive comment from Citi analyst Gregory R Badishkanian, as quoted,

"We believe the food safety issues are having less of an impact on sales and consumer perceptions. We believe January China SSS are still likely down, but not as much as the (20%) seen in 2H of December. This would be encouraging given MCD's comments implying that the chicken scare was having a greater impact on Jan sales vs December and the negative impact of the Chinese New Year."


Analysts' downgrades: Sanford C. Bernstein downgraded YUM to "market perform" from "outperform" and has a $72.00 target price on that company as of Jan. 30, 2013.

Misrepresentation/fail to disclose: A class action suit was filed for YUM investors by Gewirtz & Grossman, LLC, who purchased the shares between Oct. 9, 2012 and Jan. 7, 2013, for the allegation that YUM company misrepresented and/or failed to disclose that the company's chicken suppliers fed toxic chemicals to chickens sold to KFC China.

Competitions, Earnings Preview for YUM

McDonald's (NYSE: MCD), YUM's major competitor, had been performing well in Q4 2012, despite the chicken issue in China. Both YUM and McDonald were negatively impacted by the intense scrutiny from local media since the official China Central Television reported in late December that some of the chicken supplied to them contained excess amounts of antiviral drugs and hormones used to accelerate growth. McDonald's sales in China were hurt by a government investigation of chicken suppliers. However, MCD reported slight improvements in Q4 profit and revenue on Jan. 23, 2013. As reported, MCD's net income rose 1 percent for Q4 to $1.4 billion, or $1.38 per share, beating analysts' expectation of $1.33 per share. Revenue increased 2 percent to $6.95 billion, and global same-store sales increased 0.1 percent. This could provide some lights for the upcoming earnings report for YUM.

YUM's other major competitor, the Wendy's Company (NASDAQ: WEN), also performed well and declared its preliminary Q4 and full year 2012 results on Jan. 17, 2013 (the detailed financial report will be schedule on Feb. 28, 2013). WEN posted Q4, 2012 adjusted earnings of 8 cents per share, ahead of Zack's estimate. In 2012, the company's adjusted EPS was $0.16, which was ahead of the Zacks Consensus Estimate of $0.13 and year-ago earnings of $0.15. WEN declared to repurchase up to $100 million worth of its common stock through Dec. 29, 2013, and hiked its dividend by 100% to 4 cents per share.


Analysts, on average, are expecting an EPS of $0.82 with revenue of $4.11 billion for the current quarter ending in December 2012. Analysts are estimating an EPS of $3.24 with revenue of $13.59 billion for fiscal 2012. YUM is expected to report the earnings on Monday, Feb. 4, 2013. In the past 90 days, the EPS estimate was lowered from $0.85 to the current $0.82. In the last 4 quarters, YUM reported 3 positive surprises and 1 negative surprise. The majority of analysts (60.9%) rate Yum! as a buy. This compares favorably to the analyst ratings of its nearest nine competitors, which average 39.4% buys.

Key Stats and Valuation

YUM has an enterprise value of $31.10 billion with a market cap of $29.02 billion. YUM has a total cash of $942 million with a total debt of $3.02 billion. YUM generates an operating cash flow of $2.28 billion with a levered free cash flow of $917.88 million, and has lower revenue growth (3 year average) of 3.8, as compared to the industry average of 4.4. The company has a lower operating margin of 16.9%, ttm, as compared to the industry average of 17.0. YUM has a higher net margin of 11.9%, ttm, comparing to the average of 10.6%, ttm. It generates a high ROE of 77.1 compared to the average of 32.1. YUM's P/E of 18.9 is lower than the industry average of 20.5, but higher than YUM's 5 year average of 18.7. YUM's forward P/E of 15.6 is higher than the S&P 500's average of 13.3.

Reviewing Options

For conservative long-term investors, I suggest you wait until the earnings release to establish a long-term position, as the impact from China needs to be better analyzed. For more aggressive bullish investors, a credit put spread of April 20, 2013 $57.5/$60 can be reviewed to gain from the upside potentials, while having the worst case scenario of acquiring the stock at a price below $60.

Note: Investors and traders are recommended to do their own due diligence and research before making any trading/investing decisions.

NickChiu has no position in any stocks mentioned. The Motley Fool recommends McDonald's. The Motley Fool owns shares of 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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