This Quick Service Restaurant Is a Good Buy

ANUP 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) recently released second-quarter results were not impressive with sales and profit falling.

But the company gave some positive indications about its business in China which is recovering according to expectations with same store sales expected to become positive by the end of the year. 

Results and strategies

The results as mentioned earlier were not very impressive, as earnings, excluding special items, declined 16% versus last year. Although Yum! Restaurants International and the U.S. business posted an operating profit growth of 12% and 4%, respectively, the drop of 63% in operating profit (prior to foreign currency translation) in China led to a drop of 20% in overall operating profit.

KFC China's operations were mainly impacted by a poultry supply incident in late December and the extensive media surrounding avian flu in the beginning of April. The second quarter was impacted because of the residual effect of the same. Now the extensive media surrounding avian flu in China has subsided, and same-store sales at KFC are on the road to recovery.

To overcome this crisis, the company had launched a quality assurance advertising campaign in mid-April, reminding consumers of the company’s commitment to quality in China and that properly cooked chicken is perfectly safe to eat. It also created a value initiative centered on wings, along with advertising protein alternatives that are available at KFC such as shrimp and mushroom rolls. The company is hopeful that these initiatives will contribute to a recovery in sales. In fact, KFC same-store sales decline in June was 13% versus the 26% decline reported for the second quarter which indicates progress.

Going further, despite the recent negative developments in China, the company remains bullish on the opportunities in the region. The company operates 900 stores currently in China and its new unit development target of at least 700 new stores remains unchanged. This will take its total to 1,600 new units in a two-year period.

Apart from China, Yum! Brands is on target as far as delivering operating profit targets for the year are concerned. Yum! Restaurants International is banking on the high-growth emerging markets such as South Africa, Russia, and Thailand, which have shown solid performance. Yum! Restaurants India’s performance was also satisfactory.

Taco Bell in the United States continues to be positive in overall same-store sales. The company plans to open 125 net new units of Pizza Hut and 80 net new units of Taco Bell in United States. In India, the company plans to open another 150 units for the year and plans to double its restaurant count to 1,000 by 2015 in India.

What's the competition doing

Yum! Brands faces competition from McDonald’s (NYSE: MCD) across the world and Chipotle Mexican Grill (NYSE: CMG) in the United States, among other quick service restaurant brands.

McDonald’s has presence in 119 countries with 34,480 restaurants serving various food items, soft drinks, coffee and other beverages, as well as breakfast menus. Although McDonald's is upbeat over the market in China, it has taken a balanced approach. It would create a balance between franchised versus owned stores. The company has its eyes on dynamic markets such as South Korea and Malaysia, which, like China, should also see phenomenal growth.

Also, McDonald's trades at a cheaper P/E multiple of 18 as compared to Yum!'s 23 times earnings. McDonald's also has a greater dividend yield of 3.1% when compared to Yum!'s 1.9%. So investors looking for a more diversified business should consider McDonald's rather than Yum! as it is a safer option and also trades cheaply, apart from offering a better yield. 

Yum!’s over 62% of company-owned stores are found in China. It derives more than 50% of its revenue from the Chinese market. In comparison, McDonald's does not believe in keeping all its eggs in one basket and hence, China represents only 3% of its operating income. So investors who want to follow the good old rule of diversity should go for McDonald's instead of Yum! which is majorly dependent on China for growth and any problem in the country affects it badly.

The Taco Bell brand of Yum!, which contributes majorly to the success of the brand, faces competition in U.S. market from Chipotle. Chipotle operates 1,450 fast casual and fresh Mexican food restaurants in the United States. Its restaurants primarily offer burritos, tacos, burrito bowls, and salads.

In challenging times, when customer spending in the market declines, Chipotle will probably have a hard time selling its $10 Burrito Bowls. Chipotle's pricing is high as it caters to the higher end of the market and doesn't have a budget offering. But Chipotle would offer a better quality of food as it offers premium quality at a premium price. Over here, Yum!'s low-price menu and its focus on the fastest growing economy of the world, i.e. China, makes it a better alternative than Chipotle because even if spending in the U.S. slows down, Yum! can benefit from China and its lower prices than Chipotle.

Conclusion

Taking into account all the facts and figures, it is clearly seen that Yum! can do better and can beat every one’s expectation in the future, if it achieves what it has set out to do in China. Its low price items will help it further in case of a downturn and investors shouldn't let go of this stock even though it has faced problems in the past.


ANUP SINGH 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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