How to Tackle Gloomy China

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

Yum! Brands, Inc. (NYSE: YUM), the yummy umbrella brand of KFC, Pizza Hut, and Taco Bell, is facing serious concerns due to the slowing growth in China. The Chinese market of Yum! has been reporting double the revenue of the U.S. market, and it contributed ~55% to its total revenue in the third quarter of 2012. But, economic slowdown in China is weighing heavily on Yum!'s stock. The stock of the company saw a fall of 10% after it announced that sales in China restaurants will further drop down in the fourth quarter. The Chinese government reported GDP of only 7.4% in the recent quarter.

But despite this slowdown, which is of course a matter of concern, investors should look deeply into the future outlook for this company, which has expansions and several other innovative offerings in its menu. Though Yum!'s sales are not as good as expected, the company has planned expansions for 700+ units in China. Other than China, it has a further 1,100 new unit openings scheduled across India. The long term demographic trends, such as the growing population, rising income of the middle class, and convenience of fast food chains will no doubt build the brand's presence and assist it in incremental sales.

On a comparative basis, two of Yum!’s peer group companies are also focusing on market extension through acquisitions and new initiatives.

McDonald's (NYSE: MCD) – the company has pushed its marketing efforts towards projecting itself as a healthy and kid friendly food hub. McDonald's has come up with an innovative idea of iPad installations on the tables where consumers can enjoy a complimentary free usage. This initiative reveals the company’s technology-forward image and will help it to remain relevant.

But on the negative side McDonald's is also experiencing the effects of the Chinese economy, and it has reported a same store sales decline of 1.8% in October for the first time in nine years. Also, there are issues in retail in India due to McDonald’s sourcing policies. However, that is not a big concern for investors, keeping in mind that it is still a high dividend paying stock. McDonald's is among the best dividend paying stocks on the market, with an annual yield of 3.08%.

Starbucks (NASDAQ: SBUX) – the world’s largest coffee chain is on a spree of expansion with the announcement of its Teavana acquisition. This acquisition will benefit Starbucks a lot, giving it direct access to Teavana’s mall presence of ~300 stores across the globe. These stores are best known for selling premium loose-leaf tea. Starbucks is also planning to introduce a ready to serve tea beverage with its Tazo brand. Additionally, Starbucks has launched its Verismo system, which provides consumers an option of having Starbucks Caffe Lattes, Espresso, and Coffee from a single machine. It has already been placed at 6,400 retail locations, providing consumers with a compact design product without compromising on quality.

Coming on to our analysis of Yum!, I believe that it has also prepared its strategies with regard to expansions and menu introductions and that it is well spread across geographies too. Two action plans that are pointed towards two different directions have, however, begun generating startling benefits.

Refranchising of Pizza Hut U.K.
Yum! has sold its Pizza Hut‘s UK Dine-In Restaurant business to Rutland Partners, as it is looking for more investment in China. Rutland acquired the share capital of Pizza Hut UK Ltd with its 330 dine-in restaurant units, which will operate under a franchise agreement with Yum!. Yum! will receive royalty from Rutland and the two companies will work together to grow the Pizza Hut brand in Britain. Yum! is looking to increasing its investment in the fast growing emerging markets leveraging the demographic benefits of their large population. These new unit openings in these markets will drive in high returns with high-franchise fees for the brand.

Taco Bell US Turnaround
The introduction of breakfast and the reinvented Taco has been successful for Yum! in getting consumers to enjoy the food. The innovation was a turnaround for the company, returning high same store sales from the first quarter. The First Meal approach is a return to low cost entry, which was earlier used for the “Fourth Meal” concept. For the reinvented Taco, Yum! has partnered with Frito Lay to create the new “Doritos Locos Tacos.” The popular snack chip was easily noticed and has been loved by consumers.

Return to Shareholder
Yum! has announced a share buyback plan of $1 billion with timely repurchase up to May 31, 2014. In 2012, Yum! has spent $815 million on its share buyback program with an average price of $66. Additionally, the company has announced a dividend of $0.335 per share to be paid in Feb. 2013.

To conclude, the fundamental points and the benefits of franchising will return Yum! with a profitable and consistent revenue stream. Despite share price drops, the stock has done well over the year with an appreciation of ~14%. The company has well diversified plans across the globe with new innovations in menu and new openings for specific markets. I would recommend investors that avoiding the short term negativity this stock offers a good buy opportunity backed by strong future prospects.

ShwetaDubey has no positions in the stocks mentioned above. The Motley Fool owns shares of McDonald's and Starbucks and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend McDonald's and Starbucks. 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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