Yum! Brands Will Remain Yummy Despite Chinese Slowdown
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Yum! Brands (NYSE: YUM) has widely reported to announce second-quarter earnings on July 18. Analysts are expecting Yum Brands to report a 16.7% year over year rise in earnings to $0.7 per share and a 10.7% year over year rise in revenues to $3.12 billion. Although most investors are concerned about the Chinese slowdown, we believe the company makes a good buy despite these concerns.
Slowing growth in China will be the biggest concern for investors in Q2 as first quarter sales in the world's most populous country were slower than expected. Same restaurant sales in China grew 14% in Q1, missing analysts' high expectations. Yum Brands’ margin in China fell from 25.1% to 23.6% due to an increase in commodity and labor costs. An even bigger slowdown in China could have a huge impact on the company. Another concern is NYC's Mayor Bloomberg's proposed ban on soft drinks and other sugary beverages larger than 16 ounces. The idea is gaining popularity, as Mayor Henrietta Davis of Cambridge, Massachusetts is also considering a similar ban. Since, soft drinks have higher margins than coffee and juice, this could have a further negative impact on the restaurant industry.
Despite these concerns, we feel that the company’s growth drivers going forwards can outweigh the concerns many investors have over the restaurant industry. Below are some of the reasons why we believe YUM will be able to post good returns in the long term.
Well Positioned U.S. Business: The company’s U.S. business is well positioned this year and can reap ample rewards in the future. Last quarter, Taco Bell's Doritos Loco tacos were a hit in the U.S. (Taco Bell’s comps are running in very high single digits as per the company’s comments), boosting sales, and the fast food chain is continuing to improve its menu offerings to tempt a broader range of customers. Last June, YUM tested the Cantina Bell menu, featuring high-end ingredients like fire-roasted corn salsa and cilantro rice in order to compete with Chipotle Mexican Grill (NYSE: CMG). The tests of Cantina Bell appear to have gone well. The company is also expanding its breakfast offering from an existing 800 stores to another 200 by year end. Pizza Hut likewise appears to have moved ahead confidently with its use of bundling to raise its average check.
Non-China Emerging Market Momentum: Emerging markets offer a large-scale growth opportunity for restaurants, and Yum has significant exposure to the world’s largest developing markets. Even with the Chinese economy slowing down, Yum Restaurants International's (YRI) emerging market system sales grew 13% in 1Q12, driven by 8% same store sales and 6% unit growth in comparison to 10% sales growth in 1Q11, driven by 4% SSS and 6% unit growth. Including China, emerging markets account for 55% of YUM's operating profit. This proportion is likely to rise as YUM has announced that it will set up company-owned stores in high-growth emerging markets such as South Africa and India. The company expects 70% of its company units to be in emerging markets by 2014, up from 57% in 2011 and 16% in 2001. This will enable YUM to tap consumer base growth in emerging markets.
Brand Diversification: Yum Brands owns Pizza Hut, KFC, and Taco Bell, so it offers something to everyone and in this regard remains fairly immune to changing consumer preferences and tastes.
YUM is trading at a forward PE of 16.68x, which is a discount to its peer group of Chipotle Mexican Grill (with a forward PE of 34.26) and Papa John’s (NASDAQ: PZZA) (17.17). We believe it is undervalued given its persistent growth and continued evolution towards higher return business. With its good product mix and brand diversification, YUM stands safe compared to Papa John’s. Also, with its Taco Bell business showing good results and posing a threat to Chipotle Mexican Grill’s market share, a 51.3% value discount to Chipotle Mexican Grill is not justified. Thus, we recommend it a buy.
TheAnalystBlog has no positions in the stocks mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill. Motley Fool newsletter services recommend Chipotle Mexican Grill and Yum! Brands. 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.If you have questions about this post or the Fool’s blog network, click here for information.