Strong International Trends and Increasing Popularity of Taco Bell Makes us Bullish on Yum
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On 22nd August, YUM Brands (NYSE: YUM) held its annual Yum Restaurant International (YRI) analyst day in Dallas focusing on the strategy of international business segment that encompasses the world, excluding the U.S., China and India. Given that YRI has operations in over 120 countries and contributed 26% of the total revenue and over 30% of operating profits in 2011, we find strong trend in this segment encouraging. The company’s domestic business is also doing good, driven handsomely by Taco Bell’s increasing popularity. We also anticipate a recovery in China. Thus, we remain bullish on this stock.
Higher Exposure to Emerging Markets
Yum plans to raise company-operated presence in its key emerging markets to capture more of the economics for its shareholders. Emerging markets have been outpacing developed markets in both net unit growth and same store sales (SSS) while posting better margins. While developed market margins have hovered around 11% over the last several years, emerging markets have grown from 9% in 2008 to 19% in 2011. During H1, emerging market margins dropped to 17%, but it was merely due to exclusion higher margin India results (India business is now operating as a separate unit ), and pressures in Thailand that are not expected to continue.
We believe the company can enjoy the same success in key emerging markets like Russia, Africa, Malaysia & Indonesia as it enjoyed in China, since they have similar unit economics to China. The cash paybacks on new units in these emerging markets are about 3 years, similar to China. Going forward, good trends are expected to continue, and higher emerging market exposure will have significant impact on the overall results.
Recovery Likely in China
Last quarter Yum Brands generated more than 44% of sales and 42% of operating profit from China. With so much exposure to the Chinese market, investors are concerned that slowdown would harm this stock. However, it is important to keep in mind that the company has a good brand value in China and its products are perceived as premium products not as cheap or junk. China’s Q2 SSS growth 10% reflects the acceptance of Yum Brands in the country. Going forward, we believe Yum’s strategy to raise prices gradually in China probably will prevent consumer demand from falling sharply, so the company should be able to hit its goals in the second half of 2012 for SSS and restaurant margin growth.
Taco Bell’s Increasing Popularity
Yum Brands’ Taco Bell is providing a tough competition to Chipotle Mexican Grill (NYSE: CMG) and Jack in the Box (NASDAQ: JACK) owned Qdoba Mexican Grill, in the Mexican food business. Chipotle’s recent malaise can be attributed to the success of Taco Bell’s new Doritos Locos Tacos. Taco Bell’s increasing popularity is evident from its Q2 SSS growth of 13% with respect to Qdoba’s 3% and Chipotle’s 8%. Taco Bell’s impressive Q2 SSS growth not just reflects easy comparisons as it laps last year’s lawsuit, but also the success of the Doritos Locos Tacos, suggesting SSS can stay robust even as comparisons grow more difficult in the back half.
Yum is trading at a forward PE of 17x, which is at a healthy discount to Chipotle Mexican Grill (forward PE=27) and at a slight premium to Jack in the Box. We continue to believe that the company is undervalued given its persistent growth, continued evolution towards higher return business, good product mix and brand diversification. Market share gain from other Mexican food chains adds more life to the stock. 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, Jack in the Box, 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.
