Is This Food Giant Still a Buy?
Waqar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Based in Kentucky, Yum! Brands (NYSE: YUM) is the largest fast food restaurant company (in terms of units) in the world. It has more than 38,000 restaurants across 120 countries. Yum owns prestigious brands, such as KFC, Pizza Hut, Taco Bell, and WingStreet.
Recent developments
Taco Bell Horsemeat Scandal
Recently, U.K.’s Food Standards Agency (FSA) announced that it had found traces of horsemeat in ground beef at Taco Bell UK. According to FSA, out of a total of 1,797 tests conducted, more than 99% came negative for horsemeat levels at or above 1%. However, four tests were positive, which included beef skewers from Brakes and two types of Birds Eye ready meals.
As soon as the company heard about this, it withdrew contaminated products from its shelves. Taco Bell UK spokesman Christopher Fuller said, “The chain will test every batch of ground beef when it arrives at its processor and again before it is delivered to restaurants to make sure it is 100 percent beef.”
Yum cuts off Chinese suppliers
Yum! Brands has said that it’s cutting ties with more than 1,000 slaughterhouses in China amid the ongoing poultry issue, which has been responsible for a sharp decline in KFC's business. Yum! has decided to cut off ties with small suppliers that can’t modernize their operations.
Ever since the Chinese investigations revealed that small quantities of antibiotics were found in KFC’s chicken, sales at Yum!’s premier brand have seen a considerable drop. Given the fact that China constitutes more than 50% of Yum!’s business, the company’s earnings for 2013 are expected to fall significantly.
Valuation
Yum! is trading at a forward P/E of 17.44, and has a PEG of 1.81. It has a dividend yield of 2.1% and a PEGY of 1.5. Using an industry forward P/E of 22, we can value Yum. In my previous article, I valued Yum! using a discount of 15%. But, as the company has cut off its ties with small suppliers in China, customers’ trust would be regained to some extent in 2013. Therefore, instead of using a 15% discount, I would now value it using a 10% discount. Hence, a forward P/E of 19.8 would be used for its valuation.
Using 2014 consensus estimates, I value Yum! at $74. This shows that it’s an undervalued stock and has an upside potential of almost 12%.
Competitors
Yum!’s biggest competitor, McDonald’s (NYSE: MCD), has decided to open 150 self-operated restaurants in Russia within three years. The company not only plans to expand itself in the Urals, but also in Western and Eastern Siberia. Currently, McDonald’s has 357 restaurants in Russia, out of which 46 were opened last year. McDonald’s is trading at a forward P/E of 15.09, making it slightly cheaper than Yum. It has a PEG of 1.86, and a healthy dividend yield of 3.2%. A mean recommendation of 2.3 on the sell side depicts that it’s still one of the top buys in the restaurant industry. You can have a look at my detailed take on McDonald’s here.
On the other hand, Chipotle Mexican Grill (NYSE: CMG) is trading at a forward P/E of 25.97, which makes it one of the most expensive buys in the restaurant industry. A mean recommendation of 2.6 on the sell side suggests that it isn’t as attractive as Yum! and McDonald’s. According to the sell side, it has a mean target price of $332, showing that it’s undervalued by a meager 4%. In short, I still remain neutral on Chipotle Mexican Grill.
Conclusion
As China constitutes more than 50% of Yum!’s business, the poultry issue is going to take a toll on the restaurant giant. Yum! has already said that it won’t be able to grow its profits this year. The recent decision of cutting off ties with small suppliers will have a positive effect on Yum!’s KFC business. As more than 99% of tests conducted by FSA showed negative results for horsemeat, it doesn't seem to cause a major issue for the company in the future.
Yum! has also ensured that each and every batch of beef would be thoroughly tested before making its way to the shelves. Having said this, Yum!’s earnings are expected to improve in the next quarter but it still needs more time to recuperate. Thus, I remain neutral on Yum! in the short run. As the Chinese poultry market is expected to recover next year, 2014 would be the year where the company would start minting substantial profits once again. The bottom line is that I still recommend buying Yum! Brands for long term gains.
Vamosrafa7 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!
