In this article, let's take a look at Yum! Brands, Inc. (YUM, Financial), a $30.98 billion market cap company, which is a global restaurant brand, with more than 40,000 units in more than 100 countries, including the KFC, Pizza Hut and Taco Bell chains.
Core Brands
KFC, Pizza Hut, and Taco Bell have unique positions in countries such as China and should help to build this leadership in other emerging markets. This is a sub-industry with fierce competition, but Yum has the ability to generate positive returns due to its brand intangible assets as well as its scale advantages.
China: Latest News
A food safety scare in China is testing local consumers' loyalty to foreign fast-food brands, and McDonald's Corp (MCD, Financial) is also on the list. The company reported that it has cut its global relationships with OSI Group LLC , the U.S. parent of Shanghai Husi Food, which caused a "significant, negative impact" on sales in KFC and Pizza Hut locations in China. Husi became the subject of a government probe into the altering of expiration dates on food. The stock traded lower by 5% in the past days and accumulates more than an 8% year to date decline.
Further, if was reported that if the sales decline persists over time, it will impact the full-year earnings per share results.
This situation generates a negative publicity and could affect operating margin results for Yum!'s China. But two things are important here. Firstly, OSI was not a major supplier of the company and secondly, I don’t imagine this could have an important change in the structural supply chain.
China: The Largest Market
Yum! has nearly 6,400 restaurants in China and more or less 40% of the firm's operating income comes from this country, so what happens in that region is very important, for example, the projections of consumer trends. Although near-term emerging market headwinds, a long-term goal of 10% operating income growth could be possible. Yum!'s potential in this country has solid drivers like the well-established distribution infrastructure and local site development teams.
Revenues, Margins and Profitability
Looking at profitability, revenue growth by 10.3% led earnings per share increased in the most recent quarter compared to the samequarter a year ago ($0.73 vs $0.61). During the past fiscal year, the firm reported lower earnings of $2.36 versus $3.37 in the prior year. This year, Wall Street expects an improvement in earnings ($3.67 versus $2.36).
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| YUM | YUM! Brands | 50.37 |
| MCD | Mac Donalds | 34.89 |
| Â | Industry Median | 10.59 |
The company has a current ROE of 50.37% which is higher than the one exhibit by Mac Donalds. In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 17.1x, trading at a discount compared to an average of 31.1x for the industry. To use another metric, its price-to-book ratio of 5.78x indicates a premium versus the industry average of 3.4x while the price-to-sales ratio of 3.35x is above the industry average of 1.16x.
As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $24.136, which represents a 19.3% compound annual growth rate (CAGR).
Final Comment
China is a key market for every player in the restaurant industry because of it long-term growth potential due to the size of its population, the growing middle class and the rapid economic growth. With more than 6,000 KFC and Pizza Hut locations it remains at a leader in the Chinese market. Favorable disposable income as well as consumption, and a population increasing are reasons enough to bet on this sector over a longer horizon.
Further, the PE relative valuation and the return on equity that significantly exceeds the industry average make me feel bullish on this stock. I think the stock is trading below its intrinsic value, and the 8% drop would have to recover soon.
Hedge fund gurus like Steven Cohen (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), Bill Nygren (Trades, Portfolio), Jim Simons (Trades, Portfolio), Bill Frels (Trades, Portfolio), Ruane Cunniff (Trades, Portfolio) and HOTCHKIS & WILEY, Caxton Associates (Trades, Portfolio) and Manning & Napier Advisors, Inc. added this stock to their portfolios in the first quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
