Yum Brands No Longer Yummy (YUM)

By Glenn Curtis | October 16, 2006 AAA

In early July, I penned an article in which I said that Yum Brands (YUM), the company that owns KFC, Pizza Hut, and Taco Bell, looks extremely attractive under $51 a share. It turns out I was right. But now, I think it makes sense to head for the exits because I think that there is more downside risk to the shares at this point than upside potential. Here is what I am seeing:

U.S. Sales Trends Worry Me
Yum reported its third quarter earnings on October 11th. They were, from a 10,000 foot view, pretty darn good. In fact, the reported 83 cents per share figure was about 8 cents a share north of the average estimate for the period.

But delving a bit deeper into the numbers one will note that the domestic same-store-sales at KFC were flat for the quarter, while Taco Bell and Pizza Hut numbers were down 2% and 5% respectively. To be clear, this isn't the end of the world for Yum. But given that the United States represents more then 50% of Yum's sales, it is enough to give me some serious pause.

And while the company is, to its credit, rapidly expanding overseas and diversifying its revenue base, its international exposure simply won't offset excessive weakness in America. To clarify, a modest single digit increase across all concepts would be one thing. The company could leverage this growth and still bring plenty to the bottom line. But these individual concept declines just plain worry me, and lead me to believe that the future might simply not be so rosy.

Win-Lose Patterns And Trends
Yum has two things going for it. First, consumers will continue to spend their money on fast food fare before dining at higher end restaurants. Second, the recent trend in domestic fuel prices suggests that consumers may have additional money in their pockets at the end of each month, at least until the demand for gas perks up in the spring.

That being said, the outlook for fourth quarter 2006 and first quarter 2007 consumer spending remains a bit blurred right now given the interest rate environment and its effects. In addition, heavy "couponing" and advertising from the likes of McDonald's (MCD), and Domino's Pizza (DPZ) lead me to believe that Yum may have a hard time drawing domestic foot traffic at its concepts heading into the fourth quarter and the New Year.

Air Let Out Of The Balloon
In conjunction with the company's third quarter release, management upped its full year earnings forecast to $2.89 a share from its previous guidance of $2.83 a share. On the news, the stock rose almost 10% and punched through the 52-week high. But since then, the shares have trailed off a bit on downgrades from UBS Securities and JP Morgan.

And again, while a couple of downgrades might not be the end of the world, the analyst community usually runs in packs, and I am concerned that others on Wall Street may start to sour on the stock as well, thereby driving the stock lower. To be clear, this is a hunch. But if I am right and the heard mentality prevails, the stock could get hit pretty hard.

Share Buyback Program's Future
This past quarter management indicated that the company repurchased 7.1 million shares for $337 million. In fact, because of stock buybacks throughout the year, the total share count is expected to be reduced by about 6% from last year. And while repurchases are a terrific sign in my mind of a company's bullishness on the future, I can't help but wonder if Yum will be buying back stock in the open market with such zeal, particularly if its domestic stores continue to take a hit and wind up putting a crimp on its cash flow.

Put another way folks, the tough times at the company's domestic locations may impinge upon the company's willingness to soak up similar amounts of shares in the coming quarters. As such a lack of buying could have a negative impact on the share price going forward.

The Bottom Line
Yum's concepts remain a staple in the U.S. fast food market. And the company's plans to open stores overseas, particularly in Asia, makes it in my mind one of the best long term plays in the food industry. However, in the near term, the economic risks and the lack of near term catalysts lead me to believe that the stock will probably move lower from here.

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