Given that the company's troubles in China are very well known now, there's not much for Yum! Brands (NYSE:YUM), or its shareholders, to do but wait for things to get better. The company continues to look for growth in other emerging markets, while driving good profits from its U.S. operations, but it's going to take a while for markets like India, Russia, or Africa to make a difference relative to China. In the meantime, the shares don't look like that much of a bargain. Sluggish Sales For The Second QuarterRevenue came in for the second quarter more or less as expected, which is not too surprising given the periodic updates that the company provides along the way. That said, I wouldn't recommend overlooking the absolute performance just because the relative performance looked okay. Overall company revenue rose 6% for the quarter, but the same-store trends were pretty soft across the board. Same-store sales were up 1% in the U.S. against a tough comp, with Taco Bell and KFC showing gains of 2% and 3% respectively (Pizza Hut was down 2%). China same-store sales were down 20% as previously announced, with KFC down 26% and Pizza Hut up 7%. India same-store sales were up 2%, while International same-store sales were up only 1%, as emerging market growth of 5% was offset by a 1% decline in developed markets.  SEE: How To Analyze Restaurant StocksNone of those numbers are great, nor better than sell-side analysts expected. But it's also not entirely surprising. McDonald's (NYSE:MCD) has been seeing so-so sales growth around the globe, and likewise for the company's Latin American franchisee Arcos Dorados (Nasdaq:ARCO). Margins Take A Scary DiveIt isn't news that China's profits make a major contributor to Yum! Brands, but I think the significance of that contribution became more obvious this quarter. Blended company gross margin declined more than five points as restaurant margins fell 270 basis points. China's restaurant margins were terrible, dropping a whopping five points due to the combination of lower store traffic, wages, opening expenses, reparative promotional spending and so on. International margins improved almost a full point, while U.S. margins improved almost a point as well, to a company-high of over 18%. I think this is an important detail to keep in mind – while China provides the growth for this company, the U.S. business (especially Taco Bell) is a major source of company profits and cash flow, and that effectively subsidizes the global expansion plan. All told, though, profit performance wasn't great. Operating income dropped by about a third (or 20% in constant currency), with margin down over seven points. Although International op profits were up 8%, but China fell almost two-thirds. Hurry Up And WaitYum! Brands still has an attractive collection of restaurants that are likely to do well for the long-term. But the key there is “long term”. China's comps were down 10% in June, and it's going to take a while for the KFC franchise there to get its legs back under it. In the meantime, the company continues to refine its global operations, including acquiring operations in Turkey with an eye toward improving what has been an unimpressive recent trend in sales. It doesn't seem like there's as much left for the company to do in the U.S. I don't think there are too many Doritos flavors left for Taco Bell to borrow from PepsiCo (NYSE:PEP) and McCormick's (NYSE:MCK), and it doesn't sound as though new product introductions from KFC (boneless fried chicken) or Pizza Hut are capturing hearts and minds away from Papa John's (Nasdaq:PZZA) or AFC's (Nasdaq:AFCE) Popeye's in a big way. The Bottom LineIt doesn't surprise me that Yum! Brands has regained a strong multiple on the basis of investor assumptions that this downturn in China will eventually fade and growth will return later in 2013 or 2014. Long-term, I think it's still reasonable to expect low double-digit free cash flow growth from Yum! Brands, and that works out to a fair value in the high $60s today – not enough to encourage me to buy at today's price. 


Tickers in this Article: YUM, MCD, ARCO, PZZA

comments powered by Disqus

Trading Center