Thanks To China, Yum Brands Delivers

By Ryan C. Fuhrmann | October 10, 2008 AAA

Yum Brands (NYSE:YUM), known best for its KFC, Taco Bell, and Pizza Hut restaurant franchises, saw third-quarter earnings per share grow 16% from last year. A lower tax rate and share buybacks helped the company offset weakness in the U.S. and "unprecedented" commodity cost inflation, but management was confident enough to back its full-year earnings guidance, thanks primarily to solid growth in its international businesses, which should produce many years of robust growth.

Three Key Divisions
China is such an important region to Yum that it breaks out the results in its own division. For the quarter, sales in China grew an impressive 47% from $581 million in the same quarter last year to $854 million this year. This accounted for 34.4% of total company sales. Operating profit grew 19% to $161 million in the China Division for the quarter, demonstrating the significant and growing impact on Yum's overall results. During the earnings conference call, Yum's Chairman, President and CEO David Novak did suggest that growth in China could slow given overall concerns about a slowing global economy, but mentioned that even if Chinese GDP growth slows to 8% in 2009, from historical double digits, that will still qualify it among the fastest growth among major international markets. In other words, Yum expects Chinese expansion to continue indefinitely. (To get started on your own analysis, read Analyzing Operating Margins.)

Yum Restaurants International (YRI), which includes the rest of the company's overseas restaurants, eked out 1% revenue growth over the same quarter in 2007 but still managed an operating profit improvement of 9% as management kept a tight lid on costs. Total system sales (including company-owned and franchised restaurants) managed a 7% increase as same-store sales grew 4%, highlighted by greater than 20% growth in South Africa and the Middle East. YRI accounted for 23.6% of total sales for the quarter and had $138 million in operating profit.

That leaves the U.S. Division to account for 42% of sales but only $158 million in operating profit. Quarterly sales fell 1% on particular weakness at KFC, which management doesn't expect to turn around until sometime next year. Comparable sales at KFC fell 4% but strong trends at Taco Bell and Pizza Hut were sufficient to boost total domestic comps 4%. Anemic top-line trends were exacerbated by higher commodity costs for items such as beef, chicken, and cheese, which caused quarterly operating profit to plummet 16%. Given the unexciting growth prospects at home, Yum has focused on selling company-owned restaurants to franchisees, which provides more capital to repurchase shares and fund international expansion. (To learn more, read Is Buying A Franchise Wise?)

Dessert Time
Given the continued robust international prospects, management stuck to its guidance for the full year and expects earnings of $1.89 per share. At a current share price of 27.66 due to recent stock market volatility, that puts the price-to-earnings multiple at just under 15, which is quite reasonable given the overseas growth prospects and steady results that Yum Brands has posted historically. That compares favorably to archrival McDonald's (NYSE:MCD), which is the most formidable competitor to Yum both inside and outside of the U.S. But Yum is the undisputed leader in China and certain surveys count KFC as the most popular brand in the country, beating out well-known brands such as McDonald's and Coca-Cola (NYSE:KO).

Bottom Line
Add it all up and Yum's stock is worth keeping an eye on. Given the value proposition of fast-food operators such as Yum, Wendy's (NYSE:WEN) and Burger King (NYSE:BKC), this group should hold up well if the global economy continues to struggle. This value proposition is even more important in developing markets and the millions of new consumers that economic growth creates. Yum is at the forefront of this expansion and will continue to be for the foreseeable future.

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