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Yum's Wide World Of Profit
In today's restaurant business the place to be is overseas, particularly the fast-growing emerging markets of Asia and Latin America. A good example of this comes from Yum Brands (NYSE:YUM), whose KFC, Pizza Hut and other brands span more than 110 countries across the globe and where over 60% of first quarter operating profits were generated outside the U.S.
The company's first quarter earnings growth of 19% (excluding special items) was powered by the strength of its non-U.S. markets, in particular China, which grew 12% in the quarter by the important measure of same-store sales. The strategy of fast international expansion primarily through franchises appears to be a good recipe for success against the woes of high food costs and sluggish U.S. consumer spending.
Picking a niche
Restaurant stocks, like other sectors under the consumer discretionary umbrella, can be a tricky valuation prospect in an era of seemingly unlimited choices for household budgets. When those budgets are expanding the question is, where will those incremental dollars go? Will they go to more weeknight dinners out at popular mid-scale concepts like Olive Garden, owned by Darden Restaurants (NYSE:DRI), or Romano's Macaroni Grill, owned by Brinker International (NYSE:EAT)?
Today's mood is far from expansionary, though, and with the Consumer Confidence Index reading a morose 62.3 for April, down from 65.9 a month before, a somewhat different question comes to mind: which of those consumer choices will see the dollars stop flowing to them? (For more on the CCI, check out Consumer Confidence Index: A Killer Statistic.)
Darden, Brinker and perennially popular Cheesecake Factory (Nasdaq:CAKE) are all currently 23-35% below their 52-week highs while Yum actually hit its 52-week high just a few days ago on April 30 when it hit $41.73 (it closed about 5% below that on Friday). McDonald's (NYSE:MCD), whose Dollar Menu is plenty friendly in recessionary times, is also currently trading about 7% off its one year high point.
Asia Loves KFC
Darden and Brinker have been the greater crowd-pleasers so far in 2008. Darden stock is up a bit more than 30%, and Brinker is up about 13%, while Yum is up about 4% year to date. Both Darden and Brinker have also benefited from generally positive earnings reports released this quarter. However, I look at near-term prospects in the context of attendant risks. What has a higher probability of occurring, increasingly stringent budgets will keep more U.S. families home for weeknight dinners, or that the rapidly growing Asian middle class will lose its taste for Colonel Sanders? There are more than 2,000 KFC outlets in mainland China and more than 1,300 more in the populous markets of Indonesia, Malaysia, Thailand, Taiwan and the Philippines. India, Korea and Saudi Arabia between them boast some 588 Pizza Huts.
Indeed, the top-25 markets for Yum's traditional stores - KFC, Pizza Hut, Taco Bell, A&W and Long John Silver's - read like a well-constructed emerging markets investment portfolio, with high-growth markets like Mexico, South Africa, Poland and Egypt alongside the sizable Asia presence. And Yum is also well established in the developed economies of Canada, Western Europe, Japan and Australasia. It will be interesting to see, though, whether the company is successful in extending its penetration of these markets beyond the traditional KFC and Pizza Hut formula to its other brands. For example, seafood chain Long John Silver's is only present in three countries outside the U.S. It has 30 outlets in Singapore oddly enough. Meanwhile, Taco Bell, the second-most profitable restaurant business in the U.S. according to a December 2007 Yum investor presentation, is still just tiptoeing into a handful of markets outside the U.S. and Canada. Brand expansion can be a potent factor in the growth equation, but the jury is still out on this one.
Conclusions
Costs are high and consumers are low. That's a bad recipe for U.S. restaurateurs. In other parts of the world from Mexico to Malaysia, middle class budgets are still growing. Yum has achieved a strong degree of penetration in these markets with more upside potential from brands that have not yet been fully exploited. This could make for a tasty investment alternative in a troubled sector.
For more on the tricky restaurant game, see Sinking Your Teeth Into Restaurant Stocks.
The company's first quarter earnings growth of 19% (excluding special items) was powered by the strength of its non-U.S. markets, in particular China, which grew 12% in the quarter by the important measure of same-store sales. The strategy of fast international expansion primarily through franchises appears to be a good recipe for success against the woes of high food costs and sluggish U.S. consumer spending.
Picking a niche
Restaurant stocks, like other sectors under the consumer discretionary umbrella, can be a tricky valuation prospect in an era of seemingly unlimited choices for household budgets. When those budgets are expanding the question is, where will those incremental dollars go? Will they go to more weeknight dinners out at popular mid-scale concepts like Olive Garden, owned by Darden Restaurants (NYSE:DRI), or Romano's Macaroni Grill, owned by Brinker International (NYSE:EAT)?
Today's mood is far from expansionary, though, and with the Consumer Confidence Index reading a morose 62.3 for April, down from 65.9 a month before, a somewhat different question comes to mind: which of those consumer choices will see the dollars stop flowing to them? (For more on the CCI, check out Consumer Confidence Index: A Killer Statistic.)
Asia Loves KFC
Darden and Brinker have been the greater crowd-pleasers so far in 2008. Darden stock is up a bit more than 30%, and Brinker is up about 13%, while Yum is up about 4% year to date. Both Darden and Brinker have also benefited from generally positive earnings reports released this quarter. However, I look at near-term prospects in the context of attendant risks. What has a higher probability of occurring, increasingly stringent budgets will keep more U.S. families home for weeknight dinners, or that the rapidly growing Asian middle class will lose its taste for Colonel Sanders? There are more than 2,000 KFC outlets in mainland China and more than 1,300 more in the populous markets of Indonesia, Malaysia, Thailand, Taiwan and the Philippines. India, Korea and Saudi Arabia between them boast some 588 Pizza Huts.
Indeed, the top-25 markets for Yum's traditional stores - KFC, Pizza Hut, Taco Bell, A&W and Long John Silver's - read like a well-constructed emerging markets investment portfolio, with high-growth markets like Mexico, South Africa, Poland and Egypt alongside the sizable Asia presence. And Yum is also well established in the developed economies of Canada, Western Europe, Japan and Australasia. It will be interesting to see, though, whether the company is successful in extending its penetration of these markets beyond the traditional KFC and Pizza Hut formula to its other brands. For example, seafood chain Long John Silver's is only present in three countries outside the U.S. It has 30 outlets in Singapore oddly enough. Meanwhile, Taco Bell, the second-most profitable restaurant business in the U.S. according to a December 2007 Yum investor presentation, is still just tiptoeing into a handful of markets outside the U.S. and Canada. Brand expansion can be a potent factor in the growth equation, but the jury is still out on this one.
Conclusions
Costs are high and consumers are low. That's a bad recipe for U.S. restaurateurs. In other parts of the world from Mexico to Malaysia, middle class budgets are still growing. Yum has achieved a strong degree of penetration in these markets with more upside potential from brands that have not yet been fully exploited. This could make for a tasty investment alternative in a troubled sector.
For more on the tricky restaurant game, see Sinking Your Teeth Into Restaurant Stocks.
by
Katrina Lamb
Katrina Lamb is an investment analyst based in Washington, DC, where she researches and advises on portfolio strategies employing a wide range of asset classes and means of investment exposure. Katrina has spent more than 15 years in the investment profession including a great deal time of living and working overseas in markets such as Japan, Southeast Asia, Central and Eastern Europe and the former Soviet Union. She is fluent in several languages including Russian and Japanese.
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