Tickers in this Article: YUM, MCD, SYY, AFC, CMG, ARCO, SBUX
The list of American companies that have done a better job than Yum! Brands (NYSE:YUM) of growing their brands and business in China is a short one indeed. In fact, YUM has been so successful in its international growth that it is now worth wondering if the U.S. business is still capable of being part of the company's future growth plans, or whether there might be some sort of "value-unlocking" transaction in the company's future.

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Second Quarter Results Tell a Story
Overall, YUM reported that sales rose more than 9% in the second quarter, surpassing the average estimate by more than $100 million, but not quite beating the highest estimates in the range. There are no two ways about it - China was the story here. U.S. same store sales fell 4% as Taco Bell and KFC were both weak, but Chinese same-store sales shot up 18% on 21% higher store traffic. The company's other foreign operations were a more moderate grower, with 2% same-store growth.

Margins are proving to be problematic. When protein producers like Tyson (NYSE:TSN) are showing double-digit sales growth and suppliers like Sysco (NYSE:SYY) are talking about persistent food inflation (to say nothing of the packaging and paper companies who supply boxes, cartons, and wrappers), that is no great surprise.

YUM reported that gross margin fell about 80 basis points this quarter, with food and paper costs climbing 13%. Operating income growth was limited to about 2% (and operating margin fell a point), and the company would have missed estimates if not for a sizable beat on the income tax line - all the more problematic given the decent revenue strength. (For more on gross margin and operating income, see Understanding The Income Statement.)

Is the U.S. Business a Help or Hindrance?
It is impossible to ignore the fact that China represented more than 40% of first half operating income and is growing at a very healthy clip.

In the meantime, the U.S. business is sluggish. Whether AFC Enterprises' (NYSE:AFC) Popeyes or Bojangles is grabbing share or not, KFC seems stagnant, and Taco Bell seems to be suffering from those past accusations regarding its food quality, to say nothing of a host of competitors in the pseudo-Mexican restaurant space like Chipotle (NYSE:CMG). Likewise, Pizza Hut is already ever-present and bumps up against the likes of Papa John's (Nasdaq:PZZA), Domino's (NYSE:DPZ), and a host of regional and local businesses.

Looking around the world, there seems to be considerable opportunities for YUM to open stores in India, Indonesia, Southeast Asia, South Asia, and Africa, and perhaps Latin America as well. With all of that growth overseas, do investors want the cash-rich but growth-poor U.S. business? It may not be so outlandish to think that the company could eventually see pressure to recapitalize and spin off the U.S. business. Not only would that give investors the option to invest in the kind of business they prefer (slow and steady or fast and volatile), it could also free up capital for YUM to get more aggressive with store openings or additional acquisitions (like the bid for China's Little Sheep). (If a company that you're interest in announces an acquisition, see our article on Analyzing An Acquisition Announcement.)

Few International Options
If YUM did spin off its international operations, it would be a decidedly rare asset in the markets. Like YUM, Starbucks (Nasdaq:SBUX) and McDonald's (NYSE:MCD) are internationally successful restaurant chains, but there is no way to separate the overseas potential from the domestic sluggishness. That makes a stock like Arcos Dorados (Nasdaq:ARCO) all the more interesting - as the largest McDonalds franchisee in Latin America, it's one of the very few ways to play international food service growth with a domestically-listed stock.

The Bottom Line
As a quality company with a great franchise, good returns on capital, and real growth prospects, YUM stock is seldom cheap, and today is no exception. It's a great stock to continue to hold for those who already own it, but it is harder to recommend as a new buy today, particularly with cheaper names out there in the stock market. Still, it is a name that should be on a watch list and scooped up on a 10% pullback. (For related reading, see Is Buying A Franchise Wise?)

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