Previewing Yum! Brands’ Fourth Quarter Results
publication date: Feb 2, 2014
author/source: Brian Nelson, CFA
Yum! Brands (YUM), the owner of KFC, Pizza Hut, and Taco Bell, will report its fourth-quarter results after the market close Monday. The quick-service restaurant giant is a global powerhouse with solid brands and strong cash-flow generating capacity. Yum! Brands has generated cash flow from operations of $1 billion or more in each of the past 10 years, with the firm pulling in more than $2 billion in each of the past two years. The company’s greatest growth opportunity resides with its KFC brand in China. Per one million people, there are just 3 KFC units in China. In other Asian countries, this ratio is closer to 20 to 1, implying significant long-term expansion in the country. China’s consumer class will grow to 600 million people by 2020 from 300 million people today, and GDP continues to chug along at a nice 7%-8% annual clip, even though this may be a bit less than economists are hoping for.
Yum! Brands, however, continues to suffer from the one-two punch of the poultry supply issue in December 2012 and the unexpected bout of avian flu in the spring. New concerns about avian flu keep coming up as well (the most recent a few weeks ago in Hong Kong). This has punished KFC China for most of 2013. Yum Brands preannounced its same-store sales performance for the fourth quarter earlier in January. For the fourth quarter, same store sales declined an estimated 4% for the China Division, which included an estimated decline of 4% at KFC and 5% growth at Pizza Hut Casual Dining. KFC China’s same-store sales increased 5% in the month of December, which was an improvement from previous months. We’re looking to hear how things in KFC China have been progressing in January in the release and/or on the conference call. In 2014, the firm will benefit from significantly easier same-store sales comps.
Yum! Brands expects a high-single-digit, low double-digit earnings per share decline in 2013, implying an earnings per share range of $2.86-$2.99 per share for the year (-8% to -12%). We’re looking for $0.80 per share in the fourth quarter, which would put earnings for the year at the low end of the guidance range (due to promotional efforts related to restoring its KFC brand in China). 2013 will be a humbling year, following consecutive years of 10%+ annual earnings per share expansion. We’ll be looking closely at the company’s margin performance in the quarter to see how well productivity and cost-controls mitigate potential de-leveraging. The company’s China division restaurant margin declined 190 basis points in the third quarter and fell 400 points through the first nine months of the year.
Looking ahead, Yum! Brands expects 20% earnings-per-share expansion in 2014 thanks to improvement in its China business followed by a return to a more normal 10% earnings-per-share expansion in 2015 and beyond (augmented by share buybacks). Though the 2014 growth expectation may be ambitious, the company’s unit growth potential in China is remarkable. We think management's focus needs to be on the long-term, and restoring its KFC brand image in China is paramount (shoring up its supply chain and carrying out its “I Commit” quality assurance initiatives). KFC is China’s #1 foreign brand name, ranking higher than Coca-Cola (KO) and McDonald’s (MCD). Yum! Brands expects to open 1,850 international units in 2014, including 700 and 150 in China and India, respectively.
On a discounted cash flow basis, we think Yum! Brands is worth about $60 per share, or roughly 20 times expected 2013 earnings and about 17 times expected 2014 earnings.