Yum Brands - Pace Of China Slowdown Is Shocking

Dec. 1.12 | About: Yum! Brands, (YUM)

Shares of Yum! Brands (YUM) lost almost 10% of their value on Friday. The fast food restaurant operator known from franchises such as KFC, Pizza Hut and Taco Bell, reconfirmed its full year outlook and issued its outlook for the coming year. Poor performance of the Chinese division and a cautious outlook send shares lower.


Yum! Brands confirmed its full year 2012 outlook ahead of its annual investor meeting. Full year 2012 earnings per share growth is expected to come in at least 13%, with earnings per share coming in at $3.24, excluding special items.

For the full year of 2013, Yum! expects to deliver 10% earnings per share growth. Two weeks ago, the Board of Directors authorized the repurchase of $1 billion of its own shares to be executed before May of 2014.

CEO and Chairman David C. Novak commented on the results, "I'm pleased to report we remain on track to deliver at least 13% EPS growth this year. Our 2012 EPS growth is driven by double-digit operating profit growth, prior to foreign currency translation, in all thee of our major operating divisions: China, Yum! Restaurants International and the US. Solid same-store sales growth at each of our division and record international new-unit development highlight the quality of our growth."

Some Warning Signs

For the current fourth quarter, Yum! sees stronger than expected performance in the international division and in the US. Same store sales are expected to grow by 4% and 3%, respectively.

Strength is offset by softer sales in China. Same store sales in China are expected to fall by 4%, following a 21% growth last year. This would mark full year same store sales growth of 6% in China.

This year, the Chinese division has developed itself significantly. Yum! opened 800 new units during the year and has another 700 store openings planned for 2013. Yum! remains confident about the future of China's role in Yum!'s operations.

2013 Outlook

Yum! expects earnings per share growth of at least 10% compared to 2012, with earnings per share coming in north of $3.56 per share. Operating growth in China is expected to increase 15%, driven by an expected mid-single digit same store sales growth, and moderate sales leverage.

International operating profits are expected to increase by 10% driven by a solid same-store sales growth of 2-3%, new restaurant openings and margin improvement.

US operating profits are expected to increase by 5%, driven by a solid 2% same store sales growth.


Yum! ended its third quarter of its fiscal 2012 with $942 million in cash and equivalents. The company operates with $3.02 billion in short and long term debt, for a net debt position of $2.08 billion.

For the first nine months of its fiscal 2012, Yum! generated revenues of $9.5 billion. The company reported a net profit of $1.26 billion, or $2.65 per diluted share. Full year revenues could come in around $14 billion with earnings coming in around $1.5-$1.6 billion, or $3.24 per diluted share.

Factoring in Friday's 10% decline, the market values Yum! at $30.3 billion. This values the firm at 2.2 times annual revenues and 19-20 times annual earnings.

Yum! currently pays a quarterly dividend of $0.335 per share, for an annual dividend yield of 2.0%.

Some Historical Perspective

Year to date, shares of Yum! have risen some 13%. Shares rose from $58 in January to highs of $75 in April on the back of strong performance of the Chinese division. Shares fell back to $63 during the summer on fears of global consumer spending slowing down, but recovered after the strong third quarter earnings report. Shares are currently exchanging hands at $67 per share.

From lows of $24 in 2009, shares have tripled based on the strong international growth performance. Revenues grew roughly 30% from $10.8 billion in 2009 to an expected $14 billion in 2012. Earnings grew from $1.1 billion to an estimated $1.5-$1.6 billion this year.

Investment Thesis

Investors were not too happy with Yum!'s latest comments regarding its current and future performance. The company is becoming more and more reliant on its Chinese operations and it could obtain roughly half of its total revenues from the country in 2013.

While the Chinese economy is slowing down, growth is stabilizing around 7%. Despite the decent growth, consumers have cut back on spending given the slowdown, uncertainty about future macro-economic conditions and a recent government transition. This explains why Yum! expects to report a 4% decline in same store sales growth compared to a positive 21% last year. Competitor McDonald's (MCD) reported a decline in Chinese same store sales as well for the month of October.

I think shares are reasonably fairly valued, but I am negatively surprised by the weakness in China. The slowdown in Chinese same store sales growth has been significant. Third quarter same store sales grew by 6%, followed by a 4% expected decline in the fourth quarter.

In general the valuation is reasonably fair, however in the short term risks are towards the downside.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.