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Executives

Rick Carucci – President

Steve Schmitt – Vice President, Investor Relations

Analysts

Alexia Howard – Sanford C. Bernstein

YUM! Brands, Inc. (YUM) Sanford C. Bernstein Strategic Decisions Conference May 29, 2013 2:00 PM ET

Alexia Howard – Sanford C. Bernstein

Okay, good afternoon everybody. I’m Alexia Howard, the US Food Analyst standing in for Sara Senatore, our Restaurant Analyst who will be back in a few months. It’s my great pleasure to welcome Rick Carucci, President of YUM! Brands to our conference this year, and he’s joined by Steve Schmitt, also of YUM! Brands, Director of Investor Relations.

Now Rick was appointed to the role as President of YUM! Brands in May of 2012 after serving as the company’s CFO since 2005, and he’s been with the company for twenty years. Rick, thanks so much for coming along and with that I’ll hand it over to you to tell us a little bit more about the outlook. Thank you.

Rick Carucci

Thank you, Alexia. Before I get into my main subject of building strong brands at YUM!, I’d like to start with another subject and that’s a… [technical difficulties]

A lot of you may know a bit about us but I’m going to give a pretty broad overview of our company right now, and there are going to be some forward-looking statements so our Safe Harbor Provision is in effect.

YUM! Brands is a global brand, becoming more and more a global company. We have 39,000 restaurants among 130 countries. We have three strong brands – KFC and Pizza Hut are very strong global brands; Taco Bell’s our strongest brand in the US but still in its early stages in international growth.

And running a global company and restaurant business, we’ve made the election to have versatile ownership. The majority of businesses franchise; we have company ownership as well. We’ve also run some creative schemes to get to one of those ownerships over time because we think that serves our shareholders best, being flexible ownership for different countries.

One of the things that is our trademark is that we have a very large and growing business in emerging markets. We believe we’re the clear leader in restaurants in emerging markets with over 13,000 units and it makes up, at least in 2012, close to 60% of our operating profit.

We’ve had a fair amount of success over the years. 2013 has been a tough year but before that we had eleven consecutive years of at least 13% earnings per share growth. You’ll see that a lot of that has been driven by our international success. Our 2013 outlook is tougher. We’re having a tough year in China. Our normal growth target is 15%; we’re going to be significantly below target. I’ll talk a fair amount about China in a little bit.

Our growth model, this is our model that we’ve had for a year or two and we expect to last a year or two more, would be 10% growth at YRI and 5% growth in the US, and we’re on target to achieving those. But because China will be significantly below last year when you do the math we’re still expecting a mid-single digit EPS decline in 2013 although China’s very hard to call. And you’ll see why in a little bit.

Some of you I recognize have followed our company for a while, and you see these strategies really have not changed much. So we’ve tweaked them a little bit over time but these are largely the strategies we had three years ago; these’ll probably be pretty close to the strategies we have three years from now and we intend to run the business this way. And I’ll talk more about them when I get to the individual businesses. What I’m going to do now is just talk about these four areas fairly briefly and then there’ll be plenty of time for questions and answers.

In China where we want to build significant leading brands in every significant category, although our models as we said are struggling this year the reason we have success ultimately in China is really based on history and based on the competitive situation, and based on what we think the market is going to do over time. It’s a powerful market. Historically, and for those of you who haven’t followed us why China is important is most of our growth is development-led.

So in that 15% earnings model that I showed, two thirds of that is meant to be unit growth. And you can see we’ve actually had 17% unit growth over the last five years. Same-store sales is becoming more important in that model. To get to 15% growth we’ve sort of assumed that we need same-store sales of about 5%. The five-year average, although the numbers fluctuate a lot it’s been 7% and China has been very profitable for us, compounding at 23% per year.

And we’ve had a pretty long history in China and especially the last decade has been very significant, and people have asked me about comparisons today to previous years. I think the most significant comparison would be in 2005. In 2005 we had a food incident, it was called Suzanne Red – it was a foreign product that got in the food supply, it had a significant impact on our business. And about six, seven months later we had the first onset of avian flu in China, so as our business was starting to come back we had a huge decline. And 2006 came back as a very strong year and then we’ve obviously been on a great run since then.

I think there’s some similarities, obviously some differences with every crisis. Here we had a much shorter timeframe. So the first poultry incident we had in China happened in late December but the publicity really ran through until the beginning of February. Just as things were starting to recover the avian flu hit again really right at the end of March, so as we were starting to recover we got a big hit in March. And some of you may have seen our same-store sales in April because of that: the total company was down minus 29% and for KFC it was down around 35%.

So we have a long way to go in order to come back, but one of the things we feel good about is our history. We have been able to come back from these things before and you also are able to bounce back more because a lot of our growth there is development-led. So those units are in the ground and when sales bounce back we’ll have a lot more units in the ground in 2014 than we have in 2013 and that we had in 2012.

People ask us what are we doing about the situation in China, and in just a second I’m going to show a commercial. This is on the air; it was on the air pretty heavily in February when we launched Operation Thunder. It’s still showing sporadically now. In addition to this we’re doing some things on our food supply that I’ll talk to in a second, but why don’t you see this commercial. [plays commercial]

What we’re also doing on the food supply is that we have reduced the number of farmers that would meet our standards for our suppliers, so about 1000 small farmers have been taken out of the system. And we don’t really want to be talking about how we raise chickens a year from now but the impression we want to leave people with is that we’re doing more than anybody else on food safety in China, and I think people really are starting to give us credit for that. And I think they sort of knew that all along.

Another reason we’re very optimistic about China is I mentioned the country itself is continuing to grow, and our competitive position there continues to grow. So within Tier 1 and Tier 2 populations, Tier 1 would be the largest four cities in China; Tier 2 would probably take you down to about City #30. Tier 3 and below there’s a lot of cities in that range and they make up 1 billion people. And you can see still most of the units today, a majority of those are in Tiers 1 and 2. But we’re shifting and more than 50% of the units last year were in Tier 3 and below cities and we expect that to continue.

Interesting, there’s been different reports on the economy in China. There’s a recent [Boston Consulting Group] report that came out that estimated between now and 2020 there’ll be 200 million more people in the consuming class in China, and 70% of those are estimated to be in Tier 3 and below cities. So we expect that the Tier 3 and below city will continue to grow. We think we’re particularly well-placed in those cities.

This compares us to our leading competitor McDonald’s in China, and we have a little less than a 2:1 advantage to them in number of units in Tier 1 and Tier 2 cities. However, when you get to Tier 3 through Tier 6 cities we have a 4x increase in number of units and that gap has actually been increasing over time. And we have continued to drive sales in that arena.

And then lastly we really like our competitive position, not just in Tier 3 and below where we have a clear advantage but if you just look at our brands are very well-loved. KFC and Pizza Hut are leading brands. We have an unbelievably strong team in China – really every function, our operations at the restaurant level are very strong. It’s the one country in the world we have a distribution system. We believe that continues to give us an advantage in the smaller-tiered cities because we’re able to get there more profitably.

The other advantage we have in the smaller-tiered cities is we have a development team, now over 1000 people. We have real estate folks everywhere and they’re able to scour the country to find the best sites in some of these smaller cities in China. And we have scale, and part of that scale is a $400 million advertising budget. So when you look at China in terms of our historical resilience, the growth we still expect there and our competitive position trust me, we’re as bullish as ever about our prospects in China.

Moving to some other businesses, in our YUM! Restaurants International business which makes up all of the other countries except China and India outside the US, it’s mostly a franchise business – about 90% franchising. And you can see it’s a large, growing business. So we had, we’ve grown in the past decade from about 7000 units to about 13,000 units. Our franchisees when you throw in our royalty rate has gone up a little bit during that period of time. We’ve also had same-store sales growth so we’ve been able to triple our franchise fees.

And on my last earnings call I called this earnings stream at YUM! Restaurants International global, growing, and large, and I also mentioned it’s diversified. And I think that we haven’t always shown our diversification but here it is: this breaks out sort of by continent the number of countries that we have in each of those geographies as well as the percent of mix of franchise fees.

I’ve been looking at this, and other than maybe I would like a little bit more in South American I think this is as well-diversified a portfolio as you could ask for. And I often get the question what do people miss about our company, and I think the thing that they may miss, one I’ll come to in a little bit is the runway for growth that we have; but second is this growing, large, global, diversified portfolio. I think that people may underestimate the multiple for that business. We have no single country that’s more than 10% of that portfolio. It’s growing at the rate that you just saw and I think the diversification is second to none in the business.

The market that we have as a separate division now is India. I always say that any time your population begins with a “b” you’re in a separate category. India’s got 1.25 billion people so we think that we could have a very large business there. It’s a younger population than almost anywhere in the world. It’s growing as well, and the economy’s growing so people estimate it’s going to have the largest consuming class in the world by the year 2030 if current trends develop.

We’re excited to go in there with really all of our brands. We actually started there with Pizza Hut. KFC, we really got serious about seven years ago; Taco Bell we just started a couple years back. But in particular I think KFC in the medium term can become a large, growing and profitable brand in India and partly because it’s a very aspirational brand today. I love the positioning there. You have a great team there; I love the way they’ve positioned the brand.

We have a very strong base of fried chicken but we’ve also early on in our development learned the thing that China did well, or that McDonald’s has done well in Western Europe and that is having sales layers of multiple day parts. So we have a non-fried business that’s growing with grilled chicken. We have a great drinks and desserts business – it’s our highest beverage business in the world in India, and we have sort of two opportunities that we’re tackling especially this year.

One is vegetarian. Taco Bell and McDonald’s because of their beef challenges in India, they actually have 50% of their menu by our estimates is vegetarian. We’re less than 10%. So we love the fact that people love chicken and that they’re eating a lot of it but we actually see we have an opportunity to grow on the vegetarian side of the business. The other opportunity we think we have is on the value side of the menu. Although we thought we had great prices we introduced sort of smaller portions and more sncakable items at ₹25 and ₹50 which is $0.50 to $1.00. So we just launched that in Q2 and we’ve liked what we’ve seen so far there.

And whenever you’re starting a new business there’s two things you look for. One as I mentioned already is you really want your brand to be aspirational; the second is you want to make sure you have good unit economics. We have both of those things going for us in India so we’re very bullish there.

Moving to the US, and the US and our strategy there is to dramatically improve our brand positions, consistency and returns. And I think there’s three factors that are helping us in the US. One is our ownership piece, the second is development and the third is the reliance on Taco Bell. I’ll briefly touch on those.

In terms of franchise ownership, a decade ago we had about 25% of our units were company-owned, 75% were franchise. Are target is to have 90% franchise. We’re just about there now, we should be there by the end of this year. So that’s given us more consistency, should give us more consistency as we go forward because you have less volatility in a franchise business.

The second thing we want to do, and this we’re trying to do around the world is to grow sales layers. I mentioned that briefly when we talked about India, but the best businesses we think in restaurant land are the people who are able to build day parts – so they have a strong breakfast business, a strong snacking, strong late-night business and they have different varieties of foods.

So in the US context there’s sort of three, one for each brand that we’re working on that we’re trying to make progress on for this year and early next year, that we think will be drivers for the business in 2014 and beyond. On the Taco Bell side that’s breakfast – we have breakfast in about 600 units today. We’re going to have sort of a re-launch of breakfast in those test markets in the summertime with the hope of launching nationally in 2014.

On the KFC side of the business the sales layer we’re going after is catering. We don’t think anybody in quick service restaurants other than Chick-Fil-A does that effectively. We think our food is very well suited for that. This year we’re working on getting that into more restaurants. We already have 2000 now franchisees who are able to do catering orders. We expect that to grow throughout the year and we’ll be ready to turn on the marketing towards the end of this year.

And on the Pizza Hut side we’ve always sold wings at Pizza Hut. We’ve had branded wings now for quite a while called WingStreet but that’s, until early this year that was only in 50% of the units. We’ve unlocked and we’ve worked with incentives with our franchisees, a bit of a stick and a hammer. We expect to get to over 75% of units with WingStreet by the end of this year which will allow us to nationally advertise on our way to 90% to 95% of the system. So we think by having WingStreet everywhere at Pizza Hut that’ll give us a good platform for growing that business in 2014 and beyond as well.

And the third thing I said is we’re now more reliant on Taco Bell as a business, and we did the re-franchising. We now have 5% ownership of KFC, about 7% ownership of Pizza Hut but we’re keeping Taco Bell ownership at about the 16% range so we’re going to be more dependent on them as a brand. We think it’s a brand we have in the US that has the most excitement and has the least competition.

And we’re pretty happy with the results so far this year. In Q1 we had 6% growth on top of 6% same-store sales growth last year. We just surpassed with the launch of Doritos Locos Tacos, the launch of the Cool Ranch product, we’re now over 0.5 billion Doritos Locos Tacos sold.

One thing that’s really changed on the Pizza Hut side of the business and that we’re changing at Taco Bell is product development. If you look at our US business I think it really underperformed until last year if you look at it over a series of years. And one of the challenges where we’re losing units is year-over-year. We were gaining slightly at Taco Bell but we were losing units at Pizza Hut and KFC.

We now still have a slight decline in units at KFC but we’re increasing net units at Pizza Hut this year significantly so we think we’ll be in a net unit range of about 150 units which 2.5% growth or so, which is much better than we were declining at about a 1.0% rate the decade before that. But Taco Bell took a page out of Pizza Hut’s book and is trying to grow more in rural America, and we think that’ll unlock growth.

So we’ve had about a 50% unit growth at Taco Bell the last couple of years, or about 1% growth that would represent. We think we’re going to move that to over 2% growth next year and hopefully be able to take that a little further with the rural development. And like I said, we’re happy with Taco Bell. It now makes up about 60% of our US profitability and as I said, it’s a vibrant brand.

What I’m going to do now is show you a video with three things on it. First is a current commercial we have for Taco Bell on the Cool Ranch Doritos Locos Tacos; second is a product we’re going to be launching later this year, the commercial for that product; and the third thing is just a video that shows what we want the brand to stand for. Hopefully you’ll agree that the commercials are representative of the brand that we want it to be. So if you could please show the video… [plays video]

So we’re very happy with how Taco Bell is positioned right now. Just as a little anecdote, that first commercial is called “Her First Kiss.” The director kept the two, the young actor and actress away from each other until right before they shot the commercial, and then after the first kiss the look on her face she got in the first take, which I think because he kept them apart and apparently the guy was ready for more takes but it just didn’t work out for him. [laughter]

What I’d like to do now is to sort of just talk about what this means for shareholder value and returns, and we sort of had what I put up there earlier, our fourth strategy – drive industry-leading long-term shareholder and franchisee returns. Obviously we want to get the returns for our shareholders and it’s important for our franchisees to have strong returns so that they can continue to invest and grow their brands.

And we know in our industry, the way you build shareholder value is you have to build new units, get same-store sales growth and invest in higher returns. I’ll just talk a little bit about the new units side and the returns side.

I mentioned before that we’re the leader in emerging markets and one of the things I’m probably particularly proud and excited about our company is really what’s happening in emerging markets. When I started in international business, it was my first year in international business in 1987. The developing world was not growing. I think one of the great trends to me that’s occurred in business is the poorer countries are getting richer.

If I go back to the BRIC countries twenty years ago, Brazil had hyperinflation, Russia was communist, India was a mess and China was communist and it was a closed economy. And today all of those countries are growing as well as a lot of other emerging markets around the world. So I think it’s great for mankind and it turns out it’s good for YUM! as well.

You can see the lead we have in emerging markets versus our nearest competitor and that lead is growing. So we now have over 13,000 and that’s beyond China. We’re outgrowing 2:1 outside China in emerging markets so we feel very good about what’s happening in this growing part of the business. And the great thing about it is the runway for growth there is just so long.

In the US we have 58 restaurants per million people. If you take the top ten emerging markets around the world we have two restaurants per million people. So clearly the runway for growth in emerging markets, and people have asked us what our growth rate is in the future – we’ve said we could grow, we grow at least 10% earnings per share growth is our goal. When you do the math now it gets to a growth rate of about… If we hit the targets I said about 12%, 13% - a little bit of a cushion to get to 10%.

When we do the math out in 2020 it’s the same thing – it’s about 12% to 13% operating profit growth and earnings per share growth. And if anything I think whoever’s going to be standing here in 2020 is going to say the same thing about ten years later because the emerging markets at that point may be up to four units per million people with a great runway ahead of it.

Having said that we always want to be responsible of where we invest our capital. We are increasing our exposure to emerging markets. We’ve added equity units in Turkey and Russia and South Africa over the last several years. But we’re going to be very prudent with our capital and we think this is one of the areas that we do a pretty good job of. We refranchise markets when we think it’s appropriate and that’s raised our RIC from 19% to 22%. We’re going to take a hit on that this year a few points because of China but we then expect that to bounce back again in 2014 and beyond.

And then the last thing that makes me happy about our company is just I think how we’re positioned with employees and prospective employees. This is sort of our vision, to become the defining global company that feeds the world. And clearly people today want to work for a company that has a purpose, etc., but I think the other thing they want is to work for a company that has a great culture. And I think the culture that we have at YUM! is a really high energy culture.

When you think about people wanting to work for our company we have a lot of things going for us. One is the person who works in our company, we’re a decentralized business so you have a lot of authority into whatever position you have in our company. Second, we’re growing so there’s more career opportunities in growing companies; and third, we have a culture that people really like.

So we’re getting people to come to our company for lateral moves from some of the best companies around the world because they like that combination of characteristics we have as a company, and that’s what makes me more bullish than ever that we’re going to be very successful in 2014 and years to come. So thank you very much.

Question-and-Answer Session

Alexia Howard – Sanford C. Bernstein

Great, thank you so much, Rick. If people have any other questions please feel free to write them down on your cards and we’ll make sure we get them into the Q&A. Can you hear me at the back? I’m seeing some of that… Thank you.

Okay, so why don’t we kick start the Q&A here. I’ve got a lot of questions about China and maybe I’ll just throw in a couple of them to begin with. Can you talk about how the comps are now trending in the wake of the most intense phases of poultry supply issues and the avian flu PR issues – to what extent those events created a competitive opportunity for your peers? Thank you.

Rick Carucci

Yeah, I mean obviously it’s been a big challenge for us. As we were starting… Our worst period of time with the poultry supply we were actually down 40% and we started coming back, and then avian flu as I mentioned started hitting at the end of March. So April our total comps were minus 29% and KFC was worse than that, so clearly we have a long way to go.

It’s really hard to predict how that’ll shake out. Our best estimate is still that we think we’ll be composite in Q4. That’s about as long as previous issues have taken to sort themselves out with the consumer. We think we have some great programs coming in Q4 with new product news as well and we’re lapping previous numbers from Q4 2012. So that’s our best estimation but to be honest it’s an estimation because as you can tell we have a long way to go.

I don’t think there’s really been a lot of space for any individual competitor. Our biggest competitors are chicken – McDonald’s, most of their menu is chicken as well in China so they’re in the same boat, not as big as extensive as we have. We’re still adding a lot of units so we haven’t really taken the foot off the gas on development for when the business does bounce back so I don’t think it’s really helped any particular competitor that I can think of.

Alexia Howard – Sanford C. Bernstein

Great. Sticking with the China theme but a very different topic, do you see any change in Chinese consumers’ taste preferences, particularly preferences around healthier food options?

Rick Carucci

I’ll talk to healthier foods outside of China in a little bit. I think that there’s just more choice in some of the Tier 1 cities. If I look at our industry I always sort of say we compete with everybody and we compete with nobody because if you play your game right you can be successful, but there’s so many different restaurants that everybody can take a little bit of your business. And I think in Tier 1 cities in China today there’s just a lot more choices.

Shanghai, I remember when I first went to Shanghai the bicycles owned the road and now you can get any type of food you want in Shanghai. So there’s a lot more say, not direct competition but tangential competition in those markets. I don’t really think that the taste of people has changed that much. I do think that Western food and food from outside of China has become more accessible because there’s us, McDonald’s, there’s Starbucks, there’s other players that have come into the market. I think we probably help each other out in that regard and we’re trying to bring that to the lower-tiered cities.

In terms of healthy eating in general, I do think that that’s something, a trend that we’re obviously keeping our eye on – and not only keeping our eye on, that we’re acting towards. We want to have healthier options and I think different countries are in different states. So we have healthier options, for example in China we have vegetables and we sell a fair amount of those. We have a lot more of what we think of as healthy choices in China but really around the world we’re offering healthier alternatives and we’re continuing to challenge our teams to develop great tasting, healthy foods.

We know in our category we have to be great tasting but we also believe that people are starting to… People have always talked about eating healthier; I think more people are actually starting to follow through on that and clearly we’re going to be ready for that.

Alexia Howard – Sanford C. Bernstein

Great. I’ve got a couple questions here about comparisons between India and China. The first one is about are there similar supply chain challenges in India as in China, just in terms of the way the operations are set up? What are the similarities and what are the differences?

Rick Carucci

Well, it’s interesting. Again, both countries are huge – 1.25 billion people plus – and both are pretty spread out so there’s a lot of large cities. So even in India today… In China I mentioned the advantage we had is we went into Tier 3 and smaller cities, so depending on how you count cities but we now think we’re in over 800 cities in China. And we’re in about 200 cities for Pizza Hut [diners] to put that in comparison. India, I think both McDonald’s and YUM! learned the lesson of let’s go to some of these smaller cities earlier so even though we only have a few hundred restaurants for KFC in [India] we’re already into 40 cities, about the same thing as McDonald’s. So that’s one thing.

Regarding the supply chain itself, it’s interesting – when we started in China we got into supply chains for defensive reasons. We felt we needed to control the supply chain to maintain the food quality that we felt was necessary, and then it became an offensive weapon and we were able to have superior economics in these smaller-tier cities when you got to the interior of China. In India there are supply chain challenges but we don’t think distribution companies are the issue – the issue is transportation.

The distribution companies are very professional and we are comfortable outsourcing distribution; however, they have challenges with the infrastructure. So you have power issues that go out, the transportation is not nearly as advanced as it is in China. So those are challenges that our distributors have but we still think the right decision is not to own our distribution.

Alexia Howard – Sanford C. Bernstein

Okay. As you think about the sustainable margin rates for the businesses and in China in particular, but maybe you can comment on India as well, are there issues as competition and costs continue to rise in the Tier 1 cities? Will the margin rates continue to fall on those businesses or can the lower-tiered cities’ stores offset that?

Rick Carucci

Well I think that’s exactly the balance. I do think, I mean we have been more challenged in margins in Tier 1 cities primarily because of rents. We mentioned there’s more competition over all but there’s also competition for rents. So as leases come up in the Tier 1 cities the rents are higher and sometimes we have to move because we can’t afford those rents. I think we’re probably a little more than halfway through those leases coming up, so we’re still going to have leases that come up over the next four or five years that are going to put some negative pressure on margins in Tier 1 cities.

Now we’re combating that by we’re becoming more and more differentiated by price based on trade zone. So we used to have four different prices that we would charge in China; now we have about 14 different prices that we’re charging. So we’re trying to segment even within Tier 1 cities a little bit more on our pricing to help offset those cost pressures.

So that is a bit of a headwind, however we do have this other tailwind that you mentioned is that we are having more and more of our growth in lower-tiered cities and currently we get higher margins in those lower-tiered cities. So that’s sort of a tailwind coming away and that basically offsets those, which is why we think about 20% margins as a pretty good margin going forward.

Alexia Howard – Sanford C. Bernstein

One more on emerging markets in general – which brands and in which geographies will have the largest allocations of your investment capital over the next three to five years?

Rick Carucci

Well China still because we’re having a lot of units in China, we’ll still have the most. But we’re adding in some other places significantly. I put them in two categories. First of all about developed markets, I know the question was emerging markets: because for us we were so far behind in Western Europe to McDonald’s that they were more like an emerging market for us, so we’re still putting capital into France and Germany.

For example, Germany is actually one of our star performers this year in Western Europe. Western Europe has been pretty tough overall because we got to enough scale that we can do television advertising. We have a little bit more scale than that in France and now we’re increasing the number of weeks of television advertising. So we’ll continue to put some capital there but not necessarily proportionately more than we have the last few years.

Where we’re adding capital on the emerging market side is Russia, South Africa and Turkey. South Africa is a bit of an anomaly in that we really bought units in South Africa for two reasons – one was to help our development, put a little bit more pressure on our system in South Africa to develop; but the leading reason we bought it was to help us expand in the remaining parts of Africa so we could bring people in to train, develop operators to serve throughout the African continent. So we have a long way to go to Africa, but when you talk about markets can be big in the years 2020 and beyond I think Africa definitely has that potential.

Russia is a market that McDonald’s does extremely well. They started with a significant lead over us but we’re very happy with what we’re seeing. We have had the highest growth rate in same-store sales in Russia the last few years than any other country in the international business and we like the returns we’re getting on our new units there, so we’re going to continue to invest into new units. And Russia, it’s interesting – you go outside of Moscow, those units are pretty inexpensive. But in Moscow and in some of the major cities those are pretty expensive units that we’re building because we’re trying to build more drive-throughs there.

And then Turkey we just acquired from our franchisee… It’s interesting, we just acquired that business a month ago and part of the reason we acquired it is we wanted to develop it more. For various reasons the existing franchisee wasn’t able to develop. Even with just seven months to run the business this year we think we’re going to add 20 units. So we think that we’re going to add a significant amount of units over the next several years in Turkey.

Alexia Howard – Sanford C. Bernstein

Let’s migrate back to the US a little bit as we’re closing. Taco Bell has a history of over twenty years of spiking up with innovation but then it can sometimes fade. As you think about the Doritos Locos Tacos innovation how can you make that kind of thing sustainable over multiple years?

Rick Carucci

Well, I think there’s two ways you try to make it sustainable. One is just the ideas themselves. The two biggest ideas we had last year, one has been the Doritos Locos Tacos and the good news there is there’s more flavors. So we went with the big two first – we did Nacho last year, we went with Cool Ranch this year. The next one we’ll do will be a spicy flavor and then there’ll probably be some opportunities beyond then. So we’re trying to make that a mini layer and just not a product. So for example we still have Nacho Cheese Doritos when we launched Cool Ranch, so it’s not an in and out product – it’s two products replacing sort of the sales of one.

The other big initiative we had was Cantina Bell. You saw in one of the videos Lorraine Garcia, the chef there has helped us develop the Cantina Bell line and that’s interesting because Doritos Locos Tacos is really for our existing customer – we call it the [fastball down the meat]. We were pretty sure that was going to be popular. Cantina Bell is more of an upscale product. If any of you have tried the product you’ll know we see the high quality rice, beans, and chicken on bowls is where we started. But we continue to innovate off of that.

That has a smaller percentage of mix but will maybe be more important for the brand because there, we don’t have great reads of who our consumers are of each product but anecdotally we’re seeing a lot more females, a lot more people at lunch eating inside the restaurant with the Cantina Bell products. So with our initiatives what we’re trying to do is, instead of having products come in and out we’re trying to build mini layers. But more importantly we’re building day parts and other layers which is why breakfast is ultimately so important for us at Taco Bell. Right now we have 1% mix. If you take it nationally at breakfast McDonald’s is in the 20%s – that gives us a long runway to be able to do it.

The good news for us is if we just convert the Taco Bell user to Taco Bell breakfast, forgetting about the people who eat fast food at other places – just the people who eat fast food at Taco Bell for lunch and dinner and then go to other places to get breakfast, if we just convert our share of those customers we think we’ve got a successful breakfast business. And similarly we’d like to do other things with snacking and drinks to build over time.

Alexia Howard – Sanford C. Bernstein

Great.

Steve Schmitt

I think just one comment on that. The other piece is value is Taco Bell’s DNA so we’re never going to get away from that piece. And it’s important to have not only new products but tremendous value, and all of this leads to new unit development. So as Rick mentioned we went from, at least in the US system declining units now to unit advancement so that’s going to help not only Taco Bell but the rest of the US business.

Alexia Howard – Sanford C. Bernstein

Can you talk a bit about pricing strategy and how you price your products which may be different by region? Is it cost plus margin or is it relative to the competition, or is it some other approach that you take?

Rick Carucci

Yeah, I mean you have to look at all those things. What we try to do… I’ll talk about it within Taco Bell. Taco Bell, to the point that Steve made is we always know we’re going to need strong value on the low end. So our strategy is to try to have strong value throughout the menu. So Cantina Bell we see as great value, it just costs you $5 great value as well as having sort of the $1-type products there.

What we tend to do is have a higher percentage of our innovation though premium priced. So even if you look at Doritos Locos Tacos that’s premium priced to the base taco, more than enough to overcome our costs. And so the art of this stuff is to get the menu mix right, to have strong value throughout the menu and to have innovation that comes in. So by putting our innovation on higher-priced products we’re actually able to increase tickets without increasing pricing and that’s obviously much better from a consumer standpoint. So we try to do as much of that as possible, so our goal is to price less than inflation but still to raise tickets through other means.

Alexia Howard – Sanford C. Bernstein

Okay. And then as we’re coming to the home stretch here can you maybe talk a little bit about drivers of growth particularly around new store openings and what constrains that growth? How many new stores can you open each year?

Rick Carucci

Are you talking about in the US?

Alexia Howard – Sanford C. Bernstein

I guess maybe in both regions would be helpful.

Rick Carucci

Yeah, as we sort of said in the speech and as Steve alluded to just now, we’re very happy in the US. We had a 5.0% growth model for a while but trust me, it’s a lot harder to do that when you’re minus 1.5% on unit growth versus being plus 1.0% to 1.5% on unit growth. So that’s something that to get growth, the first thing you need is a business model that works. So we’ve been very cognizant of attacking the business model.

So for example at Pizza Hut we were able to turn around development. We basically tried to provide reliable value with the $10 menu pizza. We really attacked our supply chain and cost structure to be able to support that piece and then at the same time we developed units primarily meant for rural but other locations that we call [Delco Light] which is much more inexpensive to build. So we’re able to take a new unit opportunity that before we made those series of changes was probably about a six-year payback, a seven-year payback to a three-year payback and obviously that’s what gets franchisees excited.

So I think we’ve become more cognizant over the years of attacking the holistic business model to make development work. If you look at sort of emerging markets, usually what’s the limiting factor is how fast the economy grows and how fast trade zones develop. Typically we’re not sitting on trade zones for multiple years. We need them to develop and then as wealth occurs trade zones develop and we go in and we attack them.

Alexia Howard – Sanford C. Bernstein

Great. And then maybe just sort of a future-looking question to wrap up: if we were to go five, ten years down the road and look back at what came out of YUM! Brands that was unexpected or what we didn’t know back in 2013 about the company, for good or ill what do you think we’ll look back on in five years’ time and say “Gosh, I didn’t realize that that was a huge opportunity?”

Rick Carucci

I think what happens is that you end up getting some part of your business to pop that you don’t anticipate. I mean China for many years had 350 units and then jumped to 500, and then jumped to 650. And what happened is we have some part of the business pop. In the most recent case in China it was the dine-in business that hit on all cylinders when we made that be able to work in Tier 3 and below cities.

I think if you look at it globally the thing that could maybe make the biggest difference in five years that isn’t a definite but very possible is an acceleration of our Pizza Hut delivery business around the world. As I said, we’ve attacked the business model. We’re getting some traction there and the question is will that be a little bit of traction or a lot of traction? So in five years we’ll figure out what that is.

Alexia Howard – Sanford C. Bernstein

Great. I think we’re out of time. Thank you so much, Rick, for coming along. I really appreciate your commentary this afternoon and thanks to everybody else for coming along and to Steve. Cheers.

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