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Yum Brands (YUM) is a corporation listed in the Fortune 500. It's a company which owns three main concept restaurants and has a global fan following, excluding WingStreet, which is a hybrid combo unit with the Pizza Hut franchise. This article will examine the potential of the company's stock to satisfy the appetite of its investors.

The Company

As I am covering this stock for the first time, it's worth going over the company's business model to determine how it makes money. Yum Brands is a corporation which owns Pizza Hut, KFC, Taco Bell, and WingStreet. The company either operates through its own concept restaurants, or through franchises. It also issues licenses to traditional and non-traditional restaurants. Traditional restaurants include dine-in, drive-thru and delivery services. Nontraditional outlets include express units and kiosks, having limited menus and lower sales. These outlets function in locations such as shopping malls, airports, gasoline service stations, and other places where it's impractical for a traditional restaurant to operate its business.

In terms of system unit, it is the world's largest fast food company that operates in more than 125 countries and has 39,000 restaurants operating across the globe. At the start of 2013, the company had hired 523,000 employees out of which approximately 85% were part time employees.

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The company has 3 main concepts (brands) through which it develops, operates, licenses, and franchises its restaurants. The main concept restaurants include Pizza Hut, KFC, and Taco Bell. Pizza Hut is the largest fast food outlet which specializes in selling pizza products. KFC restaurants offer fried and non-fried chicken items. Taco Bell offers Mexican cuisine, which includes tacos, burritos, quesadillas, salads, nachos, and other Mexican dishes.

Global Presence and Competition

At present, Pizza Hut, KFC and Taco Bell operate in 97 countries, 120 countries, and 27 countries, respectively. The company opened 315 new restaurants in the second quarter. 76% of these new restaurants opened in the emerging markets. The company considers supermarkets, supercenters, convenience stores, cafes, snack bars, and restaurants as its competitors.

Yum Brands and China

The company expects China to be one of the chief contributors to its financial success. Profitable operations in China will help in preserving the momentum and improve the company's financial health. In 2013, the company will open 700 new restaurants, all across China, and will try capturing the lower tier cities of this emerging market. The company believes that its strategy in China will contribute to its success as the consuming class in China is expected to grow from 300 million to more than 600 million in the next 10 years.

Source: Jefferies Global Consumer Conference Presentation

However, recent concerns such as investigations into China's KFC poultry supply and bird flu have affected the company's targeted goals and objectives. The company is expected to bounce back from this crisis the same way as it did in the case of Avian Flu and SARS. Business in China is expected to get better in the year 2014.

Moreover, the risk of business in China includes the economic/ political conditions, income/ non-income based taxes, changes in the regulatory environment, increased completion, and fluctuations in exchange rates.

Financial performance review

As per company's latest quarterly SEC filing, net income reduced 16.62% during the second quarter. Worldwide sales grew 1%. Sales in the US grew 2% while growth in Yum! Restaurants International was 6%. In contrast, sales declined 12% in China, due to the Avian Flu and poultry supply incident.

Worldwide operating profit declined 20% mainly due to the 63% profit decline in China alone, in the second quarter. EPS reduced by 15.3% over the second quarter.

Valuation

As per the Yahoo Finance analyst estimates, the next quarter average earnings estimate is $0.87. Second quarter earnings was $0.61, and the current price of the stock is $72.57. Based on this, the average price estimate is $102, making the stock undervalued at the present moment.

Financial Analysis

As per my analysis, the company is expected to announce a moderate cut in its dividend for the next quarter as the company in China is recovering from food safety and bird flu concerns. However, as per the recent market currents, decline in the Chinese markets was more than the 10% drop in June. This shows that fear due to the Avian Flu has not subsided and has severely affected KFC. Nevertheless, the company expects sales from Chinese restaurants to recover in the 4th quarter.

As per my relative valuation of the stock, though the stock may provide a cut in its dividend yet, the price of the stock would rise. If the business tends to gain momentum in China, it would boost the price and increase the dividends, as well.

The Global Expansion

The company is also expanding its business globally and targeting other emerging markets. The plans include expanding the business in countries like India, Russia, Kenya, Nigeria and Zambia. In 2013, the company plans to attain the shores of Tanzania, Uganda and Zimbabwe. Moreover, the company is planning to expand its business in Spain, France, Germany, Middle East countries, and continue enhancing its brand image and financial returns in the US.

The company invested $1.1 billion in 2012 and expects to invest the same amount in 2013. In addition to this, it plans to continue enhancing its franchise value and making long-term shareholders financially stronger.

Other Risks/ Concerns - Globally

The company identifies other concerns, such as safety of food and other food related diseases, could harm the business globally. Similarly, changes in commodity prices, an increase in operating costs, shortages/ disruptions of the delivery of food supplies, and outbreak of viruses/ other diseases could affect the company. Other risks include the manner in which the potential customer values and perceives the brand. Furthermore, failure to meet goals (globally) could affect the future sales.

Conclusion

I am bullish on the future of Yum Brands as the management is committed to expanding its business globally, i.e. China, Europe, and other emerging markets. Sales and profits in China will begin to improve as the company begins to recover in the 4th quarter of 2013. Currently, the stock is undervalued, therefore it's a good option for long term investors to invest in this stock.

Source: Yum Brands: An Appetizing Stock