Seeking Alpha
Research analyst, oil & gas, tech, mid-cap
Profile| Send Message|
( followers)  

In China, Yum! Brands (YUM) opened its first KFC restaurant in 1987 and first Pizza Hut in 1990; today it operates total 6,000 restaurants in China. Its China division's comparable sales declined 10% in August, which was an improvement from a 13% decline in July 2013. The KFC brand has been facing issues related to contaminated poultry supplies from December 2012, which has continued to affect it in 2013. The decline indicates that customer frequency has gone down. To regain customers' confidence, it recently launched a campaign, inviting people to visit its chicken farms and kitchens. The company is also giving discounts, promoting and airing commercials regarding its food quality, and advertising menu alternatives like mushroom and shrimp rolls to win back customers' confidence. Yum! is optimistic that the comparable sales from its China division will see an upward trend in the fourth quarter.

Meanwhile, Yum! Brands' Pizza Hut, has now become the number one casual dining brand in China. There are more than 900 Pizza Hut restaurants in around 225 cities in China. Pizza Hut reported 5% growth in the August 2013, up from 3% growth in July 2013. This brand is developing rapidly in China, and we expect it to continue to drive in revenue for Yum! Brands' China division. The company is continuously improving its menu and trying to bring innovations that will help it attract more customers, accelerate its sales growth, and continue to be the number one casual dining brand in China.

Expansion in China

China is now shifting from its traditional food towards western food flavors. This trend is expected to grow in the coming years. With this shifting trend, China's fast food restaurant industry reached $74 billion in 2010 and is expected to grow at CAGR of 13% for the period of 2011 to 2014. This indicates that there is huge potential for growth for fast food companies.

Yum! observed the growth opportunity in China years ago and announced to open around 20,000 restaurants over the long term in 2007. Since then, it has been engaged in executing its long-term goal, and today it operates around 6,000 restaurants in China. This has helped the company attract more customers and gain maximum market share, which will help it generate higher revenue and earnings from China. In 2012, Yum! Brands' China division contributed up to 60% of the company's total revenue. With its long-term growth plan, we expect this division to continue to contribute higher revenue over the coming years, making China its major revenue generating division.

Total no. of units

2011

2012

KFC

3701

4260

Pizza Hut

701

987

Total

4493

5726

* As major revenue come from these two brands we have not considered other brands for calculation.

With these initiatives, we assume that it will drive in moderate revenue for this year. The company reported revenue of $6.89 billion from its China division in 2012 and $5.56 billion in 2011. Assuming the year over year growth rate of 24% for the total revenue as constant for this year, we estimate total revenue of $8.54 billion for the China division. We assume that KFC will contribute around 74% and Pizza Hut will contribute 17% to Yum! Brands total China division revenue.

Other companies expanding in China

Yum! Brands' major competitors, McDonald's (NYSE:MCD) and Burger King (NYSE:BKW), are also planning to open restaurants in China to expand their business in the Chinese market. McDonald's expects to have 2000 restaurants by end of this year. Burger King, which currently operates around 63 restaurants in China, plans to open 1000 restaurants in the country in the next five to seven years through a joint venture. This will help the companies expand their presence and portfolio in China. Looking at the changing preference among China's residents, restaurant expansion is likely to provide growth to all three companies in the coming years.

We are bullish on McDonald's. Please read here.

Valuation

Yum! Brands' stock has appreciated 11.16 % year to date, or YTD. The stock's trailing PE is 23.85 and has a forward PE of 19.18, which shows an upward trend in the company's earnings with an expected EPS of $3.79 for next year. The trailing PE of McDonald's and Burger King is 17.93 and 46.28 respectively, forward PE is 16.02 and 21.63 respectively, and each has an expected EPS of $6.11 and $0.92 for next year, which denotes a growth potential in each company's earnings for 2014.

Conclusion

Looking at Yum! Brands' initiative to regain customers' confidence, it should put its China division business back on track. Expanding the number of restaurants will bring meaningful growth to the company in the coming years. With these factors and the valuation metrics, the stock is a good option for investors looking for a long-term growth.

Source: Can China Take Yum! Brands For A Ride?

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Shweta Dubey, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.