YUM! Brands, Inc. (YUM) is the world's largest restaurant company, operating more than 39,000 restaurants in more than 130 countries and territories. The company has annual revenues of more than $13 billion. Yesterday, the company announced its financial performance for 3Q2013. The company missed revenues and earnings consensus estimates for the quarter, mainly due to soft results in China and a tax increase. YUM has been struggling to post a healthy financial performance in the recent quarters, mainly due to its ongoing problems in China. I believe the problems faced by the company in China are short term in nature, and the stock remains an attractive investment opportunity for long-term investors, as the company is likely to benefit from its significant emerging market exposure and growing consumer spending in emerging markets.
Yesterday, the company reported total revenues of $3.47 billion for 3Q2013, down 3% year-on-year, missing analyst expectations of $3.53 billion. Adjusted earnings per share for the quarter came out to be $0.85, missing analyst expectations of $0.93, down nearly 15% as compared to the corresponding period last year. The company also registered a write down charge of $258 million or $0.55 per share, on the hot pot chain in China, Little Sheep. Earnings for the quarter were adversely affected by a higher tax rate, which had a negative impact of $0.07 on adjusted earnings per share. The company's top and bottom line results for the quarter were also affected by weak sales in China.
YUM is China's largest western restaurant operator, with nearly 6,000 outlets. Also, China is a key market for the company, as more than 50% of YUM's total profit is earned from China. In recent quarters, the company experienced a slowdown in its Chinese segment and had been facing problems to grow its revenues and earnings there. The problems YUM has been facing in China are attributed to a food safety scandal that emerged last year and an avian flu that broke out earlier this year.
The company's China business segment is not turning out to be a good recipe for YUM as of late. The company has been experiencing a decrease in sales in China since the last seven months, including an 11% sales drop in the last month, September. Same-store sales for the company's largest business segment, China, dropped by 11% in 3Q2013, as compared to 3Q2012. YUM experienced a drop of 14% in the KFC same-store sales and a drop of 5% in Pizza Hut sales in the recent third quarter.
Despite the ongoing challenges for YUM in China, I believe the country remains a key market that will fuel the company's future earnings growth. According to Morgan Stanley's estimates, China's GDP and consumer spending will triple within a decade. As Chinese consumer spending increases, YUM will benefit in terms of revenues and earnings growth, as almost 60% of sales and 50% of the company's profit is earned from China. The company has been expanding its outlets in China to benefit from growing consumer spending and tap available growth opportunities. YUM plans to open at least 700 new outlets in China in the ongoing year, 2013. Also, bird flu and food scare concerns are tapering off as we move forward, which will have a positive impact on the company's financial performance.
Sales of the company's U.S. segment for the recent third quarter remained flat year-on-year, missing consensus estimates by 1.5%. The performance of Taco Bell remained a bright spot for the U.S. segment, as same-store sales for the quarter increased by 2% year-on-year, whereas KFC and Pizza Hut experienced a drop of 4% and 1% year-on-year in revenues for the quarter, respectively. The company's international segment experienced an increase of 1% year-on-year in same-store sales for the quarter.
Emerging markets other than China also are among the key growth markets for YUM. As the company has significant exposure to markets like India, Middle East, Turkey and Africa, it is likely to benefit from growth in consumer spending in these markets. To avail the growth opportunities in emerging markets, YUM plans to open at least 1,850 new restaurants outside the U.S. in 2013. As the company continues to expand and strengthen its footprint in emerging markets, it will portend well for the stock price.
Since, as noted, China is the company's largest business segment, its soft revenues and earnings for the quarter adversely affected YUM's total operating margin, as shown below in the table. On the other hand, the U.S. segment experienced an improvement in operating margin of 340 basis points, as the company is targeting to improve operational efficiencies to attain earnings growth. I believe the U.S. segment's revenue growth is hard to achieve, as U.S. markets have matured; therefore, improving operational efficiencies and cost reduction initiatives remain key earnings drivers for the company's U.S. segment. The table below shows the operating margin for different reporting segments and for the company as a whole.
YUM! Restaurants International (YRI)
Source: Earnings Release and Calculations
YUM has a solid global footprint with significant emerging market exposure, which remains a key long-term earnings growth driver. The problems for YUM in China seem to fade away, as we move forward, and the company has been making the right moves to expand its outlets in China to benefit from growing consumer spending. Emerging markets other than China also remain important earnings growth drivers and YUM has been expanding its restaurants to benefit from growing markets.
As almost 80% of YUM's total revenues are earned from markets other than the U.S., and the company has been expanding its international market operations. I believe the company is on track to benefit from growing consumer spending in emerging markets. Analysts are also projecting a robust next five-year growth rate of 11.5% per annum. I believe the problems that YUM is facing in China are short term and are likely to fade away as we move forward; therefore, I believe the stock remains an attractive investment opportunity for long-term investors.