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Due to the breakout of avian flu and continued bad publicity of poultry issues, Yum Brands (YUM) same store sales in China fell 11% in its third quarter of this year. In order to overcome these issues, Yum has been taking several initiatives to regain customers' confidence. Along with its initiatives taken in China, the company is making huge investments in other emerging markets.

Initiative taken to improve KFC sales in China

Yum is still facing issues related to avian flu and poultry that started in 2012, which scared away diners from poultry products. This led to a substantial decline in Yum's same store sales in China. The company operates more than 6,000 restaurants under different brands and generates half of its revenue from China. In order to regain customer's confidence, the company invited customers to visit the poultry farms and kitchens. Yum is also giving away discounts, promoting and airing commercials regarding its food quality, and advertising menu alternatives like mushroom and shrimp rolls.

In addition, it will also introduce a new KFC advertising campaign this month in China about quality assurance. The ad campaign will feature more than 300,000 KFC employees, buyers, and poultry farmers in China. Yum is confident that its business will soon rebound and it will be successful in rebuilding customers' trust in China.

We are optimistic that avian flu is a short-term issue and soon Yum will get over it. In fiscal year 2012, Yum's KFC same store sales grew by 3% year over year. With the initiatives taken in the past and the upcoming ad campaign, we expect this growth to increase in the coming fiscal year.

Despite continued downturn in KFC business, Yum's other brand, Pizza Hut, is on track. The brand reported 5% year-over-year growth in its same store sales in its third quarter of this year. Pizza Hut has now become a leading Western casual dining concept in China. Around 20% of its menu is redesigned twice a year, and the company recently launched a new project with a Stone Pan Sizzling Steak. Yum is also planning to expand its breakfast menu, which poses a huge opportunity for Pizza Hut to grow in China. Currently Yum has 950 Pizza Hut Casual units and plans to have around 1,000 by the end of the year. In fiscal year 2012, Pizza Hut Casual Dining sales in China grew 10% year over year. Looking at its positive growth over the past few quarters, we expect this growth to increase in this year and next year as well.

Further, growth from Pizza Hut and Yum's other brands in China will compensate for losses from its KFC brand and post moderate growth 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.

Peer affected by avian flu

Yum's peer McDonald's (MCD) also suffered from the consequences of avian flu and poultry issues. McDonald's has been reporting negative same store sales over the past three quarters. The company incurred losses despite of having a wider range of items such as a fish burger, an alternate option for chicken, compared to Yum, which has a chicken specific menu for KFC. Chinese residents prefer chicken over fish, but due to the avian flu and poultry issues in China, they were resistant to consume chicken, leading towards decline in McDonald's same store sales. It recently stated that it might face a challenging fourth quarter, as it may continue to incur negative sales due to flu issues.

We are bullish on McDonald's. Please read: McDonald's: Can Loyalty Programs Drive Further Growth?

Huge potential lies in India

Yum plans to invest around $10 billion and aims to have more than 20,000 restaurants in emerging markets by 2020. The company will be opening its 40,000th restaurant, a flagship KFC restaurant, in Goa, India. By 2015, Yum expects to have system sales of about $1 billion from India, which includes company and franchises restaurants. When it comes to India, Yum foresees to have more than 1,000 KFC, Pizza Hut, and Taco Bell outlets in more than 100 cities across India by 2015.

For Yum, India is the key emerging market. India has a strong retail environment and is the sixth largest poultry consuming market in the world. Customers under the age of 35 are more attracted to western dining such as KFC and Pizza Hut. Yum has a huge opportunity in this rapidly growing population of more than 1.2 billion, with around 65% under the age of 35. The 'eating-out' market is estimated to be around $94 billion, out of which only 2% is organized with national and international brands.

Even though KFC is the leading brand and the fastest growing quick-service restaurant in India, Yum thinks Taco Bell may have bigger potential long term. Taco Bell could result in a big growth opportunity, as India has a huge population of vegetarian consumers. To capitalize on this opportunity, Yum is making efforts to localize the menu for Taco Bell. Indian residents are slowly adapting to different cuisines, and Mexican food has gained popularity among the youth. Taco Bell can capitalize on the Indian market, which is expected to grow by 25%-30% each year.

Dividend Analysis

Year

Dividend Per Share (in $)

2009

0.80

2010

0.92

2011

1.07

2012

1.24

2013

1.38

Yum Brands increased its dividend every year as depicted in the table above. Over the past five years, its dividend has grown at a CAGR of 11.52%. Assuming the same growth rate for next year, we get a dividend of $1.53 per share for next year. At the current stock price level, it is providing shareholders a dividend yield of 2.28%. Despite the downturn in its same store sales in China, Yum's business in the U.S. and other international markets has been posting positive results. Hence, it generates sufficient cash flow from other businesses, and we believe it will continue to bring in enough cash flow to increase the dividend as it has over the past few years.

Conclusion

Yum is taking several measures and efforts to regain its customers' confidence in China. Hence, we hope Yum's sales in China recover over the coming years. The company has a huge potential growth opportunity in India, and it can be a China-like opportunity in terms of growth. Also, investors can note that the company is paying dividends regularly. Yum's other brands in China, the U.S., and other countries are performing better. We view this stock as a good option for investors looking for a long-term growth.

Source: Yum Brands: Rewiring A Behemoth