YUM Brands: Time For Major Changes

Feb. 3.14 | About: Yum! Brands, (YUM)

Yum Brands Incorporated (NYSE:YUM) has released its earnings expectations for full year 2014. YUM aims to make the world recognize the power of YUM Brands leveraged by global growth. The year 2013 definitely failed to meet expectations and disturbed the momentum of the company's continued growth. However, the company expects 2014 will be the year for YUM Brands to regain its lost status in the market. According to the company's presentation, investors are expected to receive a strong bounce-back in the form of a 20% EPS growth in 2014. In this article I would like to explore whether or not there are possibilities available for the company to take advantage of and achieve its goals.

YUM Brands Inc operates in 4 geographical segments: the United States, YUM Restaurants India, YR International and last but not least YR China. YR China contributed more than half of the revenue for the 3rd quarter of 2013 proving itself to be the heart of the YUM Brands business.

Source: 10-Q

Realizing the importance of the emerging markets due to the saturated market environment in the UK and USA the company aims to concentrate on opportunities in the emerging markets mainly in China and India. Along with other franchise partners the company aims to invest $10 billion in the emerging markets by 2020. Therefore I think it would be wise to focus on what those two markets have to offer YUM Brands Inc in 2014 and beyond.

YR China: Will it be Able to Recover?

YR China once a centerpiece in the YUM Brand's portfolio was eclipsed by the poultry scandals accompanied with the avian-flu outbreak in 2013. This was particularly devastating for YUM because all of the KFC's in China were under the company-owned and made up 10% of its global restaurant count. Therefore the company needed to satisfy Chinese customers regarding their health and hygiene concerns so that the situation did not worsen and lead the business towards the closure of its fast food restaurants. It seems that the company's efforts in advertising and its social media blitz labeled "I commit" to pull KFC out of a tailspin will not only proclaim KFC as safe but will also reignite the brand. This is evident from the 1% growth in KFC's sales in November in China and a 7% growth in Pizza Hut's casual dining. Out of the 1850 new international store openings the company plans to open 700 stores in China.

The Chinese New Year beginning Friday, Jan. 31 is considered a seasonally strong period for business and therefore YUM Brands had pushed its new restaurant openings to the first quarter to benefit from the in peak sales during the week long holiday. KFC's China sales were expected to improve but now it seems iffy as the spread of bird flu is once again threatening the restaurant's recovery. Shanghai is halting chicken sales for 3 months and Hong Kong for 3 weeks. It is anticipated that the flu fear and poultry bans will adversely affect KFC since it specializes in chicken meals.. It seems history is repeating itself as in 2013 KFC's sales in China significantly declined (see figure below) after an avian-flu outbreak and one of its supplier discovered the overuse of antibiotics. Although the bird-flu related death of more than 20 people was not linked to KFC the scare will definitely affect demand for chicken. This scenario casts doubt on YUM Brand's recovery and planned bounce back in China.

Source: Bloomberg

While China remains among one of the best retail opportunities in the world it is expected to be the world's largest economy any time soon. The Chinese consumer confidence interval is expected to rise from 98.9 to 99.36 but this really does not mean that investors will be interested in eating the same chicken products they used to eat 10 years ago. Increasing income levels have also affected consumer behavior and preferences and it is evident that the extravagance of adopting the Western culture, once a dream held by the Chinese, will soon vanish. This leads us to the conclusion that undoubtedly China will provide lucrative opportunities for YUM Brands but consumers will not want to try the same old menus offered by Pizza Hut and KFC. Also, the increasingly viral avian-flu will make customers more cautious about chicken meals at these restaurants. Taking into account the changing behaviors and sentiments of consumers and offering them exotic new menus can help YUM Brands to outperform other competitors and new entrants. Understanding the consumer pulse, Sam Su, the company's vice-chairman demanded the creative team refresh at least half of the menu every year. This revitalization can earn help the fast food chain earn a robust demand.

India can be the "Low Hanging" Fruit in the Future

YUM Brand's India division consists of India, Bangladesh, Nepal and Sri Lanka. Spotlighting the emerging opportunities in India, YUM Brands aims to have 1,000 restaurants in more than 100 cities in India by 2015. YUM Brands has seen the huge growth potential in India since there are only 2 restaurants per million people in the emerging markets in contrast to 58 restaurants per million in the U.S.

As far as the future outlook is concerned, India is on its way to becoming the world's 3rd largest economy after China and the United States. Driven by demographics, economic growth and the increasing number of wealthy people in India the population's preference for Western culture is increasing at a rapid pace in every aspect of life whether it is style or food. India has a casual dining market of approximately $94 billion 2% of which % is comprised of quick service restaurants and the remaining 98% is still unorganized. Expanding its QSR network in India by leaps and bounds can offer YUM Brands the first mover advantage despite the presence of competitors like McDonalds. By turning India into a major revenue contributor the company can soon receive positive earnings.

Source: CRISIL Research

Analysis: What's Hidden Behind the Numbers?

YUM Brand's Dupont analysis leads us to the conclusion that the return on equity generated by the company is mainly the result of the huge net profit margins. The asset turnover shows the efficiency of the company's management and has been at the same level through out the period under analysis. On the other hand, the company has tried to reduce its financial leverage over the time period. This scenario puts the company in a good position because the company can sustain its ROE if its sales and profit margins are stable and not jolted due to some kind of scandalised scenario. The ROE declined in 2013 but glancing at the demand growth drivers ahead we can easily predict it to gain a rising or stabilising trend.

Source: Company's Earnings Releases

Source: Earnings Presentations

Final Thoughts

When stuck in saturated markets, shifting focus towards emerging markets with enormous growth opportunities can prove to be a profitable initiative. YUM Brands aims to revamp itself due to the unhygienic conditions leading to avian-flu and poultry scandals in 2013. However, the bird-flu epidemic will certainly hinder its ability to regain growth in China. Therefore, the fast food giant should try to grab the market share in India rather than heavily relying on China's market otherwise, YUM brands will be putting all of its proverbial eggs in one basket. China's market is giving Yum Brands a tough time while the heavy investments in India will take time to payoff and become a major part of the company's revenue generating pipeline. Such a scenario makes it doubtful that the company will achieve its targeted 20% EPS growth in 2014. In this context, I believe it will be able to regain the luster it had lost by 2015 and therefore I regard it a candidate for long term investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by a Blackstone Equity Research research analyst. Blackstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Blackstone Equity Research has no business relationship with any company whose stock is mentioned in this article