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With over 40,000 restaurants in more than 130 countries and territories, Yum Brands (YUM) has expanded vigorously over the past few years. Its expansion is continuing at a staggering rate and the company is adding over five new restaurants to its chain every day. The company announced its intention to further add 1,850 restaurants in 2014 in its fourth-quarter earnings report and the company is planning to spend $1.2 billion as capital expenditure.

A large number of these restaurants are to be opened in growth markets of China and India on which YUM has a strategic focus. The company is planning to spend $1.2 billion in 2014 and wants to open 700 restaurants in China and 150 in India. The restaurant industry is forecasted to grow by a double digit rate in these emerging markets. YUM is positioning to gain from this growth.

In the recent fourth-quarter report the company gave a mixed performance in 2013. Its revenues were short of analysts' consensus estimates by 80 million. However it's per share earnings of $0.86 beat analysts' estimates of $0.80. The market took it positively and share price gained 4% the same day earnings were released on Feb 3rd.

If we look at the financial results of 2013 we find that YUM's consolidated revenue decreased by 4%. Revenues from the China division were flat with almost no growth. The YUM! Restaurants international division had a negative revenue growth of 6% and the US division had a negative growth of 12%.

Consolidated operating profit decreased by 22%. Operating profit from the China division did not grow. The international division produced a negative growth of -6% in operating profit. Only the US division showed increases in its operating profits.

It was mentioned in the fourth-quarter earnings report that comparable store sales in the China division fell 4% while the US comparable store sales were down by 2%. This is not good news for investors who expect good growth in the emerging markets. The YRI segment experienced a positive increase of 2% in the US.

In 2013, YUM struggled in its strategic growth market of China. It was substantially affected by safety concerns regarding KFC poultry suppliers at the end of 2012. China is a market with a rapidly growing middle class that makes it a big target market for companies like YUM but with the growing income levels of the Chinese the nation is increasingly becoming concerned about the safety of food. This is a challenge for Western restaurants that are now under intense public scrutiny in China. Avian flu cases also badly hurt YUM's performance.

In his message in the fourth-quarter earnings report, David C. Novak, Chairman and CEO, said that YUM is strengthening its supply chain through its Operation Thunder initiative and that the company is taking measures to improve customers' perception of KFC's food safety. YUM needs to be very cautious about food safety in China and needs to protect its brand image from erosion if it wants to realize the expected growth in this exploding but competitive market. YUM faces competition from its rival McDonald's (MCD) and a large number of other large and small Chinese restaurant chains.

The US division has been facing challenges over the past few years. Uncertain economic conditions and depressed customer spending is one of the reasons for YUM's stagnant revenues. Another culprit of YUM's stale performance is the intense competition from other QSRs such as McDonald's that are struggling to grab the market share in the saturated US restaurant market.

The third big challenge for YUM in the US is the competition from fast-casual restaurants that are promoting their food as healthier than traditional QSRs. With increasing health concerns among customers in the US, QSRs are finding it difficult to defend their market share. QSRs were unable to grow their customer traffic in the past five years while fast-casual restaurants enjoyed high single-digit growth in customer traffic over the past few years. These fast-casual restaurants such as Chipotle Mexican Grill (CMG) and Panera Bread (PNRA) are gaining double-digit revenue growth. This is now a big challenge for YUM to grow in a highly competitive and saturated US market. Inflation in supplies is another big problem that caused a big hit to the company's margins. Intense competition is restricting YUM from increasing its menu prices to keep its margins intact.

Despite this negative growth, YUM has given an EPS guidance that will offer investors some respite. YUM has indicated an EPS increase of 20% for 2014 and indicated that the company is all set to turn around its 2013 performance. This earning guidance is one of the important factors that supported the share price and caused it to bounce back. We shall see how YUM uses this to its advantage.

YUM still has a lot of space to grow internationally in many emerging markets especially in India. India along with other emerging markets is expected to offer significant top and bottom line growth in the future. YUM should keep expanding into emerging markets to ensure its continued top and bottom line growth in the future. YUM also need to focus on customers' demand for health food menus.

Conclusion

YUM faces many challenges in the markets in which it operates. YUM needs to strengthen its position in the emerging markets especially in its strategic growth market of China where the company is facing demanding Chinese customers and intense competition. Other emerging markets also offer growth potential. YUM has a huge foot print in the US market but it is currently facing many problems including depressed customer spending and intense competition from other QSRs. Fast-casual restaurants are also posing a threat for YUM. YUM is a strong contestant with strong fundamentals but a great number of challenges currently makes it an uncertain investment. I do not think investors should invest in the stock in the short run. They should wait and see how YUM tackles these problems in 2014.

Source: Yum Brands: Facing Enormous Challenges