Yum Brands Inc. (NYSE:YUM) is the world's largest fast food restaurant company in terms of system units, with more than 40,000 restaurants around the world in over 125 countries. Over the years, the company has grown larger, and back in October 2013, the company opened its 40,000th store in India. Yum Brands, owns and franchises the KFC, Pizza Hut and Taco Bell brands, and plans to expand further into different markets to fuel its earnings growth.
In the last twelve months, Yum Brands performed well, and its stock price climbed 15%. However, Yum Brands underperformed the S&P 500, which was up around 19.3% in the same period. The reason for the underperformance is justified by the fact that fast food chains are facing stiff competition from existing and new fast food brands.
Financial Performance Analysis
Yum Brands' impressive performance continued in the first quarter of fiscal year 2014. The company recorded double-digit earnings growth of 24%, excluding special items; the Chinese division's system sales increased 17% with an operating profit growth of 80%. Yum Brands recorded better than expected profits on the back of strong performance from China; however, the U.S. market remained challenging.
The top-line growth was primarily driven by a recovery of same-store sales growth in China, where Yum Brands generates half of its total revenues. The same-store sales in China showed an upward trend in the first quarter after declining for five consecutive quarters. Despite the growing numbers in China, the same-store sales in the U.S. market are still weak because customers are shifting eating habits away from fast food. In this situation, Yum Brands has targeted China and India, since these markets still offer a lot of growth potential for fast food chains.
For the first quarter, the company's net income increased at an impressive growth rate of 18% from $337 million to $399 million for the first quarter of fiscal year 2013. The bottom-line growth helped the earnings per share to grow to $0.89, beating the analysts' earnings per share estimate of $0.84 for the quarter.
KFC Expansion Plans
China and India remain separate divisions due to their strategic importance and growth opportunities for Yum Brands. To fuel the growth rate, Yum Brands announced a plan to aggressively expand its restaurant network, particularly in China and India. During the first quarter of fiscal year 2014, the Chinese division's system sales increased at an enormous rate of 17%. The sales growth was driven by 7% unit growth and 9% same-store sales growth. On top of that, the restaurant margins increased 6.8% to 23.4%, and operating profits increased to 80% for the quarter. These impressive numbers are evidence of the company's successful penetration in China.
KFC, the key brand of Yum Brands in China, has been facing a rough patch since the official media reported that the chicken the company purchased was fed an excess of antibiotics in late 2012. After the report, revenues dipped, and sales in China at established restaurants fell 4% during the fourth quarter of 2013. However, the situation has changed to some extent, and the company's initiative to upscale its KFC brand has helped the results of the first quarter. KFC's results continued to improve with an 11% same-store sales increase in the quarter.
Taco Bell is Another Integral Growth Factor
Taco Bell's entry into the U.S. breakfast market has created tough competition for McDonald's (NYSE:MCD). Most of the market believed that McDonald's recent weakness in U.S. sales was attributed to Yum Brands' Taco Bell. The company has been aggressively marketing its new line of products to attract customers, and this strategy has been quite successful. In response to the aggressive marketing, Yum Brands' share price has increased. In the first quarter, the Taco Bell division's system sales were even, and the 1% unit growth was partially offset by the 1% same-store sales decline. The operating profits declined to 16% due to Taco Bell's aggressive pricing strategy to increase its customer traffic. However, in the coming quarters, Taco Bell is likely to add some reasonable growth number to the total earnings stream, as the company has introduced the new breakfast menu across 5,500 restaurants. Although Taco Bell introduced the new menu too late to affect the Yum Brands revenue stream, the great start will bring some growth going forward.
Last month, Pizza Hut unveiled the Garlic Parmesan Pizza. Pizza, the second most common item on fast-food menus after sandwiches, rose 2.3% between 2010 and 2013 for all fast-food restaurants. With a nod to McDonald's, which has invested heavily in its breakfast menu, Taco Bell launched an ad campaign for its Waffle Taco breakfast, one of the few bright spots on the fast food menu.
Recently, Yum Brands announced the opening of the first KFC in Bolivia, with franchise partner, DELOSUR. The introduction of the first KFC in Bolivia reflects the reach of the KFC Brand and the company's expansion into the emerging markets. Yum Brands is keen to expand aggressively in the emerging markets, and this expansion will help the company to grow further.
Recently, Citigroup has raised its earnings per share estimates based on Yum Brands' impressive latest quarterly performance. The analysts at Citigroup revised the EPS estimates to $3.68 for fiscal year 2014, $4.44 for fiscal year 2015 and $4.86 for fiscal year 2016. The analysts also increased the target price by $10 to $85. Yum Brands is trading at $83.23, and looking at the year-to-date upward price trend, it is clear that this stock will go higher than its stated target price.
Disclosure: The author has 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 Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.