Yum! Brands: Satisfy Your Cravings

| About: Yum! Brands, (YUM)

Restaurant stocks had a rough ride through most of 2006, but Yum! Brands (NYSE:YUM) is up 27% since we put the spotlight on it six months ago and it just delivered better-than-expected earnings again on Tuesday. This despite several challenges such as an E. coli outbreak last quarter at some of its Taco Bell restaurants and stiff competition at its Pizza Hut chain. Yum! Brands delivered 3% growth in net earnings, an 8% increase in EPS, and 4% revenue growth. The key to its resilience has been diversity as well as global growth, and the outlook is for steady growth ahead in earnings over the long haul.

Yum! Brands has an answer for just about every food craving. It operates over 34,000 quick service restaurants based on five themes: Long John Silver's, KFC (Kentucky Fried Chicken), Taco Bell, A&W, and Pizza Hut. The stock has more than doubled in the past three years, easily outpacing the broader market, as investors flock to it combination of growth and dependability.

Yum! Brands has delivered upside earnings surprises for four straight quarters. On Tuesday, EPS of 83 cents was four cents better than the consensus. For the year, the company posted earnings of $2.92 per share compared to $2.55 in 2005. Revenue was $9.56 billion in 2006, up 2% on the year. For 2007, Yum projected operating profit growth of 20% in China, 10% in its international division and 5% in U.S. operations.

Yum! has a track record of growing EPS at least 10% each year, and it's easily on a trajectory to top that again this year. The key drivers are opening over 1,500 new restaurants globally and growing U.S. same-store sales by +2% to +3%. Even Taco Bell is expected to bounce back from the E. coli scare and deliver 1-2% same store sales growth in 2007, according to the company.

Formerly known as Tricon Global Restaurants, the company changed its name in 2002 to Yum! Brands Inc. Its principal activities are to operate, develop, franchise and license traditional restaurants and non-traditional restaurants. Traditional restaurants prepare, pack and sell food items through dine-in, carryout and drive-thru or delivery services. Non-traditional units include express units and kiosks that have a limited menu and operate in non-traditional locations like airports, gas and convenience stores, stadiums, amusement parks and colleges.

One potential concern for investors about this company is its debt. Yum! Brands has a debt/equity ratio of 1.58. Anytime you have this kind of leverage, you have to consider the cost of the debt and the company's ability to pay the interest on it. As long as the company keeps its pattern of strong cash flow, it will have no problem in covering its interest payments. Of course, when a company uses a lot of debt successfully, it can improve the bottom line dramatically and add to shareholder's equity. The Return on Equity [ROE] on a trailing-twelve-month basis is 55.9%, an incredible number.

Future growth should come from a combination of factors: share buyback to decrease the shares outstanding; continued strong cost control; expansion overseas, particularly in China; and the fact that people are still going out to restaurants despite a moderation in economic growth.

Domestically, Yum! Brands has saturated its markets, yet it continues to find ways to deliver profit growth. Improving U.S. sales will have to come from higher productivity at its existing outlets. In the latest reported period, blended same-store sales were down 2% which disappointed some investors. Look for more combinations of two of the franchises together, such as a Taco Bell with a Pizza Hut, to perk things up domestically.

YUM dipped $1 yesterday on disappointment about the comps, and the heavy debt load may be a concern for some investors. The opportunity for international growth is attractive, though, and the company is the category leader with four out its five restaurant themes. Whether you want pizza, chicken, Mexican-style or quick-serve seafood, Yum! Brands is in place to satisfy the craving--even if you're overseas.

YUM 1-yr chart

Disclosure: Author has no position in YUM.