Last month, I recommended McDonald's (NYSE: MCD) and Starbucks (NDQ: SBUX) as low-risk defensive securities that offer good overseas growth potential. Both have held up well in this lousy market. McDonald's, which was recommended at $88.29, finished last week at $92.32 (figures in U.S. dollars) after reporting strong earnings growth. Starbucks, which was trading at $39.20 at the time I picked it, closed on Friday at $42.09.
Today I'm going to add a third fast food icon to the list. It is Yum Brands (NYSE: YUM). Even if you aren't familiar with the corporate name, the chances are that you have been one of its millions of customers at some point - maybe you'll even be eating some of its food today. You'll certainly recognize Yum's principal brands: KFC, Pizza Hut, and Taco Bell.
Yum franchises can be found in every city and town in North America but the real story is the company's expansion into China. The preponderance of Yum's growth comes from that country and therein lies the opportunity. Most Chinese-related issues have been crushed during the recent market turbulence, based on the theory that China is embroiled with the problems inherent in a massive property bubble along with the potential of runaway inflation. As a result, investors are fearful that the Chinese growth story that has propelled world markets for several years may be coming to an end. It's possible this could be true but I believe it's unlikely there will be any protracted downturn in China. So I see this pullback as an opportunity to buy into some issues like Yum Brands that will continue to benefit from the ongoing China story.
Yum Brands got into China early in 1987. It was the first to bring franchising to China in 1992 and opened the first drive-through restaurant in China in 2002. Currently it has 3,300 KFCs in more than 700 cities and has plans to open 20,000 restaurants in the upcoming years. Right now, the company is opening one KFC restaurant in China every day.
The Pizza Hut franchise opened in 1990 and now has more than 500 Pizza Huts in over 130 cities in China with plans to open many more. That is a ton of fried chicken and pizzas, but then again there are more than a billion Chinese to eat all that food.
China isn't the only place that Yum Brands is opening restaurants outside of the U.S. and Canada. The company has more than 14,000 restaurants in over 110 countries and opened over 800 new ones outside of the U.S. and China this past year. That was the tenth year in a row the company has opened more than 700 new restaurants outside the U.S. and China. It even does well in France, home of the food snob, where KFC units enjoy the highest per unit volume of anywhere in the world. Evidently even the French like their chicken finger lickin' good.
I shouldn't ignore the U.S. where the business started and continues to do well, although growth is slowing since it already has deep penetration in U.S. markets, which limits its ability to add new units.
I should also mention that Yum owns the A&W and Long John Silver brands, although it was announced in September that agreements have been reached to sell them to two separate buyers headed by franchisees. These are relatively small operations compared with the three flagship brands but A&W has been around since 1919 and there are 359 outlets in the U.S. and more than 260 in 11 other countries. No prices have been announced.
Yum, which was owned by PepsiCo (PEP) before being spun off in 1997, recently reported financial results for the 2011 third quarter (to Sept. 3). Earnings came in at $383 million ($0.80 a share), up from $0.74 a share in the same period a year ago. Excluding write-downs and other charges, earnings rose to $0.83 a share from $0.73, in line with analyst expectations. Revenue was $3.27 billion, ahead of the consensus estimates of $3.1 billion.
The U.S. earnings actually fell 16% in the latest quarter on a 3% same-store sales decline. The decline in domestic sales was expected given the slumping U.S. economy. But the international divisions, which account for the bulk of sales, continue to show strength. China saw a 7% jump in profits (before foreign currency translation) from a 19% gain in same-store sales. With 65% of the company's business coming from overseas markets, the company is broadly diversified geographically.
The stock pays a decent dividend, which will be increased by 14% to $0.285 per quarter ($1.14 per year) effective with the Nov. 4 payment to shareholders of record as of Oct. 14. Based on Friday's closing price of $53.74, the yield is 2.1%. The company is aiming for an annual dividend payout ratio of as much as 40%. Additionally, Yum has been buying back stock. Year to date it has repurchased more than $500 thousand worth of shares.
The stock seems reasonably priced at current levels. It is trading at 16.35 times forward earnings. With a lot of growth potential in front, Yum should be able to produce double-digit expansion for the foreseeable future.
What could go wrong? Like all restaurant chains, the company could be vulnerable to increasing commodity costs but Yum has showed it has some pricing power in the past and commodity increases have slowed as fears of a global recession persist.
I like this company for the same reasons I like McDonald's and Starbucks. In an increasingly uncertain world, people still have to eat. Admittedly, they don't necessarily have to eat at these places but history has shown that all these companies have been able to adjust menus and maintain high levels of customer loyalty over the long haul. That should give investors some comfort in what generally is a very uncomfortable market.
The shares have sold off a little based on fears about China and are down about $4 from their 52-week high of $57.75, reached in July.
Action now: Buy with a target of $65. The stock closed Friday at $53.74.
Disclosure: I am long YUM.