Yum Brands Inc.: The Big Short

| About: Yum! Brands, (YUM)

Summary

Yum Brands Inc. has been showing good dividends and buybacks since 2010. Nevertheless, the earnings results were have not been great.

Despite the fact that the company still has a good level of ROE, the situation can easily change because the revenue growth and operating margins have been declining.

The DCF, zero-growth, and comparative analyses show that the stock price should be two times cheaper. Hence, I recommend shorting Yum Brands’ shares.

Yum Brands Inc. (NYSE:YUM) is a worldwide restaurant chain with operations in more than 125 countries under brands like KFC, Pizza Hut, and Taco Bell. In 2014, the company made around $13.3B in sales, while its closest competitors, Restaurant Brands International (NYSE:QSR) and McDonald's (NYSE:MCD), showed $3.4B and $25.6B, respectively. According to the average industry sales level of $1.5B, all three companies are above-average earners, and YUM is somewhere in the middle.

During the last two years, YUM has shown unsatisfactory earnings from operations. Its net income decreased by 34% in 2013 and by 4% in 2014, which caused the total earnings CAGR to be at negative 3.5%. The company's free cash flow has decreased even worse - by more than 17% CAGR. The operating cash flow, as a part of the free cash flow, has not changed much since then.

However, there are some good points worth mentioning. First, the company still shows a close to zero cash conversion cycle. It means that the company's working capital turnover is at an excellent efficiency level (see Diagram 1). Secondly, the company shows good ROA and excellent ROE levels of more than 43%. This means that the company can pay a considerable amount in dividends and can still grow its equity. Moreover, above-average ROE is achieved with below-average Debt-to-Equity level (see Diagram 2). It also means that the company can increase its debt level and, therefore, grow ROE further. Finally, the company does pay dividends and performs buybacks. As you can see from Diagram 3, the total amount of shareholder compensation has been increasing year-over-year since 2010. This is a sign of stability.

Diagram 1

Click to enlarge

Source: data - Morningstar.com, infographics by author

Diagram 2

Source: data - Morningstar.com, infographics by author

Diagram 3

Source: data - Morningstar.com, infographics by author

There are arguments both for and against investing in this company. However, the stock has shown a good return for investors (see Diagram 4). The company's market capitalization has increased by ~37% during the last five years, and the average dividend yield has been at a level of ~2%. The stock has been a good investment but not a great one. Nevertheless, the current market price seems too high given the unsatisfactory performance over the last several years. Hence, I would like to do my own valuation of the company's shares.

Diagram 4

Source: data - Morningstar.com, infographics by author

DCF analysis

My DCF model is presented in Diagram 5. In Diagram 6, you can see how different metrics of YUM Brands are expected to change during this period. I have made several assumptions, which can be easily seen in the "Assumptions" tab of my Excel file.

My model shows that, after subtracting the market value of debt, minority interest and adding back cash and investments, the market value of equity is around $14.5B in the Base scenario. Consequently, the fair value per share is $32.45 per share. It is more than 52% lower than the current price ($67.09 per share).

Diagram 5.

Click to enlarge

Source: data - Morningstar.com, DCF model by author

Diagram 6.

Click to enlarge

Source: data - Morningstar.com, infographics by author

Sensitivity Analysis

The sensitivity analysis is presented in Diagram 7. According to the Base scenario and the assumptions for the EV/EBITDA multiple and WACC, the price range is estimated to be between $29 -$36 per share. This price range represents a 48%-58% downside risk for the stock.

Diagram 7.

Click to enlarge

Source: data - Morningstar.com, model by author

Zero-growth Analysis

The Zero-growth analysis has been described in one of my articles. You can read more about it here.

According to this analysis, the current stock price shows no margin of safety. The valuation gives a fair market value of equity of $20.8B, which translates into a fair price of $47 per share. This price is 32% lower than the current market level. If we only used net income in the calculations, the result would give us a fair value per share of only $25.56. It is 63% lower than the current price. Therefore, we can definitely say that the stock has no margin of safety at current valuation.

Comparative Analysis

My comparative analysis is based on three key ratios: P/E, P/S, and P/BV (see Diagram 8). Most ratios show that the stock is overvalued by 20%-25%, on average. However, the top-25% P/S ratio shows that the stock price is undervalued by more than 60%, while the industry's average and median P/S ratios show that the stock price is trading close to its fair value. However, these ratios do not reflect the fact that the company has a complicated capital structure. Anyway, the stock still looks overvalued. The current EV/EBITDA multiple is at a 14.8, which is above the industry's average of 12.7x (according to Damodaran's data tables). Hence, the stock seems to be overvalued.

Diagram 8.

Click to enlarge

Source: data - Morningstar.com, infographics by author

Opinion

In view of the last revenue and earnings results and according to the analyses, Yum Brands Inc. is overvalued. Hence, I recommend selling the stock and set a target price range between $29 and $36 per share. This price range translates into a 46%-56% downside opportunity for the short sellers.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in YUM over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.