Yum Brands (YUM) reports earnings after the close of trading Tuesday, with its conference call set for Wednesday morning. There is a decent likelihood that its discussion about the future could prove troubling for shareholders. Now YUM has not warned for the quarter, so perhaps it will make its number this quarter, after missing in its last reporting period. However, there are enough reasons to be concerned about the future.
Like many companies, Yum Brands jumped at the chance to expand internationally. The world welcomed YUM and its iconic American brands of Kentucky Fried Chicken, Pizza Hut and Taco Bell. So YUM and companies like Starbucks (SBUX) and McDonald's (MCD) found opportunity to extend their growth in markets hungry for their goods. Today, YUM has 38,000 restaurants in 120 countries, and its second largest market is China (4,465 stores at end of 2011).
The strategy should be fine for as long as the world trends toward civility and as long as the global economy benefits from its ties. However, the trend today seems to be more toward chaos and global economic meltdown. Chinese economic growth is slowing as the European economy is falling deeper into recession, and depression for some. The company's Chinese business actually hampered its second quarter, costing operating profit on narrower regional margins. YUM also has exposure across troubled Europe, though the majority of its stores are in Great Britain, France and Germany.
When YUM last reported results, its adjusted EPS of $0.67 fell three cents short of the analysts' consensus. Also, over the last 90 days, the consensus estimate for the current quarter ended September has backed up a penny to $0.97. Inflation hit the company's Chinese operations causing these issues, but YUM said it expected the problem to be short-lived.
But the international stresses are no longer limited to Europe and nascent China issues. As the Arab Spring has turned to Arab Winter, suddenly there are new issues. As all things western became hated during the latest protests through the region, some American branded stores in parts of Asia, Africa and the Middle East were forced to close for the safety of the employees. Protests in Pakistan led to the burning of theaters that showed Western films, and so I propose the environment is turning outright hostile in some markets within which many of these companies operate. Yum Brands operates across parts of the world where protests occurred or could occur in the future, including in Egypt (171 stores in 2011), Malaysia (795), Indonesia (661), Thailand (492), Saudi Arabia (321) and the UAE (153).
So suddenly, what was worshipped in international market growth could hamper the shares of companies like YUM. Whatever YUM may report on Tuesday, I expect its forward outlook will include discussion of the disruption of business as usual internationally and uncertainty regarding the future. If the company does not talk about it, I expect some analysts will. Therefore, just as I warned with regard to McDonald's just one day before the company offered an earnings warning, I'm raising the red flag about this company as well.
YUM's shares trade at a P/E ratio of 19X a simple EPS estimate for the next 12 months, including the September quarter being reported Tuesday. I derived the estimate of $3.50 by taking a simple average of the December 2012 and December 2013 fiscal year consensus estimates. Earnings growth is estimated at 14.7% for 2013 and 13.7% for the next five years, according to data at Yahoo Finance. Thus, the PEG ratio using the long-term growth forecast is 1.4X. That's not especially expensive, but neither is it insulated from the bad news I view likely to be found in the company's discussion of its outlook. For this reason, I would sell YUM ahead of its report.