Yum Brands Avoids Getting Hammered In China

| About: Yum! Brands, (YUM)

Fast-food heavyweight Yum! Brands (NYSE:YUM) reported better than expected third quarter results Tuesday afternoon. The firm saw revenue grow 9% year-over-year to $3.6 billion, roughly in-line with consensus expectations. Earnings jumped nearly 24% to $0.99 per share net of a one-time refranchising benefit, a few pennies better than consensus estimates. For a read on how we derive Yum Brands' intrinsic value and the fair value estimates for the hundreds more companies in our coverage universe, please click here.

Though the firm is based in the United States, China has been the primary profit driver for the company in recent years, and 6% same-store sales growth alleviated some of the fears we've had about the company's performance in the region. Based on results we've seen from other consumer names like Nike (NYSE:NKE), we thought results might fall short of expectations. However, much like fast-food consumption in the US, the Chinese consumer continues to migrate towards eating more meals outside of the home. Revenue growth in the region totaled 23% overall, with restaurant margins actually increasing 10 basis points to 21.4%, in spite of wage and commodity inflation. The firm remains committed to opening at least 750 restaurants in China during the year; thus, we are confident that consumer spending and commercial construction in the country isn't grinding to a halt as fast as industrial production.

The smaller US division of the company also posted strong third quarter results, driven again by Taco Bell. Same-store sales at the chain surged 7% year-over-year, while Pizza Hut grew 6%, and KFC grew 4%. The Cantina menu continues to drive traffic and likely higher average checks, in our view. This bodes negatively for Chipotle (NYSE:CMG), but it may also have negative implications for McDonald's (NYSE:MCD). Please check out our call for a big fall on Chipotle here when it was trading over $400 per share. Obviously the menus differ greatly, but we view both restaurants in the value category, and these numbers suggest consumers might be flocking toward the Mexican food competitor. Meanwhile, we thought Pizza Hut's results were also quite strong as it continues to fight Domino's (NYSE:DPZ) on the value front. Overall, operating margins expanded 420 basis points to 20.5%, driving 13% growth in operating profit.

Unfortunately Yum! Brands doesn't provide as much clarity with regards to its international business, but we saw strong results from Africa, which grew sales 20%, as well as Russia, which grew sales 45% year-over-year. We continue to believe emerging markets will be a compelling opportunity for the company, if not just as exciting as China was a few years ago. We've seen evidence that KFC is very popular in Africa, and the firm might be better positioned to grow in emerging markets than its peers at this point.

Overall, we were encouraged by Yum's strong third quarter results, particularly in China and at Taco Bell in the U.S. Going forward, the firm upped its earnings guidance to at least $3.24 per share from $3.22 per share. We see a possibility for solid same-store sales growth from Taco Bell in the fourth quarter (thanks to its new Cantina menu), and we remain confident in the firm's competitive position. Still, we believe shares are fairly valued, so we aren't interested in adding the name to the portfolio in our Best Ideas Newsletter (please see links on our left sidebar for more information).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.