The parent company of international brands KFC, Pizza Hut and Taco Bell, Yum! Brands Inc. (YUM) reported its Q3 earnings yesterday. The stock is up 8% after the company beat analyst estimates for EPS by 2 cents. We think that investors should buy the stock on a dip, as it is not exactly cheap after a YTD run of 12%. The company's 2% dividend yield can be counted upon as a stable stream of income.
Sales missed analyst estimates by $70 million, while Q3 EPS of $0.99 beat expectations of $0.97. Last year, the EPS was $0.83, which means a growth of 19%. The company attributed this performance to strong sales and profits from all divisions. The company raised its full year EPS growth guidance to 13%, excluding special items, and expects at least 10% EPS growth in 2013.
To dig deeper, Chinese system sales grew 22%, U.S. by 1%, India by 29% and YRI (YUM! Restaurant international) increased by 4%, prior to foreign exchange and -2% with foreign exchange. YRI sales were affected by weak sales at franchises in Europe, Japan, Asia and Canada, although emerging economies sales grew 10%.
YUM in China
With 40% of YUM's business coming from China, there is no doubt that any adverse news out of the country would affect YUM's stock. While the slowdown in the Chinese economy adversely affects the stock, Pizza Hut and KFC have enjoyed much success in China, with 4,043 KFC and 738 Pizza Hut casual dining. A Forbes article attributes much of this success to the rebranding of KFC and Pizza Hut as upscale and trendy destinations with localized menus. In five years, Yum's Chinese business will be twice as much as its U.S. business, according to some analysts. Citi however is of the opinion that new KFCs are cannibalizing existing KFC restaurants, and that competition from McDonald's (MCD) and Burger King (BKW) is stepping up. Revenues from China rose 31%, including foreign exchange in Q2, but operating profit was flat. In Q3, Chinese revenues increased 23%, but there was a 24% growth in operating profits. This compares with Q32011, with revenue growth of 36%, and operating profit improving by 13%.
192 new units were added this quarter on top of 160 in the second quarter. The total new units expected this year for KFC and Pizza Hut have been raised from 700, according to Q2 new release, to 750 in the latest earning release.
Same store sales in China are up 6%, same as last quarter. There was an impressive 19% jump in same store sales in Q32011 and 6% in Q32010. This shows that there might be some truth to Citi's comment regarding the aforementioned competition and cannibalization.
Competition in the U.S.
Pizza Hut faces competition from Domino's (DPZ) in the U.S., when the latter moved into offering pan pizza early last month. Pizza Hut's Chief Marketing Officer is still confident that the company has the right product. Domino's has been unsuccessful in this category in the past.
Taco Bell Cantina menu is definitely an improvement, which is evidenced by the 7% same store sale increase in Q32012 as compared to -2% in Q32011. It accounts for 60% of YUM's U.S. sales. However, we do not agree with it being a direct threat to Chipotle Mexican Grill (CMG) as David Einhorn said in Value Investing Congress.
One attractive aspect of YUM is its double digit dividend growth. The last dividend hike was an 18% increase from $0.285/share of quarterly dividend to $0.335/share. This means a dividend yield of almost 2% with a payout ratio of 35%. The levered free cash flow yield is approximately 2.8% and cash per share is $2.17. The company also repurchases shares. $414 million was spent to repurchase 6.5 million shares in Q32012. With a market cap of $30 billion, the YTD repurchase of $702 million forms about 2.3%.
The forward P/E of YUM is 18x, while the last 5-year average is 19x. MCD has a forward P/E multiple of 15x, BKW 21x and DPZ 17x.
At 2013 expected EPS of $3.74 and a forward P/E multiple of 18x, the price comes out to be $67. The 52-high is $74, while the 50-day moving average is $66. The consensus target price is $76.
Analysts expect a 13% growth rate in earning for the next five years. The Chinese division has started to look less attractive because of slowing growth, but brings in almost half of the company's total operating profits. The company is also concentrating on its Indian division, with a record number of new units opening this year, although the division has reported a YTD operating loss of $1 million. Taco Bell is leading the surge in U.S. sales. The stock is not the cheapest, given the 12% appreciation YTD, and an investor should ideally start a long position after a dip. The sustainable dividend is good for income investors.