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Lucas McGee is a consultant and private investor with more than ten years of business and finance experience throughout Asia, including China, Hong Kong and Vietnam. Lucas has provided consulting and advisory services with regard to operational business issues, due diligence, investment... More
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  • YUM! Brands: A Way to Play the China Growth Story 0 comments
    Nov 4, 2010 4:42 AM | about stocks: YUM, PEP, KO, WMT, CL, PG

    It’s fairly clear that emerging markets will witness more rapid growth over the next decade as compared with developed countries. Numerous factors are contributing to this, including increased urbanization, lower labor and production costs, underlevered economies relative to U.S. and Europe (Brazil and Mexico, in particular, have relatively low private and public market debt-to-GDP ratios), etc.

    Countries like China, India and Brazil will not only continue to benefit from export-oriented growth, but are also increasingly reinvesting their export dollars in their own consumption, fueling strong growth for their own domestic end markets.

    Yet while it’s obvious that emerging markets will feature higher growth, that doesn’t necessarily translate into obvious investment options. Many U.S. investors aren’t comfortable investing in foreign companies, given different norms for corporate governance and disclosure, and an inability to vet foreign products or industry trends as easily as one can investigate U.S.-based products, trends or companies.

    As a result, one of the more conservative ways to place a bet on emerging market growth is by investing in U.S. or European companies that are expanding rapidly in emerging markets. Particularly attractive are consumer-oriented companies that are taking proven business models from developed countries and replicating them abroad. Examples like Coca Cola, Colgate, and Procter & Gamble come to mind, as well as retailers like Wal-Mart or Tesco. These companies can use their best-in-class operating techniques and large financial resources to expand quickly and efficiently in new foreign markets.

    For a U.S. investor, these sorts of stocks can provide opportunities to benefit from emerging market growth without venturing outside of one’s comfort zone.

    In this post, I’ll profile one multinational that has done a first-rate job at taking its proven U.S.-based business model, and has fanatically copied it throughout the developing world, particularly in China: Yum! Brands (NYSE:YUM).

    Yum! Brands

    Yum! is one of the largest quick-service restaurant operators in the world, operating such household fast food restaurants as Kentucky Fried Chicken, Pizza Hut, Taco Bell, Long John Silver’s, A&W and other smaller banners. Spun out of PepsiCo in 1997, Yum! has mainly grown organically, and has completed no major acquisitions since its spinoff.

    For our purposes, we are most interested in documenting the company’s transformation from a peddler of age-old American icons 10 years ago to one of the most aggressive global fast food operators in developing markets today. In 1997, the company’s international units accounted for 24% of the company’s total sales and 22% of operating profit. In 2009, international operations accounted for 59% of sales and 63% of operating profit. YUM’s focus on global expansion has converted it from a predominantly U.S. fast food chain to a predominantly non-U.S. operator.

    The company’s expansion in China has been particular impressive. Below are some stats about the company’s Chinese operations (US$ in millions):

    As we can see, the company’s units have more than doubled since 2004. Its operating profit has tripled. Although I don’t provide any statistics here on their return on invested capital, it’s fairly obvious that the return on the company’s investments in China have been tremendous. To see a restaurant business growing EBIT at a 25% CAGR when it’s spending only 50% to 75% of EBIT on capital expenditures is nothing short of phenomenal.

    Below are metrics on the non-China international operations (US$ in millions):

    While not as impressive as the China metrics, the non-China international operations have also performed well over the past 5+ years. It’s important to note that these international operations include Australia, UK, Canada and Japan, which are relatively mature compared to countries like China, India, Brazil, Vietnam, etc. So we can’t necessarily see whether YUM has achieved the same level of success in other emerging markets as it has in China.

    One reason to be excited about a company like Yum! is its potential for growth in developing countries not just during the next few years, but over the next 10-20 years. Below is a chart that compares the population per Yum! restaurant in developed markets as compared with the population per Yum! restaurant in emerging markets (unit data taken from YUM's most recent Investor Day).

    Naturally, many rural areas of developing countries may be unsuitable for a KFC or Pizza Hut, but the above chart nevertheless demonstrates the tremendous room for growth for YUM’s banners.

    Focus on China

    In the most recent quarter, China accounted for 34% of sales and 31% of operating profit. This makes YUM one of the most levered U.S.-based consumer companies to China. YUM is the leading foreign fast food operator in China, with its 2,800 restaurants nearly double the 1,200 units of McDonald’s. YUM’s Pizza Hut banner is the #3 operator in China. Two years ago, the company’s chief of operations in China was appointed YUM’s Vice Chairman.

    The company’s growth in China has not been without its bumps; for instance, YUM’s China same-store sales experienced negative trends in 2005 and 2006 due to an ingredient supply issue and an Avian Flu outbreak. But over the long-term, the company’s focus on becoming a dominant restaurant chain in China has essentially transformed YUM from what would have been a stodgy, cash-generating, dividend stock to a global growth story.


    With YUM’s promising long-term growth trajectory, it’s no surprise that Bill Ackman at Pershing Square recently disclosed a position in the company. The company’s future will be determined by emerging market growth, as opposed to what happens with the U.S. economy. At 22x P/E, YUM trades at a premium to many other fast food chains, but the premium seems justified and the stock is not particularly expensive. For investors looking to diversify their investments out of the United States, YUM! is a viable option.

    Disclosure: Long YUM
    Stocks: YUM, PEP, KO, WMT, CL, PG
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