In the midst of plans to split the China business into a separate company, Yum Brands (NYSE:YUM) plans massive capital returns to shareholders. Unlike other typical large-scale capital return plans, the stock actually trades near all-time highs.
At around $89, Yum trades at valuation multiples questioning the sudden aggressive stock buybacks, considering the split provides no new cash influx. Should investors line up behind this capital return plan?
Capital Return Plan
On the close of business on October 31, the China business will split off into Yum China Holdings (NYSE:YUMC) that will start trading on the NYSE effective November 1. The separation makes Yum China a licensee of Yum Brands, providing exclusive rights to KFC, Pizza Hut, and Taco Bell. The new entity will have over 7,300 restaurants in China.
In the process, Yum Brands will shift franchise ownership to 93%, up from 77%. The ultimate goal is to reach a franchise target of 98% over the next couple of years. The benefit of this shift is a significant reduction in G&A expenses and a reduction in capital expenditures. Most importantly, the G&A expenses will drop around $300 million by 2019.
All of these moves lead to the massive capital return plan. While the company touts a plan to return $13.5 billion to shareholders by 2019, the amount includes a large stock buyback that has already occurred.
By October 4, Yum had already returned $5.5 billion to shareholders via stock buybacks along with dividends of about $186 million per quarter, reducing the amounts remaining on the stated capital return plan. The company makes the analysis very difficult, with part of the capital return plan taking place prior to the split and the original goal excluding dividends, while the updated plan includes dividends.
Investors need to really review the plan as returning up to $7 billion in capital to shareholder over the next three years.
Source: Yum Brands Investor Day presentation
High Yields Built On Debt
Where the capital return gets interesting is that the buyback plan has already reduced the share count by 16%. In addition, Yum offers a recently hiked dividend yield of 2.3%.
The net payout yield that combines the net common stock buyback yield and forward dividend yield surged beyond 15% using the returns through FQ3. Additional buybacks during FQ4 and the higher dividend will boost this number even higher depending on the market cap.
The odd part is that Yum Brands completely missed the opportunity to buy shares on the lengthy dip below $70, only to load up on shares recently at $80. Even worse, the restaurant concept borrowed $4.6 billion during FQ3 to repurchase the shares. The company ended the quarter with over $9 billion in debt.
The key investor takeaway is that this stock buyback plan is very perplexing. Yum Brands repurchased a ton of stock prior to a split, minimizing any big benefit to either entity. In addition, the stock trades at over 21x forward EPS estimates, questioning the reason for such an aggressive stock buyback plan that involves a large amount of debt.
For anybody looking at a yield play, Yum Brands doesn't get interesting until after the split. At that point, the stock can be evaluated based on the updated valuation and confirmation of capital return strategies of the independent company going forward.
Disclosure: I/we 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.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.