Monday, 20 July 2015

Yum! Brands - good themes but no need to rush today

Back in April I concluded on Yum! Brands that:

'Even though debt is less than x1 ebitda the current EV/ebit of around x16 for FY16e is full.  A x14 multiple would be attractive (c. US$73s) to buy but here around the US$84 level I would have a more neutral view.  For longer-term holders no need to panic given this is a growth theme over time but for shorter-term and more tactical investors I would be more neutral/take some profits'

Since then the stock did push up towards the mid US$90s as activist shareholders (agitating for a splitting off of the company's strategically interesting Chinese operations) overtly joined the shareholder list.  However last week's numbers pulled the shares closer to the mid US$80s levels of my last report.

So what were the key quarterly reporting insights?  Well...China trading remained negative on a year-on-year basis as the company continues to recover from its food hygiene and related issues (see the previous link above).  

With China still currently c. 40% of profits clearly this is hugely influential.  What was noticeable in the numbers was that both same store sales AND restaurant margins were down.  
Clearly conditions remain difficult.  As the company themselves noted on the conference call following the numbers:

'We never said that the recovery was going to be linear and so there is natural choppiness from month-to-month, but as we step back and look at how traffic has rebuilt since the incident last summer, we are seeing a nice steady improvement in that curve'

Still, restaurant unit growth is occurring - especially at Pizza Hut franchises in China:

Saying that such continued patchy trading in China has upped the ante further.  As @BarbarianCap noted some of the risks are rising shorter-term: 'needs 30% EPS growth in H2 to deliver the promised 10% EPS target. All-in bet on H2 China sales growth. Good luck'.

Structurally - and unfortunately due to the general rise in 'fast food / fast casual' dining - Yum! Brands remain in a strong position in China but clearly the above shows some tactical issues.  By no means is their H2 nailed on.

Elsewhere (ex-China) KFC numbers were solid enough outside any FX factors with underlying constant currency sales and margins up plus a good balance between all different geographic regions.

Pizza Hut was a bit more patchy (slightly down operating profitability and negative like-for-likes in international developed markets)... contrast Taco Bell was very strong ('Taco Bell is a definite bright spot for the company. Breakfast now accounts for 7% of the division's sales. Management says it's confident Taco Bell will become the company's third global brand').  Note how Taco Bell profitability is approaching that of KFC:

So put all of that together and EPS was down: 

Despite the activist chat noted above the reality is that a China split-out is not going to happen shortly.  Given this - and the positive longer-term dynamics - holding on is fine but at least a return to the US$70s is going to be required to get more excited about the stock.  Frankly the risk of a bit of sluggishness associated with the Chinese bounceback could also be apparent. So for new money no need to rush today.  

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