Friday, 11 December 2015

Yum! Brands - investor day thoughts

I last wrote about Yum! Brands in October (link here) with the observation that:

'Buying Yum! Brands today in the mid US$60s with a target of US$80+ on a China turnaround/positive potential structuring of the business feels the right conclusion to me. Fortunately or unfortunately fast food and related remains a growth area with good cashflows attached to it'

Since then the company has pushed up a little although it remains 10%+ below my hoped-for US$80+ share price level...

...but usefully yesterday they held their annual investor event to discuss how their business is currently progressing including the splitting off of their China division.  Following a number of chart-heavy presentations what were the highlights?

Well first they reconfirmed their previous trading guidance...

...but talked also about the scope for a massive return of capital to investors as detailed below. (And just to put this into context, US$6.2bn is equal to 18% of the company's EV).  


So how can this come about...or even be financed?  At the heart of this is the split of the company by the end of 2016 into two: Yum! China and 'Yum! New': 

However these are going to be two very distinct models: a 15% EPS growth target company and a 15% shareholder returns target company...

...and two very different sources of return:

Of course you should expect differentiation.  After all Yum! China is about building on the company's already super strong position for its KFC and Pizza Hut brands...

...and taking advantage of the inherently low restaurant penetration in China:

Of course ironically the 15% growth profile has not been easy to achieve in the last couple of years due to various food hygiene and related scandals - and hence why the share is well off its highs as noted above:

The better news however is the trading reiteration as noted above plus a continued bounce/improvement in 'consumer trust' levels: 

A credible medium-term 15% EPS grower?  Well there is clear potential.  Before we move onto valuation however let's consider the 'returns business' which the company has dubbed "New Yum!".  

As noted above this evolves into much more of a franchise fee heavy business split as shown indicatively below: 

So no growth opportunities then?  Actually not at all...

But the key undoubtedly remains the stability/level of cash flow generation (already estimated to be an annualised US$1bn)...hence why the company has chosen to materially increase the level of net debt held by the business:

Again that made huge sense to me...despite the initial conclusion from one rating agency to push the corporate rating of the stock to 'junk':

The downgrade primarily reflects our expectation of the company’s meaningfully higher leverage as it executes on its newly communicated financial policy with a leverage ratio of about 5x, which results in our assessment of its financial risk profile as “highly leveraged”. We continue to view the company’s business risk profile as “strong”.

So what about valuation?  So looking at the current metrics I would put the China business - already self-financing - on a growth rating of x16 EV/ebit.  Given that ebit figure is impacted by the recent difficult trading I am giving the unit an indicative value of around US$11bn (x16 FY16e ebit of US$0.7bn) as the valuation will suitably compress over the next year or two.  

As for "New Yum!" I think you value it off cash flows.  US$1bn today at an indicative 5% free cash flow yield implies a US$20bn valuation but given there is also some growth here I am tempted to increase this to a base cashflow of US$1.2bn or a value of US$24bn.  Of course - additionally - there is some financial engineering going on here and despite the rating agency comments above I think the accretion is pretty material given the aforementioned 18% of current EV that the buyback equates to.  So I have inflated my final statistical value for the "New Yum!" by half this amount (for prudence) so 9% addition to US$24bn gives c. US$26bn.  

So add together US$26bn and US$11bn for Yum! China gives a value of US$37bn on a reasonable basis today - and frankly this is not aggressively discounting the future either.  Apply that today's share price and you get an equivalent level of US$80 a share.  

On that basis the stock remains a core buy AND has significant untapped potential.  

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