Yum! Brands and What the Yankees and China Have in Common

by Jason Jenkins

Remember the Yankees in the late 1990s? The Evil Empire, as I call them, won three World Series (four if you count 2000). And the team has had so much success over the past decade or so, that many fans feel championships are a birthright.

Now that the team goes to the playoffs every year, many Yankee fans just moan and complain when they don’t win the Series. Meanwhile, the rest of Major League Baseball just looks on and asks, “What is wrong with you people?”

In my eyes, the Yankees are just like the current state of the Chinese economy…

In the third quarter, China reported an economic growth rate of 7.6%. Look around, that isn’t too bad. However, in 2011 and 2010 it posted 9.2% and 10.4% growth, respectively.

Because of the declining growth rate in China, Yum! Brands, Inc. (NYSE: YUM), along with many other companies with strong ties to China, saw some pressure. But Yum! is no Starbucks (Nasdaq: SBUX) or Dunkin’ Brands (Nasdaq: DNKN), as last quarter’s numbers show.

Last November, I first wrote about Yum! Brands, the parent company of KFC and Pizza Hut, among others. At that time it won approval by China’s Ministry of Commerce to buy Mongolian “hot pot” seller Little Sheep Group Ltd.

Little Sheep Group Ltd. is the Chinese operator or franchisor of 480 Little Sheep hot pot restaurants. The deal would extend Yum!’s lead as China’s biggest restaurant operator.

Updating Yum!’s Forecast From a Year Ago…

Yum! had 4,100 locations in China where the company did more business than it does stateside – and the majority of those locations were KFC and Pizza Hut units.

The Little Sheep acquisition gave them around 460 outlets across China and 22 units outside that country offering local cuisine. Before the merger, Yum! didn’t have an Asian or Chinese full-service operation, and authentic Chinese food is still much more vast market than that for Western food.

Sara Senatore, restaurant industry analyst with Bernstein Research, wrote in a research note that Yum!’s interest in Little Sheep “reflects its intent to be the leading brand in every significant category among restaurants in China.”

Yum! had lofty goals for the second-largest economy on the planet. It seemed as if it was on track, but some worried. It wasn’t so much about Yum! though, the issue was with China’s declining growth…

What We Learned Last Week

Now, I usually don’t put too much into quarterly earnings, but this was some eye-opening information.

Yum! Brands earned $0.99 per share last quarter that beat the forecasted $0.97. Revenue missed at $3.57 billion when forecasted $3.63 billion – but that won’t be too much of a problem as the rest of the numbers show a company poised to dominate its market in China.

The company’s China division made up 56% of its sales and reported a 22% sales increase in the third quarter. The company is growing at an astonishing rate in China. Yum! Brands opened its 4,000th KFC outlet in China last quarter. It expects to open another 750 new restaurants by the close of 2012.

Take away the growth aspect and the numbers are still impressive. Same-store sales – this statistic tracks the sales at units open for over a year – still went up 6%.

Yum! Chairman and CEO David C. Novak in a recent Bloomberg BusinessWeek article stated, “Our China business is having another strong year. But as I’ve said before, China is going to have its inevitable ups and downs… We now face a slowing economy. But that doesn’t change our long-term outlook in China one iota. Our annual performance has been pretty consistent, and I expect this to continue.”

Yum! Not Just Happy With China

I think it’s a little far-fetched to expect a Pizza Hut in the Sahara or a KFC somewhere in the Amazon rain forest. But the company isn’t resting on its laurels with its growth in China.

Mr. Novak has gone on to note that this quarter’s numbers stemmed from what he called a “further strengthening of [its] leadership position in emerging markets.” He announced Yum! would open 1,750 new restaurants outside of the United States. Mr. Novak also spoke of their improved guidance. The re-adjusted expectations now have its full-year EPS growing at a rate of 13% this year. In 2013, they expect more than 10% earnings growth.

One of those new emerging markets will be India. India has a middle class that’s rapidly growing. According to the research firm RNCOS, this is a market with a gigantic upside. The fast-food industry in India is expected to record a combined annual growth rate of 34% from the stretch of 2011 to 2014.

Yum! is already on top of it. It has its own India division that continues to grow strongly. The third quarter showed an increase in sales of 29%. And just as in the case with China, the increase was not due totally to location growth. Same-restaurant sales swung upwards of 5%.

And just in case you’re a little old school and don’t believe in all this emerging market business, domestically Yum!’s same store sales were up 6% while restaurant margins made a huge comeback from 12.1% up to 16.7% – that according to Trade the News.

No matter what market they set in their sights on, Yum! seems to be growing with no obstacles in the foreseeable future.

Good Investing,

Jason

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