Why Yum! Brands Could Underperform, According To Credit Suisse

In a report published Tuesday, Credit Suisse analyst Jason West initiated coverage of

with an Underperform rating and $74 price target, reflecting ongoing concerns in China. According to West, the pace of recovery of Yum! Brands China business (which accounts for approximately 33 percent of profits) will be slower than expected due to weak macro trends and continued aggressive supply additions in the market. The analyst added that the company faces a potential earnings miss this year and the current valuation (24x Next 12 Months earnings per share) does not reflect the risks involved. West also noted that the Chinese economy has slowed in recent years with GDP now tracking at approximately 7 percent compared to around 9 percent from 2010 to 2013. In addition, Yum! Brands faces stiffer competition with 30,000 restaurants within Chinese malls versus 8,000 just four years ago. Nevertheless, West argued that the company continues to "plow ahead" with aggressive unit growth in China, noting "we fear the market cannot support this new supply, particularly given the weakened state of the KFC brand and the Chinese economy." Commenting outside of China, West argued that Yum! Brands portfolio that is approximately 90 percent franchised is "much more stable" but has still shown mixed results over the years, especially in the U.S. West also commented the company's move to increase its franchise mix to the mid-90 percent range will support overall margins and returns but could pressure absolute earnings growth in the near term.