Yum Should Split Off China Biz, Do Leveraged Buyback, Says Credit Suisse

• Yum! Brands, Inc. YUM shares have lost 18 percent in the last three months, having plunged 10 percent since September 21.
• Credit Suisse’s Jason West maintained a Neutral rating on the company, with a price target of $75.
• Keith Meister’s appointment to Yum’s Board indicates a higher willingness to consider structural change to the company’s business model, West mentioned.

Yum has reduced its guidance for the second time in two weeks. The guide down has resulted from a reduction in the 4Q China SSS guidance from +mid-single digits to +0-4 percent. “The guidance update highlights very poor visibility into China sales trends,” analyst Jason West said.

West believes that sales decelerated after the end of the Golden Week on October 7. Since comps would become tougher in the coming months, the revised guidance does not appear conservative, he added.

Yum has appointed Corvex founder Keith Meister to its Board of Directors. This move is indicative of the company’s “heightened willingness” to consider structural change to its business model, West said.

In the report Credit Suisse noted, “We believe a China separation combined with a leveraged buyback is the most logical strategic change for YUM to implement. We highlighted this possibility as a key reason behind our upgrade to Neutral following the 3Q result.”

“Our China separation analysis indicates ~$82 per share of combined value (down from $84 on lowered ests.). The valuation upside created by a potential separation is largely due to the leverage that would be added to the franchise company,” West added.

Credit Suisse has reduced the 4Q China SSS estimate from +5 percent to +2 percent. The adj. EPS estimates for 2015, 2016 and 2017 have been reduced from $3.21 to $3.12, from $3.56 to $3.47 and from $3.98 to $3.87, respectively.