Yum!'s Earnings in Line; Pizza Hut Mutes Growth in China

Yum! Brands Inc. YUM posted mixed second-quarter 2014 results. While the Chinese division repeated its stellar performance, comps decline in the U.S. market dampened Yum!'s results. Shares of the leading restaurateur slid more than 2.0% in after-hour trading in response.

The company's adjusted earnings of 73 cents per share were in line with the Zacks Consensus Estimate but 30% higher than the year-ago quarter figure of 56 cents. The upside reflects strong year-over-year sales and margin gains, diminishing concerns related to the chicken supply chain issues.

 

In the second quarter, total revenue went up 10.0% year over year to $3.20 billion, thanks to strong comps at the China division. However, quarterly revenues were in line with the Zacks Consensus Estimate, as sluggish comps in the domestic market, offset a robust performance in China.

Comps Discussion

Yum! restructured its business divisions, effective from first-quarter 2014. The company currently reports under five segments — China, India, KFC, Pizza Hut and Taco Bell.

China Division's comps increased 15.0%, much better than a decline of 20.0% in the year-ago quarter and 9.0% rise in the prior quarter. The sequential increase in comps is attributable to 21.0% improvement in KFC comps, which was offset by flat comps at Pizza Hut Casual Dining.

KFC is Yum!'s new reporting division that includes all KFC restaurants except the China and India divisions. Comps at this division were up 2.0%, up from 1.0% in the last quarter. The upside reflects comps growth of 4.0% in the emerging markets and 3.0% in the developed ones, partially offset by 3.0% decline in the U.S.

Comps at Pizza Hut, also a new reporting segment, declined 3.0% in the reported quarter (excluding China and India), comparing unfavorably with 2.0% dip in the last quarter. The downside reflects comps decline of 4.0% in the U.S. and 2.0% in developed markets. However, comps in the emerging markets were even.

Taco Bell, the third new reporting division, includes all Taco Bell results except the India division. Comps at this division were up 2.0%, better than a decline of 1.0% in the prior quarter.

Comps at the India Division declined 2.0% during the quarter compared unfavorably with a decline of 1.0% in the previous quarter. Beginning last quarter, results of 28 franchised stores located in Mauritius are being included in the KFC and Pizza Hut Divisions instead of this division.

Margin & Costs

In the reported quarter, Yum! Brands witnessed 8.0% increase in total costs and expenses, primarily due to a 10.0% increase in food and paper costs and 7.0% increase in occupancy and other operating expenses.

Company-restaurant expenses also went up 8.0% year over year to $2.3 billion due to higher restaurant costs in the China, KFC and Pizza Hut Divisions, partially offset by lower expenses at Taco Bell.

Worldwide operating profit increased 23.0% in the quarter with majority of the growth coming from China.

Brand Restaging and Unit Growth

After being plagued by chicken issues for quite some time now, Yum! Brands has announced an aggressive and comprehensive strategy in Feb 2014 to reinstate the KFC brand in China. It recently launched a new menu at 4,600 KFC restaurants across 900 cities and introduced innovative marketing strategies to improve brand awareness and traffic. Given the strength at both KFC and Pizza Hut, the company expects to open at least 700 restaurants in China in 2014.

Outside China, the company intends to open 1,250 international units mainly in the emerging markets. The company recently launched breakfast menu at all the Taco Bell divisions.

Guidance

Management expects its business to gather steam in 2014 driven by its new sales-driving initiatives. The company maintained its guidance for 2014 and expects 20% earnings growth this year. The company also expects double-digit EPS growth in 2015 and the following years.

Our Take

China has been one of the key contributors to Yum!'s revenues over the years. While the China division has started to show signs of improvement, it is still not out of the woods. The economic growth rate of China has also moderated lately making consumers cautious about their discretionary spending. This can also restrain sales momentum at Yum!'s all-important China division.

Going forward, we are encouraged by the company's efforts to bank on high-growth emerging markets like Russia, Southeast Asia, Africa and Latin America for future growth. However, we are concerned by the company's continuous decline in comps in the U.S.  The increasing preference for healthy and nutritious foods among American consumers, along with intense competition, is denting Yum! Brands' sales.

Yum! Brands presently has a Zacks Rank #3 (Hold). Better-ranked stocks in the same sector include Chipotle Mexican Grill, Inc. CMG, Ignite Restaurant Group, Inc. IRG and Domino's Pizza, Inc. DPZ. All these stocks have a Zacks Rank #2 (Buy).

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