Yum China Has Better Chance Of Being Undervalued Upon October 31 Spinoff

Morgan Stanley’s John Glass believes there are greater chances of YUM China (YUMC) being undervalued when Yum! Brands, Inc. YUM spins of this business on October 31.

Glass maintained an Equal-weight rating on the company, while raising the price target from $86 to $96.

Value Creating Transaction

“This value creating transaction will allow current YUM investors to decide which they want to own: YUMC, a franchisee pure play on the Chinese consumer that is both the largest restaurant business in China and the largest publicly traded franchisee of any brand in the world or YUM, a globally and brand-diversified, near all franchised, asset light brand owner,” the analyst mentioned.

Glass believes the market appreciates the value of the “new” Yum Brands, but that the China business is likely to be undervalued since the shareholder bases would separate.

Related Link: Credit Suisse Previews Yum's October 11 Investor Day

Drivers Of Increased Value

Apart from having a “more refined” model for each segment, the analyst believes that the drivers of increased value include better fundamental performance, year to date, from the China business, and increased valuations for the U.S.-based, all-franchised businesses.

“Our bull case suggests the value of the combined entity could exceed $124-126 if two things happen: one, YUM gets more aggressive on refranchising and G&A cuts, and two, at YUMC, the rate of China comp recovery accelerates with compounding benefits from a leaner cost structure,” Glass stated.

As compared to its peers, the analyst expects Yum Brands to see a lower tax rate, as well as near term benefits from refranchising.

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