Yum Brands: buzzwords

The China woes of Yum Brands are apparently over. That's at least what the stock price would indicate. Last summer a meat supplier to Yum, whose brands are KFC, Taco Bell and Pizza Hut, was discovered to be selling expired meat. Yum's shares naturally dipped. Yet since their trough last October they have rallied a third - that includes the reaction to reports late last week that multiple hedge fund investors have taken stakes in the fast food conglomerate. A single supply chain mishap could be an aberration. But Yum faced another one in 2012 when a company from which it bought chickens was alleged to be improperly using hormones and antibiotics.

Yum generates more than half of its revenue in China, with no signs of its expansion slowing there. The wager on Yum could be seen as how sharply China rebounds. But as a conglomerate, Yum's remaining appendages are starting to get more attention.

In the fourth quarter of 2014 and the first quarter of 2015, same-store sales in Yum's China division were off 16 and 12 per cent, respectively, because of the bad publicity from last summer. However, it still plans to open 700 locations in the country in 2015, increasing its store count by a tenth. Yum believes that even with 4,800 KFCs, its core Chinese brand, there is room for three times more. In the first half of 2014, before the scandal, same-store sales were up 12 per cent in China and its operating margin was nearly 20 per cent.

Setting China aside, burritos and tacos are becoming quite popular elsewhere. Same-store sales at Taco Bell were up 6 per cent the last two quarters as the company's efforts at targeting youth and introducing menu innovation (such as breakfast items) are working. Yum restaurants in China are company-owned, but most stores elsewhere are owned by franchisees who are responsible for the capital investment in stores. Yum's net debt-to-earnings ratio (before interest, tax, depreciation and amortisation) is a modest one times. One financial manoeuvre could be separating the Chinese business and then adding leverage to the remaining businesses.

With the recent run-up, its shares are trading at 26 times 2015 earnings (even while this year's earnings growth may be just 10 per cent). That seems juicy, but throw in the words "China" and "spin-offs" and the hype becomes explainable.

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