Should I Buy Yum! Brands? 3 Pros, 3 Cons

by Tom Taulli | August 30, 2012 9:10 am

For the past decade, fast-food stock Yum! Brands (NYSE:YUM[1]) has been very good to its shareholders, averaging an annual return of 16% during this time.

… which makes the company’s 9% gains year-to-date for 2012 seem almost disappointing.

So, have Yum! Brands’ breakneck returns finally started a long-term slowdown, or should you buy YUM expecting a return to normalcy? To decide, here’s a look a the pros and cons:

Pros

Powerful Brands: Yum’s brands are some of the best in the quick-service category, with names like KFC, Pizza Hut and Taco Bell. More important, they all continue to be great sources of growth. During the past 10 years, Yum has consistently posted earnings above its goal of 10%, and 2012 looks to hit roughly 12% growth.

Innovation: Yum continues to invest in location upgrades and, more importantly, menu additions. The company recently scored a bit hit with the launch of its Doritos Locos Tacos[2], and it is openly challenging burrito-roller Chipotle Mexican Grill (NYSE:CMG[3]) with its Cantina Bell menu[4], inspired by celebrity chef Lorena Garcia. The menu features create-your-own-burritos with fresh ingredients like whole black beans, cilantro and corn salsa.

Emerging Markets: This has been the engine for Yum! Brands of late. The company has made both hires and long-term investments to get traction in huge markets like China and India. Yum! Brands also is starting to get a foothold in frontier markets, such as Africa.

Cons

China: While China has been a huge driver in the past, and Yum’s aggressive store expansion overall is a smart move, the company faces short-term headwinds. China’s economy is slowing — a troubling thought when you realize that about 44% of sales and 42% of operating profits come from China. Yum! Brands recently saw a slip in China profitability[5] on rising costs; and the company still could see a slowdown in sales, though its low-price strategy should help blunt the impact.

Competition: Take your pick. In the Taco Bell/KFC’s fast-food space, you have the Big Burger Three of McDonald’s (NYSE:MCD[6]), Wendy’s (NASDAQ:WEN[7]) and Burger King (NYSE:BKW[8]), Chipotle butts heads with Taco Bell, and then there’s other operators like Chick-fil-A, Arby’s, Hardee’s … the list goes on. Meanwhile, Pizza Hut butts heads with the likes of Domino’s Pizza (NYSE:DPZ[9]) and Papa John’s (NASDAQ:PZZA[10]). That’s the short list of big-time players, and don’t forget the variety of tough regional operators, too.

Commodities: Food prices are a frequent problem for Yum and other restaurant stocks. The drought in the U.S.[11] has resulted in surges in corn and soy prices, which should put pressure on margins.

Verdict

Yum! Brands has a promising long-term future. The huge populations in several emerging markets will see income gains, and Yum has a head start in key markets like China and India.

In the nearer term, however — likely the next half-year, at least — things could get tougher for Yum. China is showing signs of weakness, which really could bring down YUM’s growth rate. Other dissuading factors: A pricey P/E around 20, and a modest 1.8% dividend yield.

So should you buy Yum! Brands? No — at least not for now. It’s a good buy for the long term, but you’ll probably be able to pick up shares cheaper down the road.

Tom Taulli runs the InvestorPlace blog IPOPlaybook[12], a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “All About Short Selling”[13] and “All About Commodities.”[14] Follow him on Twitter at @ttaulli[15]. As of this writing, he did not own a position in any of the aforementioned securities.

Endnotes:
  1. YUM: http://studio-5.financialcontent.com/investplace/quote?Symbol=YUM
  2. Doritos Locos Tacos: http://investorplace.com/2012/06/new-taco-bell-treat-is-chains-most-popular-item-ever/
  3. CMG: http://studio-5.financialcontent.com/investplace/quote?Symbol=CMG
  4. Cantina Bell menu: http://investorplace.com/2012/03/can-taco-bell-cantina-bell-take-down-chipotle-yum-cmg/
  5. recently saw a slip in China profitability: http://investorplace.com/2012/07/yum-brands-q2-growth-overshadowed-by-china-woes/
  6. MCD: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCD
  7. WEN: http://studio-5.financialcontent.com/investplace/quote?Symbol=WEN
  8. BKW: http://studio-5.financialcontent.com/investplace/quote?Symbol=BKW
  9. DPZ: http://studio-5.financialcontent.com/investplace/quote?Symbol=DPZ
  10. PZZA: http://studio-5.financialcontent.com/investplace/quote?Symbol=PZZA
  11. drought in the U.S.: http://investorplace.com/2012/08/5-ways-the-drought-could-dry-up-you-wallet/
  12. IPOPlaybook: http://investorplace.com/ipo-playbook/
  13. “All About Short Selling”: http://www.amazon.com/All-About-Short-Selling/dp/0071759344/ref=sr_1_1?s=books&ie=UTF8&qid=1302184310&sr=1-1
  14. “All About Commodities.”: http://www.amazon.com/All-About-Commodities/dp/0071769986/ref=ntt_at_ep_dpi_10
  15. @ttaulli: https://twitter.com/ttaulli

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