Investors have been losing their appetite for Yum Brands (YUM). Just look at yesterday’s performance: the stock plunged 7%, down to $66.50. YUM’s year-to-date return is now about 0%.
Of course, the trigger for the latest drop was a disappointing third-quarter earnings report. Profits came to 85 cents, below Wall Street estimates of 93 cents. Revenues also declined by 3% to $3.47 billion, below analyst expectations of $3.54 billion.
The culprit: continued slog in China.
Despite troubles abroad, can Yum make a turnaround? Or should investors wait? Let’s take a look at the pros and cons:
Scale and Brands: Yum operates about 39,000 restaurants across 125 countries and territories. Because of its massive footprint, the company has the advantage of economies of scale for sourcing and marketing, which allows for strong margins. Yum also has three global mega brands: KFC, Pizza Hut and Taco Bell. These provide for ongoing customer loyalty — which can be tough in today’s crowded market — and differentiation. Finally, Yum gets a nice benefit from franchising, keeping capital expenditures fairly light and revenues streams stable.
Product Innovation: Back in 2012, Yum introduce the Doritos Locos Tacos, which have been a tremendous success, selling more than 600 million! Yum has also been an innovator with marketing, as seen with its social media savvy. And yes, the “Live Mas” advertising campaign has been a success: The US division of Taco Bell has been the only bright spot, with comp store growth of 2% in the latest quarter. That compares to -1% for Pizza Hut and -4% for KFC.
Financial Strength: Even with the softness in Yum’s business, the operating cash flows remain strong — totaling about $1.6 billion for the first half of the year. As a result, the company recently upped its dividend by 10%, allowing for a decent yield of 2.1%. The company has posted an annual double-digit increase for nine straight years, now.
Competition: Yum certainly has many tough rivals, such as Domino’s (DPZ), Chipotle (CMG), Chick-fil-A and McDonald’s (MCD). And competition in the Chinese market has been heating up as well. Discos, a Taiwan-based fried chicken operator, has been getting lots of traction — with more than 2,000 stores in China. There has also been pressure from Papa John’s (PZZA) and Bellagio Café.
The China Factor: Back in January, the country’s regulators alleged that Yum’s suppliers provided too much antibiotics for chickens (for the KFC division), although it eventually proved to be no problem at all. But Chinese citizens started to get worried about the quality of the company’s products, especially after China suffered from a bout of avian flu. And there have been other missteps, too. KFC’s new beef burger had a tepid launch, and there was a $258 million writedown for the Little Sheep operation (focused on the hot pot market), which has been underperforming.
Growth: In the US, Yum’s same-store sales were flat for the quarter. The biggest problem was KFC, which was off by 4%. But more importantly, the performance in China was just terrible. The comps were down a grueling 11% in Q3, with the biggest driver being KFC (off by 14%). Even India is showing weakness: In Q3, the comps were flat. Essentially, when it comes to Yum’s core markets, there has been a significant deceleration in growth.
There are few signs that things will improve anytime soon at Yum. Interestingly enough, in recognition of the health-scare concerns, the company is launching an aggressive marketing campaign called “I Commit.”
But the competitive landscape is also a nagging issue. If anything, it looks like Yum’s rivals are capitalizing on the company’s woes. And the deceleration in comps is definitely troubling.
So, should you buy YUM? No, the cons easily outweigh the pros on the stock for now.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.