Yum! Brands, Inc. (NYSE:YUM) has been hot all year thanks to the imminent spinoff of its Yum China business, but Wednesday’s YUM stock earnings report will tell us what’s going on beyond financial engineering.
After all, as good an idea as the spinoff is, the fast-food industry is struggling. Whether the operator of Pizza Hut, KFC and Taco Bell remains palatable beyond the spinoff is a critical question.
It’s understandable that investors would want a piece of the stock before it splits with Yum China. The restaurant operator was one of the earliest companies to get in on the outsized opportunities China affords. Food scandals, intense competition and other issues specific to that market, however, mean the best times are behind it.
At least it had a good run.
Insulating Yum from the vagaries of the China business makes shares more attractive. It was turning into a situation of diminishing returns. But that’s not really why shares are up 24% for the year-to-date. No, it’s the pile of cash Yum will get from the deal that it can then use on share repurchases and dividend payments.
And it’s not like the chain will be left bereft of exposure to China. The company will collect a royalty fee for use of the KFC and Pizza Hut brands. High-margin licensing revenue is an investor’s best friend.
Yum Brands Is Looking Pricey
Beyond that, it’s worth worrying about what’s actually going on at the counter. Low prices for groceries and prepared foods are stealing market share from the fast-food and fast-casual chains at an alarming rate. The spinoff doesn’t do anything to address such fundamental issues.
That’s why analysts are keen to see how the chain is faring with same-store sales and cost cuts. Revenue is in a period of stagnation to decline. This we know. That makes it imperative for Yum to leverage more profit out of existing operations. For the most recent quarter, analysts expect earnings to come to $1.10 a share, up from $1.07 a share in the same period last year. Revenue is expected to slide to $3.46 billion from $3.68 billion a year ago.
Assuming that earnings please the Street, analysts note that the company has other catalysts ahead. It’s hosting a meeting with analysts in mid-October and the spinoff of the China business is scheduled for the end of the month.
As much as those events could add some nice incremental upside, however, the bulk of the gains driven by the expected spinoff should largely be priced into shares by now. Moreover, investors jockeying for position ahead of the deal have stretched the valuation on YUM.
On a forward earnings basis, Yum Brands trades at greater than a 10% premium to its own five-year average, according to data from Thomson Reuters. It’s roughly a third more expensive than the broader market.
If much of this premium is due to the company’s China strategy, can it hold up even after that business is gone? If nothing else, tomorrow’s earnings report will give us some clues.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
