For the past decade, Yum Brands (NYSE:YUM) has generated double-digit profit growth, helped by substantial investments in foreign markets, especially China. In fact, on its latest earnings call last week, management referred to a “dynasty-like performance.”
And investors have been impressed: This year, the shares are up 13.6%. And that’s on top of a sizzling 42.78% gain in 2010.
But can Yum still satisfy the appetite of investors? Let’s take a look at the pros and cons:
Pros
Emerging markets. This segment of Yum’s business continues to run at an incredible clip. Keep in mind that China and Yum International account for almost three-quarters of operating profits (though part of this has been result of the falloff in the U.S.). For example, KFC China saw a stunning 17% increase in same-store sales.
Yum is also leveraging its platform in other key areas, such as Russia, India and even parts of Africa. In fact, there are operations in 67 emerging markets.
Innovation. Yum has an outstanding management team that knows how to find ways to satisfy customers. To this end, the company has been smart in providing 24-hour locations, breakfast options and home delivery.
Deal-making. Yum recently purchased Chinese-based Little Sheep Group, which operates a chain of 450 restaurants that provide Mongolian-style “hot pot” cuisine. It’s been a red-hot growth business and still appears to be in the early stages. In addition, there could be opportunities to expand operations in other Asian countries.
Cons
U.S. business. This continues to be a drag on performance. In the latest quarter, same-store sales dropped 4%. A big problem has been Taco Bell, which was an unfortunate target of allegations about the quality of its food. While the lawsuit has been withdrawn, the impact continues to linger.
Costs. Despite many rate hikes, the inflation rate continues to be a problem in China. In fact, Yum expects it to reach about 11% for the rest of the year. No doubt, there will be pressure on margins as the company tries to maintain its value-based menu.
Competition. Of course, this is intense. In fact, a variety of large players — Wendy’s/Arby’s (NYSE:WEN), Domino’s Pizza (NYSE:DPZ) and McDonald’s (NYSE:MCD) – are getting more aggressive in China.
Verdict
Inflation will continue to be a problem in emerging markets. But in such an environment, it is usually the top brands that remain strong.
However, the big opportunity for investors is the long-term potential. Yum is positioned nicely to benefit from emerging markets, especially China. Consider that over the next decade the consuming class in that country is forecasted to go from 200 million to a whopping 500 million.
In other words, there is much room for expansion. In light of Yum’s strong brands and efficient platform, the pros outweigh the cons.
Tom Taulli’s latest book is “All About Short Selling” and he has an upcoming book called “All About Commodities.” You can find him at Twitter account @ttaulli. He does not own a position in any of the stocks named here.
