Yum! Brands, Inc. (YUM) could continue to extend its market-beating performance in 2016, thanks to positive vibes from its China division revealed in its first quarter earnings.
YUM reported its Q1 2016 financial figures after close of market yesterday, sending the stock up in after-hours and premarket trading. Total sales figure clocked in at $2.62 billion vs. expectations of $2.66 billion, putting it close to flat year over year.
It’s the EPS figure, though, that made the market partly happy. YUM reported adjusted EPS of $0.95, trumping consensus analyst estimate of $0.83 and the prior-year same-quarter earnings of $0.81.
Here are a few takeaways from the latest earnings release
China Division Spinoff Is Good for Yum Brands
It’s easy to get furious, on the surface, when you see the enormous lift the Chinese division has given to YUM during the first quarter.
After all, same-store sales grew by 6% in China, the largest of any of Yum Brands’ divisions. Core operating profit grew by 42% in China, pushing the global core operating profit growth to 21% compared to the same quarter a year ago.
Moreover, the China division was once again responsible for a large chunk of YUM stock’s total revenue — roughly 50%.
The rage could come from asking how the hell it plans to make up for that after it completes the spin-off later this year.
Hold on a sec.
First, as YUM acknowledged, the impressive performance in China was down to the advantage of the Chinese New Year.
Moreover, the problem with YUM’s China division is everything Yum Brands is trying to fix right now. The costs associated with the way it has been running don’t make it as profitable as it ought to be.
A quick look at YUM vs McDonald’s Corporation (MCD).
As the chart shows, Yum spent a total of $11.18 billion to get revenue of $13.11 in 2015. That’s a 14.7% margin. And from the chart, we can say that its margin in this regard has remained pretty much the same over the last five years.
On the other hand, MCD’s margin on its expenses was 27.7%. You want to note that even MCD considers its performance in this regard not good enough, as it’s working on improving that.
So it becomes obvious that YUM needs to reduce its expense bill.
In China, despite the fact that a 42% increase in core operating profit looks huge, operating profit was just $256 million on revenue of $1.303 billion. And the business dynamics in China could make it difficult to improve operating margins in China.
A China Market Research in Shanghai analyst told Financial Times last year that, “Rising labour costs and rents, labour shortages, changing consumer tastes and increasing competition” are some of the threats to growing operating efficiency in China.
That’s understandable because the Chinese economy is the second-largest economy in the world, and it is still growing.
So for a company looking to cut costs by streamlining its operations, it makes sense to do away with a region where the costs of doing business are on the rise.
By the way, the cost issues are in addition to the problems that KFC has been facing in China.
Way Forward for YUM Stock
Along with the spinoff of the China division, YUM plans to expand its franchise model to further increase operating efficiency. And if you’re not familiar with the restaurant business, franchising is a low cost, high margin model. So this is sure to make YUM more profitable.
YUM is working towards having 95% of its locations run by franchisees by the end of 2017. If it is able to achieve this, then it could become a more profitable and sustainable company.
With a price-to-earnings multiple of 28 and a 2017 P/E of 20.4, there is no deep bargain here just yet, though a big selloff could create a bargain.
However, if you seek stability in your portfolio, YUM stock’s portfolio of companies could present that.
As of this writing, Craig Adeyanju did not hold a position in any of the aforementioned securities.