In light of the Chinese stock market’s implosion over the course of the third quarter, it can’t come as a complete surprise that Yum Brands (YUM) hit something of a headwind in that all-important market … even if it the meltdown was only a paper loss of a paper gain.
What was surprising about the Yum Brands earnings reported posted on Tuesday was the extent of the headwind Yum Brands hit last quarter in that key market, where the company drives more than half of its total sales.
How bad was it? The 18% plunge YUM stock made in after-hours trading Tuesday evening speaks for itself.
Yum Brands Earnings
Last quarter, Yum Brands — the operator of Taco Bell, KFC, and Pizza Hut — earned $1.00 per share on revenue of $3.43 billion. Both were better than their year-ago comparables, when the company earned 87 cents per share of YUM stock on $3.35 billion in sales.
However, both the top line and bottom line fell woefully short of expectations. Analysts were collectively calling for earnings of $1.07 per share, and a top line of $3.67 billion.
To say that traders noticed would be a massive understatement. Indeed, traders outright pulled the rug out from underneath the stock, sending it 18% lower Tuesday evening.
The sore spot was, of course, China, where Yum Brands typically drums up 54% of its business. Although same-store sales in China were up 2%, that growth was well short of the 9.6% same-store sales increase analysts were calling for after the company finally started to look like it was shrugging off a couple of gaffes in late-2012 and mid-2014.
That weakness in China is expected to linger, too, and put a noticeable kibosh on the company’s previous guidance. As CEO Greg Creed acknowledged:
“[T]he pace of recovery in our China Division is below our expectations. Outside of China, our Taco Bell and KFC Divisions continued to sustain their positive sales momentum while Pizza Hut was relatively flat. Given our lower full-year expectations in China, combined with additional foreign exchange impact, we now expect 2015 EPS growth to be well below our target of at least 10%.”
Still, margins for its Chinese operations were a healthy 20%.
Valuation
Although last quarter’s numbers from China weren’t stellar, they were progressive. Same-store sales had been rolling in at double-digit declines following 2012’s news that some of the meat the country’s KFC units were selling was dangerously overloaded with antibiotics … a blunder that was exacerbated in 2014 after it was reported that a supplier to the company’s Chinese restaurants sold them expired meat.
It’s also possible that tainted meat and bad publicity haven’t been the only headwinds for Yum Brands in China.
In the middle of this year, Yum Brands overhauled the menus it offered patrons in China, particularly at its KFC. The number of selections was reduced, but each item was made more compelling. KFC also expanded its delivery service in China this year. These initiatives coincide with at least modest third-quarter growth in that key market.
It’s an initiative that JL Warren Capital’s lead analyst Junheng Li has to like; Li has been concerned that KFC and Taco Bell were experiencing brand fatigue among Chinese consumers, not to mention stiffer competition. But, Li also contends that it may still not be enough. Her price target on YUM stock is still a mere $45, versus Wednesday’s opening price near $70 per share.
That target price is based on an assumption that YUM stock should gravitate between its historical P/E of 14 and 23. Even factoring in the post-earnings plunge, YUM is still priced at a frothy trailing P/E of a bit above 22.
Bottom Line for YUM Stock
It’s tempting to jump into a blue-chip name like Yum Brands on a steep decline. And the stock may well bounce back quite firmly once the dust of the Yum Brands earnings report starts to settle. However, that bounce is unlikely to last.
Between the company’s shortfall of its own expectations for the third quarter and a reeled-in outlook for Q4, Yum Brands hasn’t earned a premium price for its stock. From here, it’s a “prove it to me first” affair.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
