YUM – THE MASTERS OF DECEPTION

YUM’s 3Q08 is the single worst quarter they have had as a public company and you would never know it by reading the press release. U.S. operating profit declined 16%!! We all know China is a big market and YRI is using other people’s capital to grow, which is a good thing, but both China and YRI fell off rather significantly too...

In China, 3Q08 currency-neutral operating profit growth of 8% follows 23% and 26% growth in 1Q and 2Q, respectively (slowed on a 2-year basis as well). The same holds true for YRI. On a consolidated basis, including the benefit of currency, YUM reported 2% operating profit growth or $6 million. In 3Q08, foreign currency translation to U.S. dollars benefited operating profit by $21 million. While the currency benefit was still significant, it slowed sequentially from 2Q for both China and YRI, and management said that the foreign currency benefit would reverse to an unfavorable impact in 4Q for YRI.

On its 2Q08 earnings call, YUM guided to U.S. commodity inflation of over $100M for the fiscal year – now they are saying about $120M. As a result of higher cost inflation combined with continued weakness at KFC (KFC 3Q same-store sales declined 4%), YUM now expects FY08 U.S. operating profit to decline 8% versus its 2Q guidance of down about 3%. There was no change or update to YRI and China’s fiscal year operating profit growth targets.

  • This is the best part, the tax rate helped by $0.03-$0.05. YUM had guided to a 26% rate for the full year and they reported 21.6% in the quarter versus 25.5% last year. Additionally, the lower share count helped EPS growth by 10% - if I modeled a 26% tax rate and kept shares outstanding even with last year’s level, YUM would have reported EPS down about 1%.
  • On 8/21 I posted a note titled “Levering Up to Get Paid.” For YUM to reduce its share base by 10% it needed to borrow $1.0 billion. Senior management does not get paid unless YUM puts up 10% EPS growth. Does it create shareholder value to use additional leverage to grow EPS by 10% so management can get paid?

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