News flow for YUM in China may be negative for much of 1H13 but investors looking to buy a global retail stock for the long-term TAIL have an attractive opportunity today in Yum! Brands.
The headlines this morning are decidedly negative for YUM’s stock as the company released an 8-K yesterday after the close describing the impact of a probe into a former chicken supplier for the company as “significant”. Last night’s 8-K also revised 4Q China SSS guidance to -6% from -4%. Previously, on December 21st, the company had described the impact of the government probe on demand as “moderate”.
There will likely be pressure on YUM’s shares over the near-term TRADE as this news is absorbed but there are a couple of things worth bearing in mind:
- The suppliers implicated in the government probe represent an “extremely small percentage of product to KFC”, according to YUM. Given the size of this company and the importance of China to its overall profitability, we are confident that management will go to appropriate lengths to address any trust issues consumers have.
- In 2011, Taco Bell in the US was subject of a lawsuit, which was ultimately dropped, that had a significant impact on the US business. The company’s response was vigorous and it is clear that consumer perception has been improved. We expect management to act with even more urgency in this instance, given the importance of China to overall profitability.
China is a huge part of Yum! Brands and it is no surprise that the stock price reaction to the guidance revision has been so strong. However, YUM remains our best pick for 2013. The enterprise value will continue to accrete value at 10-13% per year with added gains possibly coming from a 2% dividend yield and share repurchases in 2013.
The argument for near-term multiple contraction is purely a forecast on sentiment. The growth potential of YUM, in our view, is unrivalled in the restaurant industry when the capability of management to execute is considered. Even if there is a one-multiple contraction in EV/EBITDA, we see downside reaching $63-64, which is where the stock rallied from in December.
The macro setup in China has been improving and, despite narratives that will attempt to attribute all of the recent softness in China to a probe into a chicken supplier of a small percentage of KFC’s product in the country, slowing growth was clearly a factor in recent decelerations in same-store sales growth. The retail sales environment in China is sequentially improving as of November 2012 and, if this continues into 2013, we believe it will benefit YUM as the negative headlines abate.
For 2013, we still believe that there is upside in the shares to $85-90 per share.