Yum! Brands remains one of our favorite names for 2013, despite the China controversy in January which, given the nature of the event, took many people by surprise. For people looking for a longer-term idea in consumer, we think they would be hard pressed to find a more attractive opportunity than YUM at these levels. YUM reports 4Q12 EPS on 2/4.
It’s only February 1st and, already, so much has happened in such a short period of time. Since YUM hosted its analyst meeting on December 6th, the following sequence of events has transpired (annotated in chart below):
1. 12/18-12/20: A story emerges that a Chinese chicken supplier had “used excessive additives in chicken feed”. We believe the stock has been punished three additional times for the same story being rehashed in the media news cycle since first emerging
2. 1/07: YUM guides down FY12 EPS and warns that, as a result of negative media exposure, KFC China significantly impact during last two weeks of the year
3. 1/10: YUM CEO issues online apology
4. 1/17: Argus downgrades to Hold. Xinhua publishes article stating that KFC supplier didn’t process sick chickens
5. 1/18: Shanghai vows “severe” punishment on KFC “violation”, according to the China Daily
6. 1/25: Bronstein, Gewirtz, & Grossman LLP announces a class action lawsuit against Yum! Brand. Xinhua says, “Shanghai finds excessive animal drugs in Yum Chicken”.
7. 1/30: Yum! Brands shares cut to market perform versus outperform at Bernstein
It is worth noting that, between the Analyst Meeting on December 6th and today, there has been a significant swing in consensus expectations for 4Q12, 1Q13, and FY13 EPS:
- 4Q consensus EPS on 12/6 was looking for $0.84 or 12% y/y growth. Now expectations are for $0.82 (9% growth)
- 1Q13 consensus EPS on 12/6 was looking for $0.84 or 6% y/y growth. Now expectations are for $0.80 (1% growth)
- FY13 consensus EPS on 12/6 was looking for $3.67 or 13% y/y growth. Now expectations are for $3.57 (10% growth)
Sell-side sentiment on YUM has changed drastically in the last six months. The percentage of buy ratings among sell-side analysts covering the stock peaked at just over 70% in May (29% hold, 0% sell). The latest reading is 55% buy, 41% hold and 3.5% sell.
It’s Not All China
News flow on YUM is focused almost exclusively on China and none of it is positive. The company needs to do its part to counteract the negative stories (often repetitive rehashes) to highlight the positive things that are happening within the company. As we highlighted in December, Yum! Brands is a resilient company because of its diversification. It is perceived to be a “China-stock”, and China is an important component of its future, but 42% of the company’s operating profits are derived from markets outside of China. Over time, this and other attributes have led to steady gains in its share price and consistent EPS growth while competitors such as SBUX have seen more volatility over the years.
Reaction to Chinese News May Be Overdone
The company has resolved its issues with the Chinese government and, as concern over the food scandal gradually dissipates, the company should be able to spend a greater portion of its time focusing on continuing to grow the business. We expect the management team to articulate a clear plan of action to reach out to the Chinese consumer, including the acceleration of new food introduction schedules in the market. It would also not be surprising to hear of an increase in the China division’s advertising budget with a view to reassuring the Chinese consumer that KFC is a trustworthy brand.
US Business Transformation From Class Clown to Teacher’s Pet
The US business is now a bright spot in the company’s press release, after years of disappointment. We expect Taco Bell, in particular, to be a positive with same-restaurant sales at roughly 6% versus consensus of 5.5%. On a consolidated basis, operating margins are expected to improve by 87 bps to 13.8%, driven by the US and YRI, offset by China. Seasonally, YUM’s business tends to produce its thinnest margins in the fourth quarter.