YUM – LOTS OF QUESTIONS

YUM is scheduled to report Q1 earnings next week.  This is what we know:

2009 guidance of at least 10% EPS growth relies largely on a U.S. recovery.

The company is expecting U.S. operating profit growth of about 15%, or at least 5% excluding the impact of the planned $60 million in G&A savings.

U.S. operating profit growth has been flat to down for the last six years with YUM posting its largest decline in 2008 of down 6% so YUM definitely has easier comparisons working to its benefit in 2009, but this has not helped in the past.

KFC has been the biggest drag on U.S. operating performance as Taco Bell (60% of U.S. operating profit) and Pizza Hut both grew operating profit in 2008.  In the fourth quarter, KFC same-store sales declined 3% while Taco Bell increased 9% and Pizza Hut fell 1%. 

YUM needs both its Pizza Hut and KFC brands to perform in 2009 to meet its 15% operating profit growth goal.  And, as YUM management highlighted on its Q4 earnings call, both concepts were off to a slower than expected start in January “because these brands focus on the higher-end ticket dinner occasion, which are under the most pressure due to customers  doing more cooking at home.”  Management also said that KFC January sales were extremely poor.   The company has since launched its first ever nationally advertised value menu at KFC and expects its Kentucky Grilled Chicken launch in Q2 to turn things around for KFC in 2009.  I am still not convinced that this will happen.

Pizza Hut started the year out slow and although management seems convinced that its new focus on pasta and chicken wings “will totally transform the Pizza Hut brand over time,” for now, it is still called Pizza Hut and pizza sales/traffic matter.  That being said, according to NPD data, QSR pizza trends do not look good.  QSR pizza category traffic declined in both January and February.  This is not that surprising as traffic has declined on a YOY basis every month for the last two years, but the 2-year average trend steepened its declines in both January and February. This does not bode well for Pizza Hut in Q1. 

YUM – LOTS OF QUESTIONS - QSR Pizza Traffic Feb 09

Domino’s has said in the past that irresponsible industry price increases are largely to blame for pizza traffic declines, which is made evident by the chart below that shows that QSR pizza traffic generally falls off as average check increases.  The industry has apparently not yet learned this lesson as the large average check increases in January and February coincided with the accelerated traffic declines.  YUM management did say that it was not assuming any price increases at Pizza Hut in 2009, which could help its traffic trends somewhat relative to the industry…we will have to wait and see what impact this has on margins.

YUM – LOTS OF QUESTIONS - QSR Pizza Traffic and Check Feb 09

U.S. same-store sales at Pizza Hut and KFC will most likely extend their Q4 declines into Q1.  Management did its best to set the bar low for U.S. performance in Q1, however, saying that much of its U.S. plans are back-end loaded, the majority of full-year commodity inflation is expected in Q1, G&A restructuring benefits will not be fully realized until Q2 and the Kentucky Grilled Chicken launch, which it recognizes as a big catalyst for U.S. improvement, is not until Q2. 

I don’t expect YUM to miss numbers but as always the quality of EPS will be low.  Domestically, KFC is terminal; Pizza Hut is struggling (along with the category); that leaves Taco Bell to carry the day domestically.  With the USA representing more than 40% of operating income, I’m not going to take that to the bank.  Given the commentary from MCD and BKC, the international markets have slowed significantly, which suggests that YUM international will post some very punk numbers.  That leaves YUM’s Holy Grail, China, to save the day; China looks like it will be a challenge, too (please refer to yesterday’s post titled “YUM – China, Not Without Issues” for more details ).

YUM – LOTS OF QUESTIONS - YUM EBIT Margin 4Q08


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