YUM: It's A Win-Win

China is in turnaround mode as Taco Bell and KFC continue to fire on all cylinders.  YUM remains on the Hedgeye Best Ideas list as a long.

 

Yesterday after the close, YUM reported adjusted 1Q EPS of $0.80, coming in ahead of consensus at $0.71.  In the release, management reiterated its full-year 2015 EPS growth goal of “at least 10%,” with the street currently projecting 12% growth for the year.

 

We continue to see fair value for YUM between $95-100 per share.

 

YUM is one of the most conservatively managed restaurant companies in the space today which leads us to believe that our long thesis presents a win-win scenario for investors. 

 

One way to win is if the recovery in China sputters and the company is pushed to pull a lever or two to enhance shareholder value.  In our view, there are currently three significant levers at management’s disposal, including:

  1. Monetizing assets in China
  2. Leveraging the balance sheet
  3. Spinning off Pizza Hut

The other way to win is if the recovery in China persists and begins building toward normalized same-store sales and margins in China.  We began to see evidence of this in 1Q15 results.

 

With that being said, the recent sales disappointment from the Pizza Hut business suggests that it would make strategic sense to consider a sale or spin of that business.  We believe this will become more evident when DPZ and PZZA report comparable sales on April 23rd and May 5th, respectively, that we suspect will significantly outpace Pizza Hut’s results.

 

In the meantime, we remain encouraged with turnaround efforts in China and the strength of the Taco Bell and KFC businesses.

 

Below, we provide brief updates on each operating Division.

 

China Division same-store sales fell -12%, better than the consensus estimate of -14.4%.  Restaurant margins of 18.9% surpassed consensus estimates of 16.03%.  KFC and Pizza Hut same-store sales declined -14% and -6%, respectively.  Not only do same-store sales and customer metrics continue to improve, but are doing so while costs are being effectively managed.  Management continues to pursue growth in lower tier 3-6 cities, which remain underpenetrated and deliver superior returns given the low costs and high AUVs.  KFC recently launched its first menu revamp of the year, during which it will introduce eight new products over the course of the next three months.  A second menu revamp is planned for later this year.  The premium coffee rollout, which is in its infancy, has added an incremental weekly sales layer of around $300 per store.  Premium coffee should be in 2,500 stores by year-end.  Pizza Hut Casual Dining continues to rollout breakfast and expand its late night offerings while Home Service is approaching 300 units total.

 

Taco Bell same-store sales increased +6%, above the consensus estimate of +5.4%.  Restaurant margins of 19.6% surpassed the 16.8% consensus estimate.  Breakfast continues to do well at 6% of sales and restaurant margins approached 20%.  Management reiterated its goal of 8,000 domestic units and also cited strong performance in Latin America and Canada.  International continues to be a significant opportunity for further growth.

 

KFC same-store sales increased +5%, above the consensus estimate of +3.1%.  Restaurant margins of 15.3% surpassed the 13.6% consensus estimate.  The brand continues to be a global powerhouse with significant growth opportunities ahead.  80% of the 72 new international restaurants in the quarter were opened in emerging markets.

 

Pizza Hut same-store sales were flat, below the consensus estimate of +1.1%.  Restaurant margins of 11.6% were in-line with the consensus estimate.  The business clearly continues to struggle, particularly domestically where its new pizza platform/campaign has failed to drive the results they expected.  Management has decided to bring Collider Lab (consumer insight driven marketing company that helped rejuvenate Taco Bell) in-house in order to help revamp the domestic Pizza Hut business.  Internationally, Pizza Hut continues to expand rapidly, with plans to develop units at a record pace this year.  Management noted it is making the necessary investments in digital for the entire brand.

 

YUM: It's A Win-Win - 1

 

YUM: It's A Win-Win - 444


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