YUM – DELIVERING, BUT THE BAR WAS SET HIGH

U.S. and China in Nirvana.

 

YUM reported 2Q10 numbers that were much better than I was modeling from a profit standpoint, with the biggest upside to my estimates coming in the U.S.  Relative to my estimates, U.S. same-store sales were basically in line, a little better at Pizza Hut and KFC but a little light at Taco Bell.  In the U.S., there was more leverage than I was expecting across most of the P&L (particularly on the labor line).   In total, restaurant level margin increased 140 bps YOY.  The improved margin performance at KFC stands out as an anomaly given the 7% decline in same-store sales, although KFC’s two-year average same-store sales trends improved 350 bps sequentially from 1Q10.  Also, management commentary about “lower insurance expense” in the U.S. speaks to managing the P&L around a difficult sales environment.   

 

YUM’s stronger-than-expected results in the U.S. enabled the company to move out of what we call the “Deep Hole” (negative same-store sales and YOY decline in restaurant operating profit margin) earlier than I had anticipated.  I had expected this segment to begin to recover in the second half of the year as the company lapped easier comparisons, but as of 2Q10, the company is now straddling the line between “Life-line” (negative same-store sales and positive restaurant operating profit margin growth) and “Nirvana” (positive same-store sales and positive restaurant operating profit margin growth).

 

Going into the quarter, I also said that I would not be surprised if YUM fell short of its 5% operating profit goal in the U.S. but this 2Q10 upside makes this guidance more achievable, particularly as the company laps 4Q09’s 23% decline in operating profit.

 

YUM – DELIVERING, BUT THE BAR WAS SET HIGH - YUM US

 

Same-store sales in China were in line with expectations, implying a 300 bp deceleration in two-year average trends, but again, the bottom line came in slightly better than expected.  Restaurant level margin improved 170 bps as food costs as a percentage of sales were down 240 bps YOY, more than I had anticipated.  That being said, the company continues to expect to face labor and commodity inflation in the second half of the year.  Overall, as expected, China continued to operate in “Nirvana” during the second quarter, but will likely move into the “Trouble Brewing” quadrant (positive same-store sales and YOY decline in restaurant operating profit margin), and potentially, into the “Deep Hole”, during the back half of the year as the higher food and labor costs materialize.

 

YUM – DELIVERING, BUT THE BAR WAS SET HIGH - YUM CHINA sigma

 

YUM increased its FY10 EPS guidance to $2.43, from $2.39, but this guidance still falls short of the street’s $2.47 estimate.  YUM has a record of beating expectations but management will likely get a lot of questions tomorrow on its earnings call about whether this new guidance is conservative.

 

Howard Penney

Managing Director