Fool on Call: Yum! Builds a Chinese Dynasty

China's importance to U.S.-based enterprises cannot be overstated. The latest results from Yum! Brands (NYSE: YUM  ) provides just one of many examples.

The fast-food operator -- running such names as Taco Bell, Pizza Hut, KFC, Long John Silver's, and A&W -- posted strong second-quarter figures, with -- you guessed it -- revenue growth from China leading the way. Comparable same-store sales from its Chinese operations rose 7%, while the rest of its international restaurants saw comps growth of 5% compared with the same period a year ago.

In this edition of "Fool on Call," we will take a closer look at the current state of the company's operations in China. Although this stock is nearing an almost 50% return over the past 12 months, based on management remarks from the company's latest earnings conference call, I think we will find that with the enormous overseas opportunities ahead, there remains plenty of growth for long-term-minded shareholders.

China is kind of a big market
The Yum! call was very revealing in regard to how the company builds brand awareness in China. For sure, it involves just a little more than plopping down a new restaurant, firing up the ovens, and opening the doors. CEO David Novak indicated that KFC would finish the year with more than 2,100 restaurants in more than 400 Chinese cities. But what impressed me more than these numbers is how the company has been able to intertwine what is very much an American icon with Chinese culture.

For instance, KFC does "an average of two birthday parties every day" in all of its restaurants. Aside from CEC Entertainment's (NYSE: CEC  ) Chuck E. Cheese restaurants in the U.S. market, I cannot think of another fast-food chain or casual diner that can compare. KFC also sponsors a nationwide three-on-three basketball tournament in China that includes more than 16,000 teams.

Building a brand that connects with a culture from another country is extremely important. In recent years, Nike (NYSE: NKE  ) , for example, has gone to great lengths to build a brand that Chinese consumers can identify with. These efforts have made Nike the No. 1-selling sports-apparel and footwear brand in the country. KFC is enjoying similar success for a similar reason.

In addition to its KFC operation, Yum! now has 289 Pizza Huts in 60 Chinese cities. The company is ramping up new restaurant openings this year, with plans to unveil 70 new units.

Beyond its full-scale restaurants, Pizza Hut also operates 41 delivery-service sites in China. Novak expects delivery to become an increasingly important part of its overall business as economic activity continues to expand, placing increased time demands on Chinese families. To accommodate, Pizza Hut opened up a second call center to handle the anticipated increase in delivery orders.

The opening of the new call center in Beijing couldn't have come at a better time. Domino's (NYSE: DPZ  ) and Papa John's (Nasdaq: PZZA  ) are rapidly expanding their own operations there. If delivery is going to be as big an opportunity as Novak believes, then it is critical for Pizza Hut to have the presence, performance, and price to make it the pizza of choice among Chinese families. The opening of this call center is a significant step in that direction.

Yum! has made huge strides in China, but company execs continue to expect strong top-line growth from the region. Investors will want to take note, however, that profits from this market are expected to be adversely affected over the near term. Tight pork supplies, lower-than-expected output in chicken, and an increase in chicken exports have affected prices.

As a result, Yum! anticipates a double-digit spike in related commodity prices in China during the third quarter, and that spike will put a dent in profits. Fourth-quarter profit margins will also likely be affected, but management is unable to predict just how much at this point. During the question-and-answer session of the call, it was revealed that in recent years Yum! implemented some price increases to absorb the escalating commodity costs. The management team is again taking a very close look at this strategy for the third quarter but refused to comment further.

Despite higher commodity prices, CFO Richard Carucci anticipates that the Chinese division will still hit its long-term growth targets. He reiterated in the call that over the long-term, Yum! is holding steady with growth projections of 20% operating profit growth in China, 10% in the remaining international markets, and 5% in the U.S.

A yummy opportunity
We've focused our attention on the company's Chinese operations, but if you tuned in to the call, you couldn't help being impressed with the rhetoric regarding the opportunities in Vietnam, the Middle East, South Africa, India, Russia, Europe, and other international markets.

Yum! is currently in 113 countries, but in most cases its market penetration is rather small. The opportunity here is quite significant for long-term-minded shareholders. CEO David Novak said business around the world is "very strong." Another company exec said, "The overall consumer dynamics outside the United States have never been stronger." If you are a prospective investor, these are very encouraging words.

Related Foolishness:

Another attractive feature of Yum! Brands is its healthy dividend. If you're looking for great dividend-paying companies that can help you beat the market, then a free 30-day trial of Income Investor is right for you.

Fool contributor Jeremy MacNealy has no financial interest in any company mentioned. The Motley Fool has a disclosure policy.


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