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Yum! Brands (NYSE: YUM ) may be in healthier shape than its range of fast-food restaurants look -- and more than the market believes. In Yum!, investors might find a high-quality company that's safely profiting from immense growth in foreign markets.
In its most recent quarter, Yum!'s earnings declined 14%, to $218 million. Overall same-store sales growth came in at 1%, including 2% comps growth in China and a 2% decline in the U.S. While there was a 12% drop in sales in the U.S., sales from Yum!'s Chinese operations rose 12%. In fact, the profit growth in China was 21% before currency translation -- yuan-denominated gains are greatly diminished when reported in dollars.
China represents a major part of Yum!'s growth strategy. The company was one of the first American fast-food chains, along with McDonald's (NYSE: MCD ) and Burger King (NYSE: BKC ) , to open stores there. Yum! has been expanding aggressively in China, with store count at its traditional restaurants (mainly KFC and Pizza Hut) up 18% year over year. Besides sheer growth in locations, other macro trends could continue to propel earnings forward.
Yum! isn't just relying on importing popular U.S. brands into China. In March, the company bought a 20% stake in Chinese hot-pot chain Little Sheep for $63 million, with plans to expand that franchise, and it will soon roll out its East Dawning concept as the country's first national Chinese-food chain.
Yum! isn't inexpensive by traditional measures; it currently sports a price-to-earnings multiple of 17. But it would look more reasonable if it could convert its swelling Chinese earnings back into dollars at a better rate.
The same is true in other foreign markets, where a recent dollar rally has depressed earnings. Since the introduction of ultra-low interest rates in the U.S., the greenback has been lumped with other risk-averse assets such as gold and yen. Now that demand seems to be coming back for equities, the dollar is pulling back.
And China is now beginning to pay less attention to its exchange rate versus the dollar as it focuses on weaning itself off its heavy dependence on exports. In the first quarter of 2009, increases in Chinese dollar reserves totaled just $7.7 billion versus $153.9 billion in the same period in 2008, as exports declined. The yuan may see some upward pressure if that trend continues, which would help Yum!'s earnings.
In addition, Chinese stimulus packages are beginning to take effect. Retail sales there are up 15% on the year for the first quarter -- three percentage points higher year over year. The government is also looking into another stimulus plan to boost consumption, following on the already-approved $585 billion package.
As one popular Chinese proverb has it: "Patience is bitter, but its fruit is sweet." For investors willing to be patient and focus on the long-term prospects of a hungry China, Yum! may be a yummy fruit, indeed.