Is This Stock the Best Play on China?

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I've called Yum! Brands (NYSE: YUM  ) the best China play that isn't Chinese. With its astounding second-quarter results in China announced last week, I'm sticking to my guns. Sure, results in the sclerotic U.S. were awful, but Yum!'s ex-U.S. results more than made up for the difference, and the company trumped sales and earnings estimates.

Overall, Yum!'s earnings rose a solid 10%, but that figure belies some very divergent results in the company's geographic divisions. Operating profit in the U.S. was down 28%, while China saw a 31% gain and the company's international division saw operating profit soar 19%.

Same-store sales reflect a similar picture. China was up 18%, international climbed 2%, and the U.S brought up the rear, with a decline of 4%. Those comps in China show just how robust this market is, and it's what has me licking my fingers at the opportunity. Yum! has more than 4,000 KFC and Pizza Hut locations in China and is also in the process of acquiring Little Sheep Group, a chain of 450 hot pot restaurants there. The company is investing where it's seeing success.

While McDonald's (NYSE: MCD  ) and Starbucks (Nasdaq: SBUX  ) are both pursuing rapid growth in China, Yum! has a clear lead, with the strength of its KFC chain. Each company is planning thousands of stores in the coming years. They're all facing significant cost inflation, with Yum! expecting commodities prices to rise 7% in the U.S. and 9% in China. Rising beef prices have hurt McDonald's and Yum! as well.

The attractiveness of investing in a U.S.-based company with significant China growth should be even more obvious following the scandals that have plagued Chinese companies this year. While China's Country Style Cooking Restaurant (NYSE: CCSC  ) has breakneck growth and local know-how in the industry, this small cap simply doesn't have the pedigree or governance credentials of U.S. peers. And while Country Style is a pure play on explosive China growth, Yum! itself earns three-quarters of its operating profit in China and internationally, so you have plenty of upside and global diversity to boot.

Yum!'s management blamed the lackluster U.S. performance on the fallout from the recent Taco Bell lawsuit. Taco Bell accounts for about 60% of the company's U.S. revenue. While the company predicted that the U.S. situation would get better by the fourth quarter, I'm less sanguine about those prospects. As the company itself noted, high unemployment among its customers is hurting growth. And that's not something that will heal quickly.

We're seeing a similar story play out with Wal-Mart (NYSE: WMT  ) and deep discounters Dollar General (NYSE: DG  ) and Family Dollar (NYSE: FDO  ) . U.S. customers are increasingly hurting, leading Wal-Mart's U.S. operation to eight straight quarters of same-store sales declines. Dollar General and Family Dollar both missed estimates in their most recent quarters.

But that poor U.S. showing wasn't enough to keep the company from increasing its earnings guidance for the year -- another great sign. The company expects earnings per share to gain at least 12%.

On the back of great growth in China and elsewhere internationally, I'm very encouraged by Yum!'s prospects, even at a P/E of 22. So do you think it's time to invest in Yum!?

Jim Royal, Ph.D., owns shares of McDonald's. The Motley Fool owns shares of Wal-Mart, Starbucks, and Yum! Brands. Motley Fool newsletter services have recommended buying shares of Wal-Mart, Brands, Starbucks, McDonald's, and Country Style Cooking Restaurant. Motley Fool newsletter services have recommended creating a diagonal call position in Wal-Mart. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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