Wait to Bet on this Food Company

Recently, Yum! Brands (NYSE: YUM  ) reported July sales for its business in China. Unfortunately, Yum!'s July sales at established restaurants in China fell by 13%. As China comprises of more than 50% of Yum!'s business, the region is of utmost importance to the company. With Yum! still struggling in China, two key questions arise: has Yum! bottomed-out, and what's in store for the company in the long run?

The story behind Yum! China
During the last few months, Yum!'s premier brand, KFC, has faced many headwinds in the Chinese market. In the first incident, Chinese officials reported that KFC's chicken had an excess amount of antibiotics in it, which severely affected its sales. Yum! regained the confidence of its Chinese customers when it announced that it had cut ties with more than 1,000 sub-standard slaughterhouses in China.

As Yum! was about to recover from this poultry issue, the avian flu came out of nowhere. As a result, Yum!'s sales in China slipped again. However, as the bird-flu scare subsided to some degree, Yum! China started to show signs of resilience. Yum!'s May sales in China proved that the company was on the right track. So, when things eventually started to work for Yum!, what could have gone wrong in July? 

Reasons behind low July sales
During the month of July, China reported a second-straight quarter of slow economic growth. With the sluggish economic data fresh on the minds of Chinese people, consumers have been rather cautious about spending their hard-earned money at restaurants.

Moreover, according to the Chinese local media, this was the hottest July in China in more than 140 years, as temperatures soared to 40 degrees Celsius. As the temperatures skyrocketed, consumers went for cold drinks and ice cream. Instead of going to Pizza Hut or KFC, people preferred McDonald's (NYSE: MCD  ) , Starbucks, and Haagen-Dazs, which are well known for high-quality ice cream and cold drinks. Unlike McDonald's, which kept on promoting its McFlurry and ice beverages in China, Yum! focused on marketing its hot-food items, resulting in weaker performance.

Going forward
As there's always the risk of another avian flu outbreak in China, Yum!'s future looks cloudy. As the bird-flu virus doesn't adapt well to extreme heat, it didn't cause much of a problem during the summer season. However, as the weather becomes mild, the virus is expected to make a comeback, which may put a dent in the Chinese poultry industry once again. This would translate into meager revenue for Yum! in the second half of this year.

Yum!'s sales in July took a battering because of extreme weather conditions in China. As this kind of weather is a rarity, July sales don't tell much about Yum!'s long-term growth prospects. However, May and June results show that the company was finally heading in the right direction, before July's heat got into Yum!'s way. Therefore, Yum! has all the capacity to bounce back once again in the future--that said, Yum!'s sales aren't expected to recover before the first quarter of 2014.

With top brands like KFC, Taco Bell and Pizza Hut in the bag, Yum!'s resurgence is almost inevitable. Underestimating Yum! in the long-run would be a grave mistake. During the last five years, Yum!'s revenue has grown by 5.5%, showing that even during such economic turmoil the company was able to grow. In a nutshell, Yum!'s issues in China are temporary, making it a good buy in the long run.

Valuation
Yum! Brands is trading at a high forward P/E (one year) of 19 times, which makes it a rather expensive buy at this stage. According to the sell side, Yum! has a one-year target price of $78, showing that it has upside potential of 11%. I expect Yum! to report weak sales during the next quarter amid a bird flu outbreak. Therefore, it should be selling around $67 once the third-quarter results are unveiled. In other words, don't buy it just yet.

Industry peers
Recently, hamburger giant McDonald's reported its sales for the month of July. Global comparable sales grew by 0.7% thanks to 1.6% growth in its biggest market – the U.S. 

One of the major differences between Yum! and McDonald's is that their core businesses are in two entirely different regions. The biggest catalyst for Yum! is its Chinese business, whereas McDonald's depends largely on its U.S. operations. While Yum! is struggling in China, McDonald's recovery in the U.S. looks to be on track. This makes McDonald's a better buy than Yum! Brands at this point in time.

Over the past few years, the great thing about McDonald's has been its dividends, which have consistently grown. McDonald's not only yields a healthy dividend of 3.1%, but its high free cash flow per share of $4.08 shows that it can easily expand its dividends in the future without much financing from external sources. In short, McDonald's is still one of the best buys in the food industry.

On the other hand, Wendy's (NASDAQ: WEN  )  president recently announced that the company has plans of rebranding itself, which includes developing new restaurants, a new logo, new products and bold new packaging.

The company has a goal of selling 425 company-operated restaurants to the franchise operators by the end of the second quarter 2014. As part of this plan, Wendy's has just sold 30 restaurants in St. Louis to franchise operators. Wendy's plans of changing its structure to the franchise system will help the company reduce its operating costs, generating more profits in the future.

Since its launch in early July, Wendy's new Pretzel Bacon Cheeseburger has seen a lot of interest among its customers, especially young teenagers. Many experts believe that the pretzel burger will be a major driving force behind Wendy's performance in the next quarter. As a result, the company has given a strong outlook for the rest of the year.

Wendy's expect to grow its same-store sales by 2%-3% by the end of this year. Furthermore, the company has also raised its quarterly dividend by 25%.

The bottom line is that Wendy's new innovative products, along with its new business structure, project a much better future for the company. This makes it a worthwhile investment.

Conclusion
As the avian flu is expected to dampen Yum!'s sales in 2013, the company doesn't look to be a great short-term investment. However, investors looking for long-term gains should consider buying it. But, as Yum! hasn't bottomed out as yet, it isn't the best time to buy it.

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  • Report this Comment On September 10, 2013, at 8:40 AM, SurveyingChina wrote:

    It is very great article, helps me to understand this company much more, thanks to post!

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