Will Yum! Brands Make You Sick?

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Results from fast-food purveyor Yum! Brands (NYSE: YUM  ) , the operator of the KFC, Pizza Hut, and Taco Bell chains, are giving the market a great deal of indigestion. Ongoing issues regarding Yum!'s food safety first surfaced several months ago and have served as a major drag on its results, particularly in one specific market that is absolutely critical to the company's success.

As a result, Yum!'s inability to turn itself around not only raises questions about its own business, but it makes sluggish results at fast-food peer McDonald's (NYSE: MCD  ) look that much better. And, with smaller industry player Wendy's (NASDAQ: WEN  ) firing on all cylinders right now, it's more than appropriate to discuss whether Yum! offers anything to potential investors that its competitors can't.

A not-so-yummy quarter
Most investors are probably bullish on Yum! because of the success of its chains in the United States. However, there's an important piece of Yum!'s puzzle that needs to be acknowledged. The most important market for the company isn't the United States at all. In fact, China is much more vital to the company's fortunes. Yum! derives more than half of its total sales from China alone.

That's why Yum!'s results disappointed the market to such a startling degree. All told, Yum!'s total revenue fell 3% and its adjusted earnings per share dropped 14%. Perhaps even more disturbing is that the company's revenue is really only being propped up by its massive expansion efforts. Same-restaurant sales, which measures only sales at locations open at least one year, fell 11% in the quarter.

A turnaround several quarters in the making
While Yum!'s numbers surely under-performed the market's expectations, investors have known for some time about the challenges Yum! is facing in China. The situation actually first started late last year. Yum! first revealed that its performance in China would be adversely affected when the Chinese government began investigating a chemical residue found in the company's chicken.

Clearly, food safety is priority number one for any fast food chain. When consumers begin to doubt the quality of a company's food, it's extremely hard to restore the lost sense of trust. Weakness was felt as far back as the fourth quarter of 2012 when China sales fell 6%. Unfortunately, the decline in sales has only accelerated in subsequent quarters. This explains why the market is quickly losing confidence in the company's turnaround efforts.

Going forward, the outlook remains murky: Yum! is guiding investors to expect full-year 2013 earnings per share to decline by a high-single to low-double digit percentage rate, a worse outlook than had been previously issued. As a result, it appears the turnaround is going to take longer than initially anticipated.

Yum! makes its competitors look that much better
McDonald's investors were likely disappointed when it increased its dividend by just 5% a few weeks ago, bucking its own trend of providing double-digit annual dividend raises. It's been a tough year for McDonald's, indicated by the fact that revenue and diluted earnings per share are up just 1.6% and 3.9%, respectively, through the first six months of the fiscal year. At the same time, growth and a reputation for high-quality food and facilities means McDonald's investors are likely sleeping well at night.

Meanwhile, Wendy's is simply thriving. The company proved that its own turnaround efforts were succeeding when it reported 60% growth in second-quarter adjusted earnings per share and 15% growth in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA).

With all this in mind, investors may be asking themselves why they'd even bother with Yum!. Yum! is fully embroiled in a public relations nightmare in China regarding the safety of its chicken. Because of this, its performance significantly lags those of peers McDonald's and Wendy's. Not only that, the stock doesn't offer its investors as much downside protection since it offers a significantly lower dividend yield. While Yum! holds popular brands and is likely to survive its current troubles, investors would be well-served to give preference to McDonald's or Wendy's for their better performance and higher dividend yields.

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Related Tickers

9/27/2016 4:00 PM
MCD $116.88 Up +0.35 +0.30%
McDonald's CAPS Rating: ***
WEN $10.81 Up +0.01 +0.09%
Wendy's CAPS Rating: ***
YUM $89.86 Up +0.34 +0.38%
Yum! Brands CAPS Rating: ****