Could Yum!'s Future Be in Question?

A look at Yum! Brands after its December and fourth-quarter results as well as how the company stacks up to McDonald's and Chipotle.

Jan 21, 2014 at 2:50PM

Last Monday, Yum! Brands (NYSE:YUM) announced the December and fourth-quarter results of its China operations. For some time now, the company's results have been lackluster. With Yum!'s shares trading just 6% off their 52-week high, investors don't seem to be terribly concerned about the company's future. Is this rational thinking or should investors be more afraid?

Yum! announced terrible results
For the quarter, comparable-store sales fell 4% in China. The company primarily attributed the decline to a 4% drop in KFC sales, partially offset by 5% growth in its Pizza Hut Casual Dining operations. This decline shouldn't come as much of a surprise because of the results Yum! reported in its previous quarter--in the third quarter, Yum!'s earnings per share fell 68% from the same quarter a year earlier. This was primarily due to the company writing down its Little Sheep acquisition in China.

Excluding that one-time loss though, Yum!'s sales metrics still came in poor. In China, Yum!'s sales have declined by 2.7% year-to-date. This statistic, though, is misleading because the drop took place while Yum! had a 12% jump in restaurant count. On a comparable-store basis, Yum!'s sales fell by a jaw-dropping 16%. But that's not all! Over the same time-frame, comparable-store sales fell 6.5% in Yum!'s YRI (international) segment while rising 1% in the United States.

Compared to those readings, the comparable-store sales results Yum! saw in China don't seem so bad. In fact, there is a possibility that business might be starting to improve. Perhaps the strongest indicator of this can be seen from the company's December results.

Despite Yum!'s gradually declining sales in China, the company's December sales rose 2% on a comparable-store basis. This mostly occurred because sales jumped 5% at its KFC operations, as Pizza Hut reported a 3% decline. An increase of that magnitude for KFC following a controversy surrounding the company's chicken supply and how it could expose consumers to the bird flu might serve as an inflection point.

Is Yum!'s trouble just a passing phase?
One thought on investors' minds is that the company's downturn in sales is a short-term blip on the radar. If this is true, then Yum! will likely have a very bright future. On the other hand, if the business is just beginning a long-term downturn, then investors might be wise to watch the company closely. To see which scenario appears likely, it's necessary to look back.

Over the past four years ending in 2012, Yum!'s revenue has grown at a decent clip. Between 2009 and 2012, Yum!'s revenue rose 25.8% from $10.8 billion to $13.6 billion. This rate was marginally faster than that of McDonald's (NYSE:MCD), which saw its top line rise only 21.2% from $22.7 billion to $27.6 billion over the same time-frame.

Looking at net income, we see a similar trend. Between 2009 and 2012, Yum!'s bottom line rose 49.1% from $1.1 billion to $1.6 billion. This far surpassed the 20.1% growth experienced by McDonald's, which saw its net income climb from $4.6 billion to $5.5 billion.

Just because Yum! is growing faster than its largest rival doesn't mean that the picture is crystal-clear. In fact, the story gets a lot murkier when you introduce Chipotle Mexican Grill (NYSE:CMG), the new Mexican-oriented restaurant on the block. Over the same time-frame used in the prior comparisons, Chipotle's revenue rose 79.9% from $1.5 billion to $2.7 billion.

While Chipotle reported strong revenue growth, especially in comparison with Yum! and McDonald's, the company reported far stronger growth in net income. Over the same time-frame, net income at Chipotle skyrocketed 119.2% from $126.8 million to $278 million. It is because of restaurants like Chipotle and rival Panera Bread Company that revenue growth at Yum! and McDonald's has slowed and, in the case of Yum! at least, begun shrinking.

Size isn't everything!
Just because something is growing faster, that doesn't mean that it's necessarily better. Perhaps more important than growth is the profitability a company can maintain. In the case of Yum!, that profitability is reasonable but far from outstanding. From 2009 through 2012, the net profit margin earned by Yum! averaged 10.6%. What this means is that for every dollar in revenue the company brought in, it earned $0.106 in pure profit. The good news is that this metric improved every year over this time horizon and it stood at 11.7% at the end of 2012.

Chipotle has been in a similar boat, but it has been improving at a faster pace than Yum!. Over the same time-frame, the company's net profit margin has risen from 8.4% to 10.2% with a four-year average of 9.5%. This is slightly lower than Yum!'s margin, but if Chipotle's strong performance continues, the company could well be on its way to looking like McDonald's!

From 2009 to 2012, the net profit margin at McDonald's averaged a whopping 20.2%. This is more than double Chipotle's margin and nearly double Yum!'s. The downside here though is that, in light of competition from newer entrants, even McDonald's is feeling the pain. This is best illustrated by looking at the company's 2012 net profit margin. While in other years it saw net profit margins between 20% and 20.5%, McDonald's saw its profitability fall to 19.8% in 2012.

Foolish takeaway
Based on the preliminary results the picture for Yum! doesn't look too yummy, but there is some indication that a turnaround might be in progress. Moving forward, it's impossible to predict what will happen. With Yum!'s business embattled on all sides (except for India, where the company has been growing rapidly but where it has a small presence), the picture looks dubious.

Now, this doesn't necessarily mean that Yum! is a poor investment. If it can achieve its goal of expanding internationally, then its future is likely very bright. However, investors should remain cognizant of the dangers associated with investing in Yum!. The threat from newcomers could signal the beginning of a long-term decline for Yum! if it cannot regain its bearings.

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Daniel Jones has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and McDonald's. The Motley Fool owns shares of Chipotle Mexican Grill and McDonald's. 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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