Are Yum! Brands Shares Worth a Second Look?

Although Yum! Brands disappointed in 2013, the company's shares might recover in 2014 following its foray into the fast-growth fast-casual industry.

Feb 11, 2014 at 11:34AM

Yum! Brands (NYSE:YUM), the parent company of Taco Bell, Pizza Hut, and KFC, was once the valedictorian of the fast-food sector and one of the fastest-growing companies in the industry. However, 2013 was anything but easy for the fast food giant as it struggled with the after-effects of the fateful Chinese poultry supply incident of December 2012. China is by far Yum! Brands' most important market, accounting for more than half of its revenue, so any trouble there spells disaster for the company.

Yum! Brands' shares has fallen very much out of favor with investors in the fast-food space. With a forward P/E ratio of just 23.44, it also badly trails fast-casual restaurants such as Chipotle Mexican Grill (NYSE:CMG),Starbucks (NASDAQ:SBUX), Buffalo Wild Wings, Dunkin Brands Group, and Krispy Kreme Doughnuts.

The first 30 days of 2014 were also rough on Yum!'s shares, with the company losing a further 11.6%.

Earnings beat boosts shares massively
Yum!'s shares got a much-needed break after the firm managed to scrape an earnings beat, however. Although the results were nowhere near impressive, investor expectations for the company were so low that anything better than the rock-bottom expectations was viewed as an achievement. The company's stock price shot up close to 10% on the "good" news.

Yum! reported full-year fiscal 2013 sales of $13.1 billion, which was 4% lower than the previous year's sales. Despite the less-than-stellar sales, shareholders were nonetheless happy about the firm's 6% increase in franchise and licence-related income to $1.9 billion. Net income came in at $1.1 billion, 32% less than last-year and short of consensus estimates. The firm's $2.97 EPS, excluding a $0.61 special item, was another bright spot in the lackluster report and managed to beat forecast estimates.

So much for the not-so-bad news. Long-term investors are more interested in the company's long-term fundamentals that will eventually determine whether it is a sound investment.

Chasing growth: Foray into fast casual foods
Fast-casual eateries such as Chipotle Mexican Grill, Buffalo Wild Wings, and Dunking Brands are the flavor of the moment. People want to eat healthier food and are willing to fork out higher prices for it. This is what's driving the wild growth for companies in this space. The fast-casual industry is growing at a 13% annual clip, compared to the fast-food sector, which is trudging along at just 5%. Yum! Brands has recognized the full implications of this threat on its top-line growth and has started to rethink its approach--starting with a full-fledged makeover of its KFC brand.

KFC has in the past tried to polish its rather greasy image significantly, but its efforts have mostly come up short. The world's largest chicken chain introduced roasted chicken a while ago, but the project failed miserably. Its "grilled" birds have not quite earned their stripes either. KFC even attempted a name change to the colloquial "KFC" from the "Kentucky Fried Chicken" of old, but to no real effect (although the name change helps the firm avoid paying royalties to the state of Kentucky).

KFC's latest concept, KFC Eleven, is clearly showing lots of early promise. KFC Eleven restaurants serve a fast-casual menu that KFC has been experimenting with since August 2013. The name bears no face of KFC maverick creator Col. Sanders, and no reference to 'fried' or "Kentucky" is made.

The KFC Eleven menu consists of fresh menu items such as chicken flatbreads, chipotle, rice bowls, pineapple, garlic, pesto, and salads. Higher-margin items such as fruit smoothies are also offered. The menu comes off as modestly ambitious yet sensible, not at all like the trite me-too menus customers are used to.

 It might still be early to start grading on the curve and labeling the project a success, but early indications and customer reviews seem to be on consensus that KFC has finally gotten its game right. Although the average KFC Eleven lunch costs a few dollars more than the typical fast-casual ticket, that might actually add to the brand appeal and gravitas of the menu and help to differentiate it from competitors.

Fast casual doing well
Chipotle Mexican Grill is regarded the as the true pioneer of the fast-casual eatery theme. The company recently delivered stellar fourth-quarter and full-year fiscal 2013 results. Chipotle managed to grow its revenue by a very healthy 20.7%, while same-store sales grew at an industry-leading 9.3%. Its operating margin improved 100 basis points to hit 25.6%.

Despite Chipotle's amazing success, its shares look a bit too pricey. The latest results have pushed up share prices by a massive 15%, and they now trade at a forward P/E ratio well in excess of 50. It might be wise to wait for a 10%-15% pullback in the share price before establishing new positions in the company. Otherwise, Chipotle remains a great growth stock.

Starbucks has also been lighting up the sector with exemplary performance. It same-store sales grew at 5% in the first-quarter of 2014, while the giant coffee chain's bottom line expanded an astounding 25% to hit $540.7 million, ahead of consensus estimates of $526.8 million. Starbucks had managed chalk up an amazing 6% same-store sales growth for 15 straight quarters prior to the latest quarter. Starbucks' revenue is expected to grow by a sound 10% in fiscal 2014, while same-store sales are projected to improve in the mid-single digits.

Although Starbucks shares are considerably more expensive than McDonald's, they are still decently priced when you take into account the firm's sound track record of consistent growth.

Foolish bottom line
Although Yum! Brands disappointed in 2013, the firm's foray into fast-casual eatery themes might begin to pay off big dividends in the near future. It's quite likely that Yum! will try to capitalize on its early success here and open up additional KFC Eleven stores in the future. The company is therefore a decent investment.

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Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and Starbucks. The Motley Fool owns shares of Chipotle Mexican Grill and Starbucks. 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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