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Does Yum!'s New Taco Venture Matter?

Yum! Brands (NYSE: YUM  ) delivered earnings this week, but the company's numbers weren't the lead story. Though Yum! showed investors that its Chinese market had recovered substantially from a multiyear struggle and ultimately beat earnings estimates, the headlines focused on one element far from the income statement. In an effort to compete in the quickly evolving fast-food and casual restaurant space, Yum! announced it would open a chain of premium taco joints -- like its Taco Bell restaurants, but not terrible. Is this the right move for a company that made its name from cheap and easy food, or an example of ill-conceived pseudo-innovation?

Plenty to celebrate
Yum! showed some top-shape earnings in its recent release, with the adjusted bottom line up 24% and a return to growth in the once-bright China segment. The company has a tremendous presence in the nation, but it was plagued by health issues and a PR nightmare surrounding its KFC chain. With 17% sales growth and 9% same-store sales growth in the just-ended quarter, it appears that Chinese customers are once again piling through the doors.

Management confirmed it is back on track to hit 20% EPS growth for the full year, helping justify the stock's relatively expensive 18 times forward earnings ratio.

What stole the show, though, was the announcement of U.S. Taco Co. -- an upscale concept readying to launch in the domestic market this summer, with the first location in Huntington Beach, Calif.

The concept
As opposed to Taco Bell, which is American food parading around as Mexican-inspired food, U.S. Taco Co. is American food admitting its own culture. The restaurant, with no drive-throughs to be had, will feature a variety of tacos starting at $4 each.

One question that has quickly arisen is whether this would cannibalize Taco Bell sales. The answer is easy: no. These are different markets and different concepts. Those ponying up $4 for a "premium" taco likely wouldn't visit a Taco Bell, because they think it's gross. While anyone in Southern California (ironically the home base of Taco Bell) would be quick to point out that some of the best tacos in the world are available on the street at half the cost, U.S. Taco Co. does have a place among higher-market, too-good-for-fast-food-but-not-really consumers.

Ultimately, the project is unexciting. This may be Yum!'s answer to Chipotle Mexican Grill (though U.S. Taco Co. will stick to tacos -- no burritos), but investors shouldn't expect similar growth for the chain. For one thing, the company is marketing the concept as premium tacos served with thick-cut french fries and milkshakes. The combination seems odd.

Luckily, management is taking things slowly, opening the first restaurant and seeing where things go.

The fast-food takeaway
Investors are best off keeping their eye on Yum!'s bread-and-butter, which is still fried chicken, pizza, and fake Mexican food. Management wants to double Taco Bell's sales by 2022. With the recent success the chain has seen, Yum! may very well hit its $14 billion goal. With double-digit gains in China and a laser-sharp focus on growing in emerging markets, this is a fantastic business. Let's just hope this foray into pop-foodie-ism isn't taking too much thought time up in the C-suite.

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Michael Lewis

Michael is a value-oriented investment analyst with a specific interest in retail and media businesses. Before coming to the Fool, Michael worked with private investment funds focusing on deep value and special situations. Currently living in the media capital of the world--Los Angeles, California.

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8/28/2015 4:06 PM
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Yum! Brands CAPS Rating: ****