Yum! Brands: Power Brands Rise, but China Still Reigns

After a setback in 2013, Yum! Brands tweaked its strategic focus. But investors still need to home in on China in the company's upcoming earnings report.

Jul 6, 2014 at 7:00PM

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KFC China bucket Image by Mike Saechang under Creative Common license.

Yum! Brands (NYSE:YUM) reports second-quarter 2014 earnings on the 16th of this month, and the report will be of keen interest to investors. After a disappointing 2013, beset by problems in Yum!'s primary market of China, the company reported positive earnings in the first quarter of this year, appearing to signal that it might have placed its wheels back on a high-growth track. Is a positive trend in sight?

Management would certainly like to see it this way. During Yum!'s most recent earnings call, CEO David Novak reiterated a promise that the company would enjoy a "stong bounce-back year," and after the first quarter, confidence seems high. The company posted year-over-year revenue growth of 7.4% last quarter, but more crucially, China revenue increased 17% from the prior year's quarter. Investors should bear in mind, however, that the avian flu crisis and chicken supply chain problems KFC China experienced in 2013 will set up positive quarterly comparisons for the rest of this year.

Management isn't taking many chances. It's ramping up on marketing, enlisting Chinese celebrities such as actors Ke Zhendong and Chen Xiao to endorse KFC, already one of the most respected consumer brands in China. As KFC China is Yum!'s most prominent growth driver, Yum! has also invested in a KFC menu reinvention, launching 15 new products simultaneously, and taking menu complexity from 59 items to 65 (accounting for removed items). Finally, the company will add another 700 stores in China in 2014, an increase of approximately 11% over its ending 2013 total.

Rethinking the sacred
While Yum!'s management team has injected much energy and ample resources into ensuring China rebounds this year, the company's growth horizon has changed subtly since last year. In discussing long-term strategies in quarterly and annual reports, in the past Yum! always led off with the following strategic imperative:

"Build leading brands in China in every significant category."

You can review filings going back at least nine years, and some variation of this statement holds. But last year, Yum! seems to have engaged in some soul searching, rightly debating its long-held belief that China is its destiny.

To this point, management reorganized its reportable business segments around its brands at the end of last year. Previously, the company presented and analyzed financial results largely by geography, with four reportable segments: Yum! Restaurants International, the U.S., China, and India. Beginning in 2014, the company views its operations through the prism of its power brands. The fast food behemoth's reportable segments are now: Yum! China, Yum! India, KFC Division, Pizza Hut Division, and Taco Bell Division. The last three segments represent all KFCs, Taco Bells, and Pizza Huts located outside China and India.

The company now leads off its strategy discussions with the following bullet point:

"Build powerful brands through superior marketing, breakthrough innovation and compelling value with a foundation built on winning food and world class operations."

Management has stated that in the future Yum! will focus on best practices for promoting brands such as KFC, Pizza Hut, and Taco Bell and will share insights and innovations across borders. The statement regarding China has been relegated to the second discussion point in company filings and includes both a reference to the importance of expansion in all markets, and the company's new-found diversification focus on India:

"Drive aggressive unit expansion everywhere, especially in emerging markets, and build leading brands in every significant category in China and India."

This displacement of emphasis indicates that while Yum!'s greatest expansion opportunities may still lie in China, without more intense diversification into other emerging markets, and without a focus on brands rather than geography, the company's promise of yearly 20% earnings per share increases may be unattainable. A more cautious Chinese consumer resulting from slower Chinese GDP growth, and increased competition from both local and international rivals, may be fueling some of this thought process. But it also reflects a pragmatic understanding that the company can't ride one horse forever.

No overnight changes
While management gingerly shifts its focus to other emerging markets and thinks in terms of brand opportunities rather than geographic concentrations, the inescapable fact is that the China division, which represented 50% of both Yum!'s revenue and operating profit last quarter, will be a make-or-break quarterly benchmark for years to come.

Yum! indicated last quarter that the China division is off to a very promising start, so we should witness the company's total top line surpass the $2.9 billion of overall revenue recorded in Q2 of last year. However, it will be worth noting on a sequential basis how much in excess of last quarter's $2.7 billion of revenue the company manages. It will also be important to see how close the company comes to its Q2 2012 revenue result (the year before the stumble), in which Yum! posted $3.17 billion in revenue.

Finally, the composition of the China division's revenue increase, provided there are no surprises, will also be important. Will the revenue expansion be driven by improved same-store sales, reflecting success of the company's effort to shore up its greatest power brand, KFC China? Or will the increase be shouldered by Yum!'s continued breakneck opening of new outlets? I'll be watching this number closely -- last quarter the China division's 17% revenue increase was of fairly balanced composition, driven by a 9% same-store-sales increase, with the balance to new store openings. In any case, the company has prepared investors for progress, with scant room to disappoint: We'll revisit both the numbers and strategic themes after Yum!'s earnings release mid-month. 

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Asit Sharma and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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