As earnings, which come out on July 16, approach, investors who own a piece of Yum! Brands (NYSE:YUM) are probably trying to figure out what to do with the restaurant chain's shares. With ownership over KFC, Taco Bell, and Pizza Hut, Yum! is one of the most diversified restaurant conglomerates in the world, and, in terms of market cap, comes second to only McDonald's (NYSE:MCD).
While this market presence should be good for the business in the long run, competition from incumbents as well as from niche competitors like Chipotle Mexican Grill (NYSE:CMG) is threatening to make life harder for Yum! and its shareholders. Despite these challenges, is Yum! poised to deliver some blockbuster returns, or would the Foolish investor be better off taking a bite out of one of its peers?
Is Yum! about to see double-digit growth?
For the quarter, analysts expect Yum! to report revenue of $3.25 billion. If this forecast turns out to be accurate, it will represent a 12% gain over the $2.9 billion management reported for the same quarter a year earlier and will likely be attributable to higher sales (mostly from increased store count but also improved comparable-store sales) coming from its operations in China. Due to concerns over the company's sourcing of chicken last year and how that might expose customers to the avian flu, Yum! reported worsening sales in the region but has posted some positive developments lately.
From an earnings perspective, the outlook is even stronger. For the quarter, Mr. Market expects Yum! to report earnings per share of $0.74. This is 32% greater than the $0.56 seen in the same quarter a year earlier and would be due to rising sales combined with lower costs and, more likely than not, reduced impairment charges year over year.
Can Yum! handle the heat?
While having high expectations is nice, it's another thing entirely to have what it takes to meet those expectations. Recently, both Yum! and McDonald's have experienced troubling performance, the former's position looking worse than the latter's.
Despite seeing sales climb 26% from $9.4 billion in 2009 to $11.8 billion by year-end 2012, Yum!'s top line fell more than 5% to $11.2 billion during the company's 2013 fiscal year. The main driver behind this downturn was the restaurant chain's YUM Restaurants International (YRI) segment (it's international operations excluding India, China, and the U.S.); the division saw revenue fall 10% from $2.4 billion to $2.2 billion as management refranchised its Pizza Hut locations and its U.S. segment, which reported a 17% drop in sales from $2.6 billion to $2.1 billion due to the same strategic move.
In its most recent quarter, Yum! reported a 7% jump in sales from $2.5 billion to $2.7 billion as its China revenue soared 20% from almost $1.2 billion to $1.4 billion. This was, however, partially offset by its Taco Bell segment posting an 11% sales decline from $438 million to $391 million as a higher store count was negatively affected by falling comparable-store sales. During the quarter, the company's Pizza Hut and KFC operations have more or less hovered around last year's levels.
The picture at McDonald's looks a little healthier (hey, something about the company has to be, right?), but it's still far from pretty. Over the past five years, the golden arches have seen sales climb 24% from $22.7 billion to $28.1 billion as a higher store count and improving comparable-store sales helped the business immensely. This has, however, started to reverse. While store counts are still on the rise, the 0.2% increase in comparable-store sales reported by management in 2013 was disconcerting to say the least.
During the first quarter of 2014, the picture hasn't shown any meaningful improvement. According to management, McDonald's saw its global comparable- store sales tick up a modest 0.5%, in spite of facing downward pressure from its U.S. operations, which posted a 1.7% drop in comparable store sales as higher prices were offset to some extent by lower traffic.
Fear the burrito!
One of Yum!'s biggest obstacles to overcome is Chipotle. Over the past five years, the gourmet burrito sensation has seen its revenue skyrocket 112% from $1.5 billion to $3.2 billion as soaring comparable-store sales and a rising store count have pushed business higher.
From a profit standpoint, Chipotle's success has been even more overwhelming. Between 2009 and 2013, the company's net income jumped 158% from $126.8 million to $327.4 million as higher revenue was accompanied by greater economies of scale. In contrast, Yum!'s bottom line grew just 2% (17% excluding some impairments stemming from China) from $1.07 billion to $1.09 billion ($1.25 billion without impairments), while McDonald's has increased 23% from $4.6 billion to $5.6 billion.
Even though last year was a wash for Yum!, analysts believe wholeheartedly that management can start to demonstrate signs of a turnaround. While this isn't out of the question, the Foolish investor should keep in mind that the company has a lot working against it.
In addition to facing competitive pressures from McDonald's, which is also striving to improve its results, Yum! also has to contend with the emergence of niche fast- casual chains like Chipotle that provide higher quality food at near-fast-food prices. Whether Yum! can overcome these challenges is something only time will tell. But with so many obstacles in the company's path, combined with mediocre results in most of Yum!'s segments, the Foolish investor should remain cautious about the restaurant giant.
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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. 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.