Yum! Earnings: More Bad News for McDonald’s

Positive same-store sales from Taco Bell likely mean that its new breakfast menu stole some of McDonald's customers.

Jul 21, 2014 at 8:00PM

There's a lot to like in the latest earnings report from Yum! Brands (NYSE:YUM). Earnings per share beat expectations by a penny per share. Worldwide system sales grew 6% and operating profit rose 34% compared with last year. The prime driver was a rebound in KFC's China business.


Source: Yum! Brands

Another bright spot was Taco Bell. Its same-store sales rose 2% in the second quarter. It appears that Taco Bell's new breakfast menu is a hit, which is definitely not the news McDonald's (NYSE:MCD) was hoping for. Any gains made by Taco Bell in the breakfast day-part come at the expense of McDonald's, which is the market leader among fast food restaurants.


Source: McDonald's

Now that the first half of the year is over, what's in store for Yum! Brands in the second half? Also, what does this earnings report mean for McDonald's and what should investors expect from McDonald's going forward?

A lot to like about international markets
When analyzing Yum! Brands, a Fool has to understand that it's a global company. Its growth drivers are outside of the US, and most of its new restaurants open up in international markets. The single biggest market for Yum! Brands is China, where Yum! Brands plans to open at least 700 new restaurants this year. It's easy to see why Yum! wants to expand in China--the China division of Yum! Brands posted a system sales increase of 21%. This was driven by an impressive 15% increase in same-store sales.

After China, its India division saw system sales increase 18%. The company added 25% more restaurants in India, but saw same-store sales decline 2% there. India remains a key market for Yum! and one which I highlighted last year in my article "Forget China, the Real Potential for Yum! Brands Is in India." Goa, India was where Yum! Brands chose to open its 40,000th restaurant. Yum! Brands plans to open 1,250 new international restaurants outside of China and I expect a good portion of these to be in India. After all, 65% of its population is under the age of 35 and the nation has the sixth-highest consumption of poultry in the world.

What I was really looking forward to
I've been waiting to see if Taco Bell's new breakfast menu and a few of its new menu items like the Quesarito could move the needle on same-store sales. Taco Bell needed a pick-up since same-store sales dropped 1% in the first quarter. Luckily for shareholders, the bets paid off. You see, Taco Bell is an important concept for Yum! Brands considering it accounts for 21% of Yum! Brands' total operating profit. Taco Bell also has plenty of room to expand internationally--only 3% of its locations are outside the US.

Taco Bell

Source: Taco Bell

Now for the weak links
The US stores of KFC and Pizza Hut continue to underperform. KFC's US same-store sales declined 2%. It seems that not even the KFC Double Down could boost sales. As Chick-fil-A has now emerged as the top-selling chicken chain, Yum! Brands launched a new concept called Super Chix. Super Chix is calling itself the home of "the last true chicken sandwich." I'm sure this has Colonel Sanders rolling over in his grave.

Pizza Hut saw its US same-store sales drop 2%, and its operating profit declined 22%. The Pizza Hut division is another critical area for Yum! Brands as it contributed 15% of its operating profit. Pizza Hut was counting on the roll-out of WingStreet to more than 5,000 Pizza Huts nationwide to help boost sales. Unfortunately, that didn't happen. For the second half of this year, Pizza Hut is looking to its tie-in with the movie Teenage Mutant Ninja Turtles and a partnership with Hershey's in desserts to help boost sales.

Where does all of this leave McDonald's?
McDonald's US same-store sales have dropped for seven consecutive months. May same-store sales fell 1%. A lot of McDonald's problems are self-inflicted as the company failed to sense that the fast food landscape was changing. 

Ronald Mcdonald

Source: McDonald's

Unfortunately, things aren't looking much better for the next six months according to a Janney Capital Markets report and CNBC. McDonald's franchisees do not have a very bright sales outlook. The franchisees cite a complex menu, a weak economy, and plenty of marketing mistakes by McDonald's as the main reasons why they're so gloomy. As a result, Janney Capital Markets lowered its sales outlook for McDonald's. Janney now expects its same-store sales to drop 2.6% in June and 1.8% in July. If that's the case, investors should not expect too much from McDonald's in its next earnings report.

Foolish final thoughts
Yum! Brands really surprised me with this earnings report. It was better than I expected. I was very pleased that Taco Bell's efforts paid off. This is further good news for shareholders in Yum! Brands since Taco Bell's CEO will be the new CEO of Yum! Brands come January 1.

For McDonald's shareholders, share buybacks and dividends only go so far. McDonald's CEO Don Thompson is going to have to get a lot more creative to keep franchisees, shareholders, and customers happy. Hopefully he'll give us some insight on the next earnings call as to how he is going to accomplish all of this.

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Mark Yagalla has no position in any stocks mentioned. The Motley Fool recommends 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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