Best Stock for 2008: Yum! Brands

Ring in the new year with more stocks for 2008.

What restaurant company has the largest number of locations in the world? No, not McDonald's (NYSE: MCD  ) . While close, with 31,045 restaurants in over 100 countries, Yum! Brands (NYSE: YUM  ) snags the title with 34,000 restaurants around the world.

But the operator of KFC, Taco Bell, and Pizza Hut isn't gleaming with glory just yet. Management is hard at work restructuring its menu, strategically growing its business outside of the U.S., and returning capital to shareholders. It's anyone's guess whether our economy will be able to get back on track in the next year. However, regardless of further slowing of domestic customer spending, Yum! Brands' international presence and plans to renovate its product selection have convinced me to recommend this as the best stock for 2008.

America: Land of no growth
I recently commented on the notion that the U.S. just isn't the economy it once was. Even when consumer spending is robust, competition in the domestic restaurant industry is fierce, making it difficult for new concepts to enter the market. Additionally, as we've observed with Starbucks (NYSE: SBUX  ) , chains that have already proven successful find it difficult to continuously expand their market share once they begin to saturate the market.

Yet even after boasting the most system restaurants in the world, Yum! Brands is far from inundating the globe with its fast-food chains. Admittedly, domestic growth is waning with over 20,000 restaurants. In fact, U.S. sales have been falling slightly in the past year, exacerbated by the e. coli and rat incidents at Taco Bell. But international potential is huge for the company, specifically China.

Last year, domestic sales slipped 6%, while international grew 9% and China increased 26%. Not only is the company growing revenue at a rapid clip overseas, but its operations are more profitable. In 2006, international operating margins were well over 17% of sales, while the U.S. division only posted 13.6% operating margins.

Colonel Sanders vs. Mao Zedong
Management envisions over 20,000 Yum! Brand restaurants in mainland China one day, which is far more than half of how many the company currently has worldwide. But more than just bombarding the country with its American business, management has adapted its restaurants to the Chinese culture, one of the reasons the company's brands are so popular there. Pizza Hut takes advantage of tea time in China, and all of its restaurants serve smaller portions that include desserts and ingredients tailored to local customs. In a similar fashion, KFC has become one of the most popular fast-food destinations in the country.

Being a first mover in international expansion enables them to form brand loyalty in high-growth emerging markets before other fast-food chains. U.S. rivals such as Burger King (NYSE: BKC  ) and Wendy's (NYSE: WEN  ) are well behind Yum! Brands in terms of expanding their global footprint, while other chains like Panera (Nasdaq: PNRA  ) have not even begun to enter international waters.

International presence is certainly Yum! Brand's major growth driver now, but management hasn't given up on domestic growth just yet. And it shouldn't. According to the National Restaurant Association, industry sales in 2008 are expected to increase 4.4%. So, despite our slowing economy, people still love to eat out. Management recently announced plans to revitalize its U.S. operations by revamping its menu to offer frozen beverages, introduce healthier selections, and enter the breakfast market.

What would Ronald McDonald do?
Sound familiar? It should, because it's exactly what rival McDonald's has done over the past years to rejuvenate its brand. Yum! Management has been visiting the golden arches, taking notes on how the company found ways to build momentum in sales. Furthermore, the company is emulating McDonald's by refranchising company-owned restaurants. By the end of 2010, management hopes to own less than 10% of its U.S. restaurants (down from 20%). While this may initially reduce sales, profits will be enhanced as more revenue falls to the bottom line from the company collecting royalty payments without having to pay operating costs.

McDonald's has been wildly successful with its efforts, as the stock has quadrupled its value since 2003. Yum! Brands looks to be right on the same track but is still in the early stages of rebuilding its domestic brand.

As gigantic as Yum! Brands may be in terms of restaurant numbers, the company still has great potential overseas. But aside from its high growth in emerging markets, management has shown that it knows how to improve its brand once the company has tapped out its new store growth. In the last 12 months, management has delivered a return on equity of 66.2%, compared to a mere 11.9% from McDonald's. All of these factors allow me to conclude that Yum! Brands will be the best stock in 2008.

Do you think Yum! Brands is the best stock for 2008? If so, vote Yum! an "outperform" in CAPS and then check back later this week to see what stock readers think you should have in your portfolio this year.


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