The Best China Play Isn't Chinese

You love Chinese companies' fast growth -- but you hate their slipshod accounting and stick-it-to-America practices. What if you could find a way to combine the growth of China with the safety of American reporting standards? Look no further than Yum! Brands (NYSE: YUM  ) .

As the company behind restaurants such as KFC, Pizza Hut, and Taco Bell, Yum!'s profit will soon be more Chinese than American. And I mean way more Chinese. Yum! was the first quick-serve chain to enter China, beating even global powerhouse McDonald's (NYSE: MCD  ) , and its KFC franchise is more popular in China than a calculator at an engineering convention. More importantly, China already delivers one-third of the company's operating profit, with just 3,500 outlets there.

In contrast, Yum! has nearly six times as many locations in the U.S., but they generate only 4% more operating profit in total than all of China's outlets year to date. The company opened more than 500 restaurants in China last year, and it plans almost the same number this year. More importantly, Yum! currently sees room for as many as 20,000 outlets in China. But surely, as China's middle class grows, a nation that has four times as many people as the U.S. should have more than just an equal number of Yum! restaurants.

If you extrapolate the same level of profitability out across those 20,000 outlets, you see that Yum!'s operating profitability will explode just from this buildout of China. Tack on potential growth in places such as India, and the long-term appreciation of China's currency, and you have the case for a blockbuster stock. That's the kind of opportunity that has CEO David Novak stating: "I wouldn't trade our long-term position in China with any consumer company in the world." True, Yum!'s Chinese workers have demanded and received increased wages, but the opportunity remains enormous nonetheless.

When it comes to China, Yum! has easily stolen a march on its rival McDonald's. The Golden Arches has about 1,100 outlets in China, and plans to expand to about 2,000 by 2013. But McDonald's profit doesn't rely to nearly the same extent on China's performance as Yum!'s does.

Despite plenty of ballyhoo over China's breakneck growth, there's still plenty of opportunity for American multinationals. Starbucks (Nasdaq: SBUX  ) is planning thousands of stores there, to complement its current base of around 400. Handbag maker Coach (NYSE: COH  ) is moving into China a big way, with the recent opening of a flagship store in Shanghai and double-digit same-store sales there in its most recent quarter. China is also a huge part of Nike's (NYSE: NKE  ) expansion plans, and the company aims to markedly add to its $1.7 billion in sales there last year.

Even the near-ubiquitous Coca-Cola (NYSE: KO  ) still has room to run in China's less developed agricultural areas, a fact that led fellow Fool and Global Gains advisor Tim Hanson to recommend the stock as a way to play China.

Given its enormous opportunity in China, combined with the benefits of American corporate governance – and a 2.1% dividend, to boot – Yum! looks like a finger-lickin' good prospect.

Jim Royal, Ph.D. does not own shares in any company mentioned. Coca-Cola is a Motley Fool Inside Value recommendation. Coach and Starbucks are Stock Advisor selections. Coca-Cola is an Income Investor choice. Motley Fool Options has recommended a bull call spread position on Yum! Brands. The Fool owns shares of Coca-Cola. Try any of our Foolish newsletter services free for 30 days. The Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (13)

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  • Report this Comment On July 20, 2010, at 5:18 PM, irvingfisher wrote:

    everything looks good (yummy in fact), expect the huge leverage ratio (6.85) sours my stomach.

  • Report this Comment On July 20, 2010, at 10:35 PM, Adamu07 wrote:

    I gotta agree with irvingfisher, there's gotta be better ways to get into China without having to roll the dice with YUM. I like China Mobile....more subscribers than the US POPULATION. Not that I've bought a position in it...I think my exposure to China begins and ends with F...

  • Report this Comment On July 20, 2010, at 10:41 PM, soycapital wrote:

    I'm 58 years old and I will never buy an individual stock in China again. Too much playing with the books by these companies. Still have a couple that are 35% in the red, dumped the rest at a loss. Lesson learned thank you.

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