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Better Buy: Yum Brands or Yum China?

By Leo Sun - Oct 23, 2017 at 7:50PM

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Which Yum company is the yummier pick for your portfolio?

Last November, Yum China (YUMC 4.37%) started trading on the New York Stock Exchange after being spun off of Yum Brands (YUM 2.82%). Yum China shares surged nearly 70% since that split, but Yum shares only rose about 20%.

Therefore, investors might be wondering if Yum's Chinese business is a better growth play than its former parent company. Let's compare the two companies' business models, growth trajectories, and valuations to find out.

A pepperoni pizza.

Image source: Getty Images.

What do Yum Brands and Yum China do?

Yum Brands owns three flagship fast food brands -- KFC, Pizza Hut, and Taco Bell. It runs nearly 44,000 stores across over 135 countries and territories. Its stores are mostly franchised, and Yum aims to have 98% of all its locations franchised by 2018.

Yum decided to spin off its Chinese unit in late 2015 as sales slowed down across the region amid outbreaks of avian flu and a brand-tarnishing scandal involving expired meat. Prior to that spin off, Yum's Chinese division generated over half of the company's revenue and operating profits.

Yum China now operates nearly 7,800 restaurants across the region, including Yum's flagship brands and local chains like Little Sheep and East Dawning. It plans to eventually expand to 20,000 locations. The company runs on a fully franchised model, and pays a 3% license fee on system sales to Yum Brands as its largest franchisee. It also recently acquired a controlling stake in home delivery service Daojia to expand its O2O (online-to-offline) delivery options.

How fast is Yum Brands growing?

Yum Brands expects its system sales to rise 5% this year, compared to 4% in 2016 (excluding the impact of a 53rd week that year). It expects its same-store sales to rise 2%-3%, and for its operating profit to grow by the mid-single digits.

A woman eating a piece of fried chicken.

Image source: Getty Images.

All three of Yum's core brands are posting decent growth. Its worldwide system sales rose 6% last quarter, with KFC and Taco Bell posting 7% growth and Pizza Hut generating 2% growth. Its total same-store sales rose 2% as positive growth at KFC and Taco Bell offset a 1% decline at Pizza Hut.

On the bottom line, analysts expect Yum's earnings -- buoyed by buybacks, refranchising, and cost-cutting efforts -- to rise 15% this year. Yum finished last quarter with a restaurant margin of 15.7%, up from 14.6% a year earlier.

How fast is Yum China growing?

With the prior safety issues in the rear view mirror, Yum China is now growing faster than its former parent. Its system-wide sales surged 10% annually last quarter, and its same-store sales jumped 6%. KFC carried the torch with 7% same-store sales growth, which offset flat growth at Pizza Hut.

Meanwhile, Yum's smaller brands -- Taco Bell, Little Sheep, and East Dawning -- represent just 3% of Yum China's total store count. Yum China isn't as upfront with its full-year guidance as Yum Brands, but analysts expect its revenue and earnings (also supported by buybacks) to respectively rise 4% and 10% this year.

Yum China's restaurant margin hit 20% last quarter, compared to 19.2% a year earlier. That improvement was mainly driven by same-store sales growth.

The valuations and dividends

Yum Brands and Yum China respectively trade at 29 and 28 times earnings, compared to the industry average of 27 for restaurants. But looking ahead, Yum Brands trades at 24 times next year's earnings, compared to Yum China's forward P/E of 26.

Neither stock is cheap, but they both offer decent dividends. Yum Brands pays a forward yield of 1.6%, which is easily supported by its payout ratio of 59%. Yum China recently declared a quarterly dividend of $0.10 per share, which translates to a lower forward yield of 0.9%.

So which company is the better buy?

Yum Brands and Yum China are both richly valued, but I think Yum China is a better overall buy. It has a higher percentage of franchised stores, stronger sales growth, higher margins, a more diverse portfolio of brands, and a wider range of delivery options (like Daojia).

I also like how Yum China is focused on a single growing market instead of multiple regions which could cancel each other out. I wouldn't go all-in on Yum China at current prices, but I think it could keep outperforming its former parent company over the next few years.

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Stocks Mentioned

Yum! Brands, Inc. Stock Quote
Yum! Brands, Inc.
$116.71 (2.82%) $3.20
Yum China Holdings, Inc. Stock Quote
Yum China Holdings, Inc.
$50.62 (4.37%) $2.12

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