Yum Brands (NYSE:YUM), the parent company of KFC, Taco Bell, and Pizza Hut, spun off its Chinese operations as Yum China (NYSE:YUMC) in late 2016. Prior to that split, Yum China's growth had decelerated significantly due to avian flu outbreaks and a scandal involving expired meat.
Some analysts praised the spin-off, while others declared that Yum was prematurely abandoning its Chinese business. But since the split, shares of Yum China surged 75% as Yum Brands' stock advanced just over 60%.
Yum China's revenue rose on strong same-store sales at KFC and Pizza Hut, and its margins gradually expanded. However, that enthusiasm recently faded when the company provided a grim update on the coronavirus outbreak during its fourth-quarter conference call.
What did Yum China say about the coronavirus?
CFO Andy Yeung stated that the outbreaks caused "significant interruptions" to its business due to the temporary closure of restaurants before the Chinese New Year and a "substantial decline in sales" at the locations that stayed open.
Yeung stated that "more than 30%" of its restaurants were still closed, and that traffic at its open locations "[was] impacted by travel restrictions, suspended festivities, and shortened operating hours as people avoid going out." Same-store sales at the locations that stayed open since the Chinese New Year fell 40%-50%.
Yeung warned that the company still couldn't "forecast when, nor at what rate, the closed restaurants will be reopened," and that it could "experience operating losses" for the first quarter of 2020 and the full year if the current trends continue.
On the bright side, deliveries remained robust as it ramped up "contactless" services in which couriers avoid direct contact with customers. CEO Joey Wat also noted that the coronavirus crisis was hurting Pizza Hut more than KFC, which relies more heavily on deliveries and in-store pickups than Pizza Hut.
Despite all those headwinds, Yum China still plans to open 800 to 850 new stores this year and boost its store count by roughly 9% to over 10,000 locations. It also expects its capex to come in between $500 million to $550 million for 2020 as it opens new stores, upgrades existing ones, and boosts its digital, IT, and infrastructure investments.
Yeung stated that the company would "continue to invest" in its emerging brands, and that its acquisition of the casual dining chain Huang Ji Huang was still on track to close in early 2020. In short, Yum China still views the coronavirus crisis as a one-time event that won't curb its long-term growth.
But is Yum China being too optimistic?
When the coronavirus outbreak started, many analysts compared the epidemic to the SARS outbreak, which lasted for roughly eight months and killed nearly 800 people in 2002 and 2003.
However, the COVID-19 coronavirus seems to be significantly more dangerous than SARS. It's already claimed over 2,000 lives and infected more than 75,000 people since the virus was identified last December.
The lack of media transparency in China, along with a widespread distrust of the government's official numbers, also makes it difficult to gauge the true impact of the virus on China's economy. China's recent actions -- including financial stimulus packages, citywide lockdowns, and the hasty construction of a massive hospital -- also indicate that the situation could get worse.
If the situation worsens, Yum China could post at least several quarters of double-digit revenue declines and collapsing margins. Meanwhile, tighter lockdowns and quarantines could prevent the company from achieving its goal of topping 10,000 stores by the end of 2020.
Wall Street currently expects Yum China's revenue and earnings to decline 8% and 52%, respectively, this year. Those forecasts mainly reflect China's economic slowdown and gains from its investment in the delivery platform Meituan Dianping (OTC:MPNGF) instead of the recent coronavirus outbreak.
Yum China's forward P/E of 23, which is based on those outdated forecasts, is already lofty for a company that faces revenue and earnings declines this year. If those forecasts are reduced, its valuation will rise even more -- which indicates that the stock is currently overvalued.
The bottom line
We can't tell how badly the coronavirus crisis will hurt Yum China yet, but there simply isn't enough fear baked into the stock price. Investors should avoid this stock until management offers a clearer view of the situation and demonstrates that it can weather the storm.