Shares of Yum! Brands (YUM 1.86%) were down 15.6% in February, according to data provided by S&P Global Market Intelligence. The struggles of its Pizza Hut brand overshadowed better results from its KFC and Taco Bell chains. And, as the largest restaurant franchiser in the world with over 50,000 locations, it has a lot of exposure to the regions most affected by the coronavirus, including China.
If Yum! Brands' management had been able to offer more concrete 2020 guidance regarding these issues, perhaps its stock wouldn't have slid so far. But a couple of months into the new year, questions remain regarding Pizza Hut, and nobody has much clarity about what the fallout from the COVID-19 outbreak will be. Therefore, many investors looking for "safe" stocks aren't choosing Yum! Brands.
Pizza Hut has underperformed compared to KFC and Taco Bell, and also compared to other pizza-chain competitors. Its U.S. operations are particularly weak, with comparable-store sales down 4% in 2019.
In its efforts to get comp sales growing at Pizza Hut, the Yum! is investing in things like restaurant remodels and an improved digital experience. But there's a small problem with its strategy. Pizza Hut is 99% franchised, and NPC International is the largest franchisee: With over 1,200 locations, it operates roughly 17% of U.S. Pizza Huts. According to Bloomberg, this NPC Internationa is currently considering bankruptcy, meaning it's unlikely to be focused on making the improvements necessary to increase sales. Yum! Management didn't comment much on that situation during the Q4 earnings call, although it did mention that in one particular market, it is working on replacing a franchisee whose operations were not up "to our standard."
In China, Yum! Brands operates exclusively through its franchisee Yum China (YUMC 2.69%). Yum China had over 9,200 locations at the end of 2019 -- about 18% of the global total of Pizza Huts, KFCs and Taco Bells. Right now, due to the COVID-19 outbreak, about 30% of Yum China's locations are closed, and sales are down between 40% and 50% at the locations that remain open. That's setting the company up for a rough 2020.
Answering an analyst's question, Yum! Brands CEO David Gibbs said that every 1% of annual comparable-sales growth for Yum China translates to $2.9 million in operating profit for Yum! Brands. It's easy to see how comp-sales declines could get expensive for the company the longer the virus disrupts China's economy. Undoubtedly, investors' recognition of this is another reason the stock is down.
It's true that Yum! Brands has more exposure to coronavirus in China than most other restaurant companies, and Pizza Hut has been struggling for some time. Investors' concerns are legitimate. But the COVID-19 epidemic is likely to prove a short-term issue, and Pizza Hut could improve. Taking the long view, there's reason to like the stock, or at least to give it a harder look. If Yum! Brands is already on your watch list, ask yourself where you think the company will be in five years -- long after the current period of market volatility has passed.