Yum! Brands (NYSE:YUM), operator of well-known restaurant chains KFC, Pizza Hut, Taco Bell, Long John Silver, and A&W, has faced some serious blemishes to its record in the past year. A New York City rat infestation issue received an awful lot of publicity, as did an e.coli outbreak at Taco Bell. Though its earnings have seemed far healthier than its public image, its fortunes could worsen in coming quarters.
Even so, Yum! topped analysts' consensus earnings estimate by 11.1% in the first quarter, as compiled by Thomson Financial. The company's international expansion efforts, especially in China, have generated impressive growth from the capital from Yum!'s domestic cash-cow operations. In fact, the China segment's operating profit climbed 31% last quarter.
Still, rising food costs are bound to pressure margins, and those costs are climbing all over the world. As Yum!'s gross margin gets squeezed, its operating margin still benefits from economies of scale in its international expansion. Last quarter, gross margin narrowed by 78 basis points, but operating margin more than compensated, widening by 69 basis points.
Estimates for Yum!'s soon-to-end Q2 are waning, from $0.37 per share in net income 90 days ago $0.36 today, according to Thomson Financial. (The figures are adjusted for a 2-to-1 stock split June 27.) Even so, full-year 2007 estimates have increased by $0.02 per share to $1.63 (split-adjusted) during that time. Analysts may be reducing their near-term outlook, but they've still had to compensate for their first-quarter shortfall by adjusting the full-year number higher.
YUM trades at 20 times the 2007 EPS consensus number; analysts expect EPS to grow about 12% this year and over the next five years. That's a bit expensive for such modest growth, in this Fool's view. Yum! still faces serious risks from rising food costs and shrinking disposable income among American conumers. Still, that pressure will likely inflict the most pain on the casual dining sector, including the likes of Darden Restaurants (NYSE:DRI), Brinker International (NYSE:EAT), and Cheesecake Factory (NASDAQ:CAKE), to bear the brunt of that pressure, not the lower ticket fast-food behemoth.
Yum! doesn't compare too poorly to fast-food peer McDonald's (NYSE:MCD), which carries a forward P/E of 19 for 2007. Even so, this Fool thinks the entire restaurant sector is in store for a valuation adjustment, thanks to indications of weakening consumer spending. As yummy as its fried chicken is, this Fool wouldn't own Yum! right now.
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Fool contributor Markos Kaminis has no ownership interest in any of the companies discussed here, but he loves McDonald's dollar menu. The Fool's disclosure policy is finger-lickin' good.
