Please ensure Javascript is enabled for purposes of website accessibility

Tasty Chicken, Tepid Price

By Markos Kaminis – Updated Nov 14, 2016 at 10:51PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Will Yum! Brands fly the coop this year, or lay an egg?

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.

Further Foolishness:

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.

None

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Yum! Brands, Inc. Stock Quote
Yum! Brands, Inc.
YUM
$110.65 (-0.13%) $0.14
McDonald's Corporation Stock Quote
McDonald's Corporation
MCD
$245.95 (-0.80%) $-1.99
Brinker International, Inc. Stock Quote
Brinker International, Inc.
EAT
$25.53 (-5.02%) $-1.35
Darden Restaurants, Inc. Stock Quote
Darden Restaurants, Inc.
DRI
$122.39 (-2.44%) $-3.06
The Cheesecake Factory Incorporated Stock Quote
The Cheesecake Factory Incorporated
CAKE
$28.43 (-2.44%) $0.71

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
329%
 
S&P 500 Returns
106%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/24/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.