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Yum! Brands Improving in China: Time to Buy?

By Andrés Cardenal – Feb 6, 2014 at 8:10AM

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A turnaround in China could provide substantial upside potential for Yum! Brands. Time to buy?

Yum Brands! (YUM -1.80%) delivered better-than-expected earnings for the fourth quarter of 2013. The company seems to be slowly turning things around in China, and the stock is reasonably valued when compared against industry peers like McDonald´s (MCD -0.53%), Chipotle Mexican Grill (CMG 0.07%), Burger King (BKW.DL), and Wendy´s (WEN -1.04%). Is it the right time to invest in this global fast-food powerhouse?

A Chinese new year
Worldwide system sales increased by 3% prior to currency translations. This includes a 3% increase in China, a strong 6% growth rate in the international division, and an uninspiring 1% decline in system sales in the U.S. Earnings per share, excluding special items, came in at $0.86 for the fourth quarter of 2013. This was better than the $0.80 per share expected on average by Wall Street analysts.

One of the biggest positives form the earnings announcement is that management reaffirmed guidance of at least 20% earnings-per-share growth in 2014. This may indicate that the company is successfully turning around its operations in China, a crucial market for Yum! Brands that was materially affected by safety concerns regarding its KFC poultry suppliers in December of 2012.

New avian flu cases have been reported in China lately, but CEO David Novak said during the press conference that the company is not seeing any meaningful impact on sales. Yum! Brands is strengthening its supply chain in China via its Operation Thunder initiatives, and it has also embarked on a series of efforts to improve customer perceptions regarding food safety at KFC. According to management, the company has made "significant progress in rebuilding consumer trust at KFC."

KFC same-store sales in China declined by 4% during the quarter, which is something the company had already anticipated. Yum! Brands is not completely out of the woods when it comes to China, but sales have been stabilizing during the last few quarters, and the company could easily deliver better performance in the country in the years ahead.

Besides, Yum! Brands still has a lot of room for international expansion into other emerging markets. India is looking like a particularly attractive opportunity in the middle term, considering that systemwide sales in the country increased by 22% during the last quarter.

Fair valuation
When compared against competitors such as McDonald's, Chipotle Mexican Grill, Burger King, and Wendy's, Yum! Brands looks reasonably valued.

Data Source: FinViz.

Chipotle is materially more expensive than the other companies in the group, but there are valid reasons for that price tag, because the organic burrito company is delivering extraordinary growth for investors, and positioned to continue outperforming for years to come.

McDonald's, on the other hand, is having serious difficulties when it comes to increasing sales. The fast-food giant has delivered stagnant revenues over the last several quarters. Menu innovations have not produced the desired response from customers, and service quality is becoming a problem for the company lately. McDonald's is quite cheap, but that's because of the company's lackluster growth rates of late.

Burger King and Wendy's are both doing better than McDonald's, even if they are no match to Chipotle when it comes to growth rates. Burger King has made an impressive comeback during the last few years, revamping its stores, and introducing successful products like its lower-calorie french fries, Satisfries.

Wendy's is following a similar path, restructuring operations, and focusing on menu innovations to attract customers. Products like its Pretzel Bacon Cheeseburger and Pretzel Pub Chicken sandwich have been smart moves by the company lately, so Wendy's seems to be moving in the right direction.

Yum! Brands is cheaper than all the companies in the group except for McDonald's when looking at P/E and forward P/E ratios. While McDonald's pays a much higher dividend yield, Wendy's beats Yum! Brands by a small margin when it comes to dividends.

All in all, Yum! Brands is attractively valued in comparison to other industry players. And if the company manages to definitively turn things around in China, the stock could offer substantial upside potential from current levels.

Bottom line
Yum! Brands seems to be making some progress in China, even if the company is not completely out of the woods at this stage. In addition, other emerging markets are showing promising growth prospects in the coming years. The stock is moderately valued in comparison too peers, so Yum! Brands looks well positioned to deliver tasty returns for investors in the coming years.

Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide, Chipotle Mexican Grill, and McDonald's. The Motley Fool owns shares of Chipotle Mexican Grill and McDonald's. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Stocks Mentioned

Yum! Brands Stock Quote
Yum! Brands
$128.27 (-1.80%) $-2.35
McDonald's Stock Quote
$270.34 (-0.53%) $-1.43
Chipotle Mexican Grill Stock Quote
Chipotle Mexican Grill
$1,509.46 (0.07%) $1.06
Restaurant Brands International Inc. Stock Quote
Restaurant Brands International Inc.
The Wendy's Company Stock Quote
The Wendy's Company
$22.93 (-1.04%) $0.24

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

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