Yum! Brands (NYSE:YUM) has suffered years of scrutiny amid reports of poor quality meat and questionable supplier practices in China. In light of these reports, some investors have been hesitant to risk ruffling their feathers and prefer to stick in their comfort zone. But a recent move might turn those investors bullish once again.
Meanwhile, Weight Watchers International (NASDAQ:WTW) has made history with its recent announcement regarding a high profile partnership that could get their numbers up and push them out of a slump.
A full transcript follows the video.
Dylan Lewis: Investors say "Yum!" to Weight Watchers on this episode of Industry Focus.
Greetings, Fools! Today is Oct. 20, 2015. I'm your host, Dylan Lewis, and I'm joined in the studio today by Motley Fool consumer goods analyst, Vincent Shen. Vincent, how you doing today?
Vincent Shen: How are you, Dylan?
Lewis: Doing all right. Perhaps not as good as some of the stocks we're going to be talking about today. A lot of big moves in the market. Why don't we start out talking about Yum! Brands and some news about the stock?
Shen: A major announcement just came out before the market opened, that the company will be spinning off its business in China. The initial response has been very positive, like you mentioned. It's up over 4%, last I checked.
Lewis: For listeners that aren't as familiar with Yum!, what's driving management to make such a big decision?
Shen: Ultimately, this all centers around its China division, which makes up about half of revenue and operating profits. The issue there is that China's previous major growth vehicle has seen revenue stagnate over the past two years, or so. To illustrate that, for the full year 2012, China division saw revenue of about $6.9 billion. Two years later, for full year 2014, it was just over $6.9 billion.
The problem is, there's a huge shift from previously when, in 2011 to 2012, you'd see anywhere from 25% to 35% annual growth.
Lewis: Okay, so there's a big drop off there.
Shen: Big drop off.
Lewis: What's the reason for that shift?
Shen: For investors who don't follow Yum! as regularly, it's just been plagued by terrible publicity as a result of some food quality scandals.
Lewis: I remember a couple months back when they had some issues with meat sourcing.
Shen: Yes. They get hit back to back, really. That's just resulted in this longer slide. In 2012, CCTV reported at the end of 2012 that local a KFC supplier was treating chickens with excess antibiotics after they did some testing in the previous two years. Management forecasted a 25% same-store sales decline as a result from that negative publicity. It actually came down just around 20%, but the pain continued.
Restaurant margin declined 7% points, operating profit fell a very significant 41%. The next quarter was more of the same. Same-store sales were down 20%, margin down 5% points, operating profit plummeted 63%. At that point it's possible -- they hit it with a lot of marketing to try and get customers back in their stores, but right after that happened there was an avian flu situation, too. So they were hurt by that as well.
It's this ongoing pain that management was feeling in their China division. When things started to pick back up over the next year or so, they got hit again recently -- last summer -- when there were reports that came out that one of their suppliers, this time at an American owned factory, was basically continuing to use tainted and expired chicken.
As you can imagine, this actually hit McDonald's and Starbucks as well, but same-store sales fell 14%, margin declined 4.6% points, operating profit down 30%. For full year 2015, the most recent quarter, management indicated that same store sales were going to come in slightly negative.
After years of suffering through this really poor recovery, and being hit by these scandals, investors are very unhappy and management has been going through this long, strategic review trying to determine what they can do to revitalize that business.
Lewis: Basically, it was issue after issue after issue, and they weren't able to rally long enough to reinstill that consumer confidence.
Shen: Yeah. They were probably picking up some momentum and looking like they would at least return somewhat to their previous growth and their success there, but they got hit by this other scandal.
Lewis: I've seen this name in some of the articles I've been reading about the issues: Keith Meister. Can you talk a little bit about his role in all this?
Shen: He's a big player here because he's an activist investor from Corvex Management. They're one of Yum! Brands biggest shareholders. I think they have a 5% stake. They made an announcement last week that he had been appointed to the board of directors. He's been very public with his view that Yum! Brands should be spinning off its China business entirely.
He presented that in a speech that he made in May of this year. The stock has traded down about a quarter since then as a result of its recent earnings reports, but it's kind of interesting to see, since that slide he got appointed to the board and then not even a week later they're making this announcement and this stock is seeing a big boost as a result.
Lewis: Yeah. This is the nudging of an activist investor.
Shen: Oh, I think it's a huge part of that.
Lewis: Okay. What are these two new companies going to look like? What can investors expect?
Shen: Yum! China operates about 6,900 total restaurants, and that's just KFC and Pizza Hut. Taco Bell has no presence in China yet. They're working on it. Under the current structure those are primarily company owned. What's going to happen is, Yum! Brands overall is targeting over 95% franchise model for their whole network of restaurants. Then Yum! China will just become an overall franchisee and it will be Yum! Brands' largest one by far.
Yum! Brands overall has 41 thousand restaurants worldwide. They've been opening about 2000 more annually. That's a pretty impressive rate of growth in terms of their number of restaurants, at least.
Lewis: When should we be looking for this deal to close out?
Shen: Deals should be completed by the end of 2016 and CEO, Greg Creed, described the deal in a way that's not all that surprising. He said "Following the separation, each stand-alone company will be able to intensify focus on its distinct commercial priorities, allocate its own resources to meet the needs of its business, and pursue distinct capital structures and capital allocation strategies. This will provide a clear investment thesis and visibility to attract a long term investor base suited to each business."
Not surprisingly, this will give investors their choice to invest in the Yum! Brands model, which is high margin, very stable due to the franchisee model where they're just getting that licensing revenue, and then more of the growth model through Yum! China, assuming they're able to get things back on track.
Otherwise, Creed is going to continue running Yum! Brands and Micky Pant who took the senior role for China late last year is going to keep running that business.
Lewis: Great. We're going to be talking about Weight Watchers in a minute, but before we do, I just wanted to remind our listeners that we have a special offer for The Motley Fool's Stock Advisor newsletter, for all of our IF listeners. As a loyal Industry Focus listener you have access to a special discount on Stock Advisor that works out to $129 for a full two year subscription. Just go to Focus.Fool.com to take advantage of this offer. Again, that's Focus.Fool.com.
You get a Weight Watchers membership, and you get a Weight Watchers membership, and you get a Weight Watchers membership. What is going on with Weight Watchers this week?
Shen: We talked about Yum! Brands jumping 4% on the news that they'd be spinning off the China business, whereas Weight Watchers has jumped well over 100% in a day and a half of trading.
Lewis: That's insane! I don't know if I've ever seen anything like it.
Shen: It all has to do with one pretty powerful celebrity, as you can see: Oprah Winfrey. Before the market opened yesterday, she announced that she would be taking a 10% stake in Weight Watchers. Basically, purchasing about 6.4 million shares for $43 million. This is part of a partnership that she's forming with the company lasting five years where they get to use her for their marketing and in all of their promotional materials.
They describe her role as three parts: she'll be a member herself. She's talked about how Weight Watchers has helped her maintain her lifestyle. She's also a board member and advisor, and lastly, as part owner as she takes on that stake.
Lewis: Very interesting stuff. This jump is positive, no doubt. It's great to have someone that can be the face of the company, especially someone who's using the product as a spokesperson. A lot of the rally that we're seeing is gaining back the huge losses that have been experienced earlier in the year. Can you talk a bit about what's been charging that?
Shen: Sure. You definitely got that right. The stock's down 70% year-to-date and the slide hasn't just been a recent thing. The shares peaked in May 2011 at $85, they've fallen over 95% since then, and this really has a lot to do with the rising popularity of mobile devices like smart phones and wearables, surprisingly enough.
The idea being that now you have all this new, technology driven resources for weight loss, for general wellness, tracking your diet, tracking your exercise, and that's attracting a lot of people. So, Weight Watchers has struggled on the technological front to hold onto their memberships and their revenues have suffered as a result.
Full year 2014 revenue has fallen 20% from its 2011 levels and the company has just seen several years of consistently declining sales overall. Before this announcement was made and the stock traded up astoundingly so, 105% yesterday, I think it's up another 30% today. The stock itself was valued about 10x its expected 2015 earnings.
The thing is, for the next five years or so, analysts were forecasting earnings to decline anywhere from 15% to 20% annually for that period. You definitely have a very down beaten stock where management has instituted things like cost cuts, changing up its management team itself, it's had a hard time competing with this onslaught of new technology, and new options that people have when it comes to weight loss.
Lewis: One the one hand there's tons of competition from mobile tech and wearable integrated products. Things like Jawbone, Fitbit, and things like that. No doubt it's eating into market share, but weight loss isn't exactly something that will be going away. It's a major trend, I think people are becoming more health conscious and there's definitely a place for a player like this.
How impactful do you think Oprah might be with her involvement in the company? Is this something that is irrational over exuberance by the market? Is there any justification for this stock raising as much as it has?
Shen: The market is obviously really enthusiastic about this. Incredibly so. Like you mentioned, I haven't really seen a stock go on a bull run like this just from a singular endorsement from a celebrity before. I think the power here is that Oprah has a very strong track record where she's proven her ability to make certain products, books, or even people extremely successful.
There are multiple people who were part of her show when it was still running, who now have their own shows. The books she recommends immediately shoot up to the top of the best seller list. Products she recommends sell out. I think one of her products, the owner didn't see any success until Oprah mentioned it, and I think it turned her into a billionaire herself.
Lewis: Yeah, it just takes off like that.
Lewis: It's really astounding how successful books become once they're on her "Book of the Month" club.
Shen: In this case, I don't think that Oprah is going to be able to solve all the company's woes, and it's not going to completely shift the competitive environment as it stands now; but where the company can benefit is first, a huge wave of increased interest, just from the stock run. Also, just from the positive publicity it's getting.
Oprah and a lot of her fans hit the demographic that Weight Watchers wants. How far Weight Watchers can leverage, how far the company can leverage this partnership and this recent success -- at least with its stock price -- is really up to them. I know they're going to at least expand into much more of an overall wellness company, rather than just focusing on weight loss as they already have begun to do.
This might be the kick they need as they have access to her huge fan base.
Lewis: It's almost like a platform play for them, really. They're getting access to this established person with this devout following, and this ready-made market that people are ready to follow pretty much anything she recommends.
Shen: It hasn't taken long. If you go to their website now she's already on there with a pretty catchy slogan. It basically says "I'm ready. Are you ready to join me?" I'm very curious to see if the enthusiasm that investors have had for Weight Watchers shares in this past day and a half will actually amount to real bottom line and topline growth.
Lewis: It will be fun to watch. Thank you for your time, Vincent.
Shen: Thanks, Dylan.
Lewis: Always a pleasure. If you're a loyal listener and have questions or comments we would love to hear from you. Just email us at IndustryFocus@Fool.com. Again, that's IndustryFocus@Fool.com. As always, people on this program may have interests in the stocks that they talk about, and the Motley Fool may have formal recommendations for or against those stocks. So, don't buy or sell anything based solely on what you hear on this show. Thanks for listening, and Fool on!
Dylan Lewis has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Starbucks. Try any of our Foolish newsletter services free for 30 days. 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.