It was an ugly quarter for Yum! Brands (NYSE:YUM) because of the slower-than-expected recovery unveiled in the China division. But the restaurant operator subsequently announced that it was going to spin off the segment; therefore, it made the matter somewhat moot.
Shares of Yum! Brands tumbled the day of the earnings announcement, losing almost 20% of their value, but they've since clawed back 10% of those losses on the basis of the spinoff news. Although the owner of KFC, Pizza Hut, and Taco Bell is still down 10% from where it was before posting its financial results, the markets see it getting out from under the risk posed by operating in China as a hopeful sign.
The earnings conference call was basically all about China, as analysts tried to tease out of management information about how Yum! Brands planned to recover. Because there's now a spinoff in the works, however, and it will be some time before it happens, here are four other things management thinks you ought to know.
1. Taco Bell is still spicy
The Mexican food chain continues to turn in impressive numbers, with system sales growing 7%, as comparable sales rose 4%, plus an additional 3% coming from Yum! Brands opening new restaurants. Year to date, it has doubled the number of new Taco Bells opened; margins are now more than 21%. It doesn't hurt that the introduction of breakfast has contributed 6% to the sales mix, and provides the Mexican food chain with a great platform to expand on.
CEO Greg Creed wishes his whole company was as good as Taco Bell. "But right now, my absolute focus is on getting these five divisions firing pretty much like I'd like them firing like Taco Bell is firing right now."
2. Pizza Hut still lags the competition
Even outside of China, Pizza Hut has been, at best, a middling performer and, at worst, a horrible one. This quarter tended toward the former rather than the latter as system sales rose 2% on a 1% gain in comps.
While the pizzeria chain essentially performed in line with management's expectations, it's also clear Pizza Hut had some pretty low hurdles set up in front of it to meet those forecasts. As Creed said, "But let's be honest; we're still significantly lagging the performance of our nearest competitors, and we clearly have much urgent work to do for this brand to fulfill its potential."
3. KFC is on the cusp of change
From bad to better can best describe how Yum! Brands' chicken chain is doing, turning in several solid quarters in a row. Not that its operations still aren't choppy: it experienced strong results in Australia, Russia, and Japan, while the situation deteriorated in South Africa and the U.K.
Overall, though, comparable sales rose 3% in the quarter, and it gained another 3% growth in sales from opening 335 new restaurants year to date. Even in the U.S., which, in comparison to operations elsewhere in the world, is just a small component of the whole, KFC saw the number of transactions made here rise 4% year over year.
CFO Pat Grismer says it's a brand that still has great potential: "This gives us great confidence in the strength of the KFC brand and its growth-oriented franchisees."
4. Commodity prices are loosening their stranglehold
The torrid rise in commodity prices seems to have abated for the time being, particularly for beef, which was seemingly hitting new records on a weekly basis. According to industry sources, finished cattle prices hit record highs of about $170 per hundredweight in late 2014 and early into 2015, but then fell below $120 per hundredweight by October. (A hundredweight is a unit of measure that equals 100 pounds.)
Cheese also got a reprieve. Forty-pound blocks that went for about $2.22 now sell for around $1.688.
But Grismer says that, while its own costs dropped, they didn't fall nearly as much as the industry enjoyed, though the declines still benefited the company. He noted that restaurant level margins were "helped by a tailwind in commodities as beef and cheese prices had both declined about 13%." That alleviated the pressure the restaurants were under, allowing margins to improve by 140 basis points, to 22%.
What it means for investors
All eyes are now on what Yum! Brands does with the China division. As the segment accounts for more than half its revenues and a third of its operating profits, spinning it out is going to cause a major shift in how the business operates and performs.
That likely explains why the stock hasn't gained nearly as much from the de-risking plan as would be expected. No one knows quite what Yum! Brands will look like when the deal is done.