Answering the calls of activist investors, Yum! Brands (NYSE:YUM) announced it would split itself in two last week. The world's largest restaurant company by locations plans to separate into one public entity comprised of primarily company-owned stores in China, and the other a pure-play franchisor focused on the rest of the globe.
The decision seemed to be a response to the struggles the parent of KFC, Taco Bell, and Pizza Hut has faced in China recently, and its acceptance that its China division behaves much differently from the rest of the business. The menu in Chinese KFC's offers such distinct delicacies as rice dishes, soy milk drinks, egg tarts, and fried dough sticks, making it essentially unrecognizable to the American original.
The decision also comes as Yum's performance has disappointed over the last three years owing to food safety scandals and other missteps. Yum! China will be passing the reigns to a predominantly Chinese leadership with the hopes of reinvigorating the three main brands and growing to as many as 20,000 restaurants in the world's most populous country. Considering the weakness in China of late, it seems that the stronger of the two entities would be Yum! Brands, the parent of 41,000 restaurants in more than 125 countries. But nearly half of those locations are in the U.S., where Yum's performance has been less than stellar.
The Colonel's long retreat
Despite KFC's rapid growth in China, the brand has fizzled at home. Over the past 10 years, the once-leading fast-food chicken brand has closed stores as sales, quality, and customer service have all fallen. Its store count has fallen nearly 20% from its peak in 2004 to 4,370, and in the meantime, Chick-fil-A has surpassed it as the nation's No. 1 fast-food chicken brand by sales.
Average unit volumes have fallen to below $1 million, considerably below rivals like Popeyes and Chick-fil-A, but the company is focused on returning the brand to growth. It plans to invest $185 million over the next three years to revamp stores, buy new equipment, and incentivize franchisees. Still, that's a modest sum to overcome 10 years of neglect, and it will remain a challenge for KFC to bring its domestic stores back to their former glory.
Pizza Hut, not makin' it so great
While KFC has managed to grow on a global basis recently, Pizza Hut has faced greater headwinds. The casual dining chain has seen comparable sales drop 1% globally in each of the past two years, and comps are flat through this year.
That weakness has been anchored domestically, where 60% of Pizza Hut locations are found. A menu revamp last year did not create the expected benefits, even as the company introduced 10 new crust flavors, a gluten-free option, and a new digital ordering experience. Pizza Hut also has some of the lowest restaurant-level operating margins in the industry, at under 10% -- indicating it's unlikely to be an attractive proposition to future franchisees -- and new domestic store growth has been flat in recent years.
Meanwhile, rival delivery concepts like Domino's and Papa John's have soared in the last five years, taking share from Pizza Hut.
Run for the border
Taco Bell is performing the best domestically out of Yum's three brands. Unlike KFC and Pizza Hut, the Mexican food chain has not made significant inroads outside of the U.S, though management hopes to open as many as 1,300 restaurants abroad in the coming years. In recent years, Taco Bell's addition of breakfast, the late-night Fourth Meal, and new menu items like the Doritos Locos Taco and the Cantina Bell menu have driven consistent sales growth. Same-stores sales have ticked up 3% over the last two years, and another 5% in the first three quarters this year.
Going forward, Taco Bell expects to add 100-200 new units a year and grow same-store sales in the low single digits. As an indication of Taco Bell's success, Greg Creed, the chain's CEO during its recent growth phase, was promoted to CEO of Yum! earlier this year.
Adding it all up
Combining Yum's three domestic brands, we have one that has closed 20% of its stores over the last decade, another with flat-lining organic sales and an unsustainable restaurant-level operating margin, and a third growing at a moderate pace.
The strength of Taco Bell's recent performance just isn't enough to offset weakness in KFC and Pizza Hut. Still other brands have found success through international franchising like Restaurant Brands International (NYSE:QSR). Burger King, now a division of Restaurant Brands International, seems like template for the new Yum! Brands. The burger chain's store count has actually been falling slightly in the U.S., but new management has refranchised domestic stores and made international franchising easier, leading to rapid growth. The stock nearly doubled in a two-and-a-half year span before merging with Tim Horton's.
Yum! Brands would like to follow suit, but with nearly half of its stores in the U.S., the domestic segment will continue to be the most important.
Management has promised to expand its global presence with "a particular focus on consumer insight-driven branding and innovation," a statement so vague as to be meaningless. With plans to expand its store count by about 5% annually, Yum will continue to deliver growth, but considering the challenges it still faces, investors can find better bets elsewhere in the restaurant industry.