Yum! Brands (NYSE:YUM) had an amazing quarter. Compared to Thomson Reuters' analyst expectations of earnings per share of $0.83 on $2.66 billion in revenue, Yum! reported an EPS beat of $0.95 per share and a narrow miss on revenue by hauling in $2.62 billion.
Additionally, Yum! reported respectable worldwide system sales increases of 5% and increased its same-store sales by 2% in the quarter. For a company with more than 40,000 restaurants, same store-sales growth is admirable. Even better, the company opened 295 new KFCs, Taco Bells, and Pizza Huts worldwide with nearly three quarters in emerging markets.
In response to the report, shares surged at high as 5% in the after-hours markets. Here's why long-term investors shouldn't care.
China is on the auction block
Yum!'s same-store sales increase was carried by the company's China division. Versus overall same-store sales growth of 2%, China same-store sales increased 6%. Even better, the company's KFC brand that has suffered in the United States grew a massive 12% in the Middle Kingdom. Pizza Hut did report a same-store sales drop of 12%, but smaller comparable store counts for KFC weighed less on total same-store sales.
Of the large U.S. quick-service restaurants, Yum! has been the most aggressive about moving into the country, looking past its communistic government and emerging-market demographics to the potential of its huge population. While there were missteps, and there were many, Yum!'s struggles were attributable to management missteps (uncompetitive pricing at Pizza Hut and KFC food-safety controversies) rather than macroeconomic problems in the country.
In many ways, Yum! was a play on China's growth. If you don't believe me, take Yum!'s word for it (emphasis mine): "Yum! Brands has a portfolio of brands with leadership positions in China and other emerging markets, with a long runway for growth."
That may no longer be the case. Recent reports say Yum! is in talks with a Chinese sovereign wealth firm to sell its mainland China operations. Last year, Yum! disclosed it planned to separate its Chinese business from the remainder of the company, but the company appeared to plan to spin off the business to existing shareholders.
We need China details, stat
Investors need clarity on what exactly Yum! plans to do with its China operations. Considering a large part of the company's growth story is tied to the country, the form of disposition matters. A proposed spinoff would still provide investors significant exposure to China, whereas selling China operations to private equity and passing along the proceeds as a special dividend would limit investors' exposure to potential China growth.
Additionally, If Yum! plans to sell its Chinese operations, investors will need to know if post-sale Yum! will receive any ongoing remuneration such as franchisee and licensing fees. Bloomberg pegs the deal at $7 billion to $8 billion for Yum!'s 7,100 KFC and Pizza Hut locations in China, if franchising rights are included in the figure, a post-sale Yum! would have no exposure to a country expected to grow its GDP 6.7% this year.
It's true Yum! has made missteps and its market share in the country has fallen as a result thereof. However, Yum! with no exposure to China presents a vastly different risk and potential return profile. Yum! needs to ensure it's receiving a good deal for its Chinese operations and not parting with the business because of management's missteps. Until I'm sure it's receiving a fair price and are properly apprised on the specifics of this deal, I can't be excited about Yum!'s earnings report.