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YUM! Brands Relies on Franchising Amid Increased Expenses

Zacks Equity Research

YUM! Brands, Inc. YUM continues to rely on its transformation plan to drive growth. The company increasingly focuses on various digital initiatives and refranchising efforts to drive its top and bottom lines. However, its de-risking strategies are weighing on near-term revenues, which pose concerns. Also, soft revenues at Pizza Hut and high costs are potential headwinds.

Nevertheless, by relying extensively on the four key drivers of growth — distinctive, relevant and easy brands; unmatched franchise operating capability; bold restaurant developments; and unrivaled culture and talent — the company remains on track to achieve long-term target.

Shares of YUM! Brands have gained 39.2% over the past year, outperforming the industry’s 33.4% rally.

 

 

Let us delve deeper into reasons that suggest that investors should hold the stock for the time being.

Top Line to Gain

YUM! Brands is well ahead at the digital race that characterizes the restaurant industry. The company announced a partnership with online food delivery platform Grubhub to enhance online sales and delivery from its restaurants. Additionally, YUM! Brands implemented various digital features in mobile and online platforms across all of its segments to enhance guest experience.

The company has also worked toward making its delivery services swifter and the results so far have been positive. YUM! Brands currently has 2,200 KFCs, offering delivery, and 3,200 restaurants available for click-and-collect on the Grubhub marketplace. Pizza Hut has 200 locations on the Grubhub marketplace. For Taco Bell, delivery exists in over 4,000 restaurants.

Refranchising & Enhanced Efficiency Bode Well

The company adopted a de-risking strategy by reducing its ownership of restaurants through refranchising. In fact, the China division’s spin-off has largely made YUM! Brands a more asset-light company, as many company-owned restaurants have been in the China market. We note that refranchising a large portion of the system reduces the company’s capital requirements, and facilitates earnings per share growth and ROE expansion.

In the first quarter of 2019, it opened 310 net new units, reflecting 7% growth. Moreover, YUM! Brands refranchised 331 restaurants at the end of 2018, including 227 KFC and 104 Taco Bell units for pre-tax proceeds of $380 million. At the end of 2018, the company’s global franchise ownership mix increased to 98%.

Meanwhile, YUM! Brands aims to revamp its financial profile, and thereby improve the efficiency of its organization and cost structure globally. It believes that a “slimmer Yum Brands” would lead to efficiency gains. Management expects to cut capex to about $100 million by 2019, increase free cash flow conversion to 100%, and reduce General and Administrative (G&A) expenditure by approximately $300 million (or 1.7% of system sales). In addition, the company aims to maintain an optimized capital structure, with the leverage of five times EBITDA. Over the next three years, it is committed to returning additional $6.5-$7 billion to shareholders through share repurchases and dividends. Resultantly, YUM! Brands expects EPS of at least $3.75 in 2019.

Concerns

The company’s revenues in the first quarter of 2019 were down 9% year over year due to sales slump, stemming from its continued refranchising initiatives. The de-risking strategy of YUM! Brands to reduce the ownership of restaurants by expanding franchise is expected to negatively impact revenues in the near term while boosting earnings.

A competitive retail environment also puts pressure on the restaurants’ costs. Moreover, with relentless expansion, the company is prone to face profit margin pressure. In the first quarter of 2019, total costs and expenses grew 0.4% year over year to $821 million. Also, operating profit declined 21.7% in the first quarter from the year-ago quarter.

Meanwhile, YUM! Brands has been facing declining revenues at its Pizza Hut division. Decline in net new unit growth and low system sales have been affecting comps as well. Further franchising has been weighing on the division’s near-term revenues. In the first quarter of 2019, Pizza Hut’s revenues amounted to $243 million, down 3% on a year-over-year basis. Comps remained flat compared with the year-ago quarter’s increase of 1%. Comps were also flat in the fourth quarter of 2018.

Zacks Rank & Stocks to Consider

YUM! Brands currently carries a Zacks Rank #3 (Hold). A few better-ranked stocks in the restaurant industry are Chipotle CMG, Papa John’s PZZA, and Noodles & Company NDLS, each currently sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Chipotle, and Noodles & Company’s earnings for 2019 are expected to grow 43.6% and 700%, respectively. Papa John’s long-term EPS growth rate is 12.5%.

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