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YUM! Brands' Shares Gain 23% in 1 Year: More Room to Run?

Zacks Equity Research

YUM! Brands, Inc. YUM continues to pursue its three-year strategic transformation plan to drive growth at KFC, Pizza Hut and Taco Bell brands. With the first quarter of 2019, the company completed three years of its transformation journey. The company remains on track to achieve its long-term target by focusing on four key growth drivers — distinctive, relevant and easy brands; unmatched franchise operating capability; bold restaurant developments; and unrivaled culture and talent.

Though YUM! Brands’ de-risking strategy of reducing restaurant ownership is likely to favor the bottom line in the long term, it is weighing on the company’s top line. Further, soft revenue trend at the company’s Pizza Hut division remains a concern.

Nevertheless, robust digital and delivery services and refranchising initiatives are likely to put YUM! Brands on growth trajectory. Backed by robust brand portfolio, shares of the company gained 22.5% over the past year, outperforming the industry’s rally of 21.1%.

 

Let us delve deeper into factors that make this stock worth holding on to.

Top Line Gains From Digital Initiatives

YUM! Brands is focused on transforming its business toward a single point-of-sale system in the United States. Further, it updated its mobile app and Hut Rewards. The company’s loyalty program has over 12 million active users.

The company announced a partnership with online food delivery platform, Grubhub, to enhance online sales and delivery from its restaurants. Additionally, it implemented various digital features in mobile and online platforms across all its brand segments to enhance guest experience.

YUM! Brands is also working toward making its delivery services faster and the results so far have been positive. The company 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 & Efficiency Initiatives Boost Earnings

YUM! Brands has adopted a de-risking strategy by reducing its ownership of restaurants through refranchising. In fact, the China division’s spin-off has largely made the company more asset-light. In the first quarter of 2019, YUM! Brands opened 310 net new units, reflecting net new unit growth of 7%. 

We note that refranchising large portion of the system reduces the company’s capital requirements and facilitates earnings per share growth and ROE expansion. Moreover, free cash flow will continue to grow, facilitating reinvestments to increase brand recognition and shareholder return. Remarkably, this shift to refranchising has substantially benefited the company’s operating margin over the years. Consequently, YUM! Brands expects to become a "pure play" franchisor with more stable earnings, higher profit margins, lower capital requirements and stronger cash flow conversion.

Meanwhile, YUM! Brands’ aims to revamp its financial profile which in turn will improve organizational efficiency 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). Additionally, the company aims to maintain an optimized capital structure, with 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, the company expects EPS of at least $3.75 in 2019. The Zacks Consensus Estimate for earnings in 2019 is pegged at $3.81, suggesting growth of 20.2% from 2018.

Concerns

YUM! Brands’ revenues in the first quarter of 2019 were down 9% year over year owing to sales slump on account of persistent refranchising initiatives. The de-risking strategy of the company to reduce the ownership of restaurants by expanding franchise is expected to negatively impact revenues in the near term but will bolster earnings in the long term.

The company has also 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.

Zacks Rank & Stocks to Consider

YUM! Brands currently carries a Zacks Rank #3 (Hold). A few better-ranked stocks in the industry include Yum China YUMC, Chipotle CMG and Denny’s DENN, each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

YUM China and Chipotle’s long-term EPS are likely to grow 9.8% and 19.2% respectively. In 2020, Denny’s earnings are likely to increase 8.2%.

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