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YUM! Brands (YUM) Banks on Expansion Efforts, Costs High

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  • YUM
  • CMG
  • JACK

Yum! Brands, Inc. YUM is likely to benefit from unit expansion, digital efforts and refranchising initiatives. In the past three months, shares of the company have gained 8.7% compared with the Retail - Restaurants industry’s 4.6% growth. However, pandemic-induced soft traffic along with high operating expenses is a concern.

Let us discuss the factors highlighting why investors should hold on to the stock for the time being.

Zacks Investment Research
Zacks Investment Research

Image Source: Zacks Investment Research

Factors Driving Growth

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” will lead to efficiency gains. Considering its existing footprint of more than 50,000 restaurants worldwide, YUM! Brands believes it can nearly triple its current global presence over the long term. During first- and second-quarter 2021, the company opened 435 and 603 net new units, respectively. Further, master franchise agreements in Brazil (Taco Bell), Spain (Taco Bell) and Russia (Pizza Hut) as well as international growth alliance with Telepizza to accelerate the development of Pizza Hut in key European markets and consolidate franchisees in Latin America and the Caribbean are likely to drive growth.

Yum! Brands continues to focus on various digital initiatives and refranchising efforts to help the company tide over the pandemic scenario. Notably, the company continues to deploy technology to enhance guest experience. To this end, the company implemented various digital features in mobile and online platforms across all brand segments. It is also continuing the transformation process toward a single point-of-sale system in the United States. Additionally, it updated its mobile app and Hut Rewards. During second-quarter 2021, the company reported digital sales of more than $20 billion on a trailing 12-month basis. Going forward, the company expects the momentum to continue on the back of its strong off-premise capabilities, digital strength and value offerings.

Meanwhile, the company adopted a de-risking strategy by reducing its ownership of restaurants through refranchising. We note that refranchising a large portion of the system reduces the company’s capital requirements as well as boosts earnings per share (EPS) growth and ROE expansion. This shift to refranchising has substantially contributed to the company’s operating margin over the years. Thus, Yum! Brands expects to become a "pure play" franchisor with more stable earnings, higher profit margins, lower capital requirements and stronger cash flow conversion. Since a major portion of its business is refranchised, Yum! Brands will be less affected by food inflation than most of its peers. Over the long term, it will reduce the company’s capital requirements. Going forward, the company intends to optimize its ownership mix by refranchising restaurants in the United States.

Concerns

The coronavirus outbreak has rattled the Retail - Restaurants industry and YUM! Brands is not immune to the aftereffects. Although the majority of dining services are open, traffic is still low compared with pre-pandemic levels. We believe that the Delta variant of coronavirus might hurt traffic and sales in the upcoming periods.

Moreover, the company has been continuously shouldering increased expenses, which have been detrimental to margins. This is due to an increase in the cost of employee wages, benefits and insurance as well as other operating costs such as rent and energy costs. In second-quarter 2021, its net costs and expenses amounted to $1,035 million from $898 million in the prior-year quarter. Costs associated with brand positioning in all key markets and ongoing investments in initiatives are likely to put pressure on margins in the near term.

Zacks Rank & Key Picks

Yum! Brands currently carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Some better-ranked stocks in the same space are Chipotle Mexican Grill, Inc. CMG, The Wendys Company WEN and Jack in the Box Inc. JACK, each carrying a Zacks Rank #2 (Buy).

Chipotle's 2021 earnings are expected to increase 137.3%.

Wendys has a three-five year EPS growth rate of 14%.

Jack in the Box has a trailing four-quarter earnings surprise of 26.4%, on average.


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