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Yum China Plans to Open up to 600 Stores This Year, Announces a $300 Million Share Buyback

- By Holmes Osborne, CFA

Yum China (YUMC) operates KFC and Pizza Hut in China. The company was spun off from Yum Brands (YUM) in November and the stock looks reasonably priced. The company is the largest restaurant operator in China and continues to grow.

The stock trades for $26.62, there are 383.51 million shares and the market cap is $10.2 billion. Trailing 12-month earnings per share are $1.36 and the stock trades at a price-earnings ratio of 19.5. There is no dividend.

Sales have been flat over the last four years and were $6.75 billion in 2016. Regardless, expenses have been held at bay and earnings grew from $126 million in 2013 to $502 million last year. Of course, this was when KFC China was part of KFC and not publicly traded. Cash flow from operations is usually in the $700 million to $900 million range and capital expenditures $430 million to $570 million. Free cash flow was $428 million last year and the free cash flow yield was 4.2%.

The balance sheet shows $964 million in cash and $74 million in receivables. The liability side shows $971 million in payables and $28 million in debt. Wow. That is strong.

Yum China has 7,500 restaurants in 1,100 cities. It operates under the names KFC, Pizza Hut and the Little Sheep and East Dawning concepts. The first restaurant was opened in Beijing in 1987. The company also launched its first Taco Bell in Shanghai.

Sales have slightly declined over the past few years until 2016. Comparable store sales were up 3%, 6% on a constant currency basis. The company remodeled 791 of its stores last year. EBITDA was $1.13 billion. That is an EBITDA yield of 16.7%. Very profitable. Currencies cost operating earnings 5% and wage inflation 8%. The company plans to build 550 to 600 new restaurants this year. In 2016, 575 stores were opened. Seventy-five percent of stores were rebuilt in the last five years or are new.

Barron Funds owned shares after the IPO but sold. Southeastern Asset Management owns shares and stated, "the China business was cheaper (than KFC U.S.), and we're very happy to own that one again." Yum China is the number one restaurant operator in China. Very impressive.

I once owned a restaurant. It is hard work. The attention to detail is incredible. The tough thing about retail, restaurants and grocery stores is ambiance. How do you make the customer feel comfortable? Imagine all of the restaurants that you have ever been to that have failed. You can probably think of hundreds. Management at Yum China is smart. They take that cash and dump it back into rehabbing these locations. No one wants to eat in some grimy, greasy spoon.

So Yum China has a few things going for it. First, it is opening new stores. Do not ever invest in retail, restaurants or grocery unless management is opening new stores. Second, there is a share buyback. Third, the stock had its initial public offering in November. It can be a great time to buy a stock soon after an IPO as shares often settle down. Fourth, there is an abundance of cash and free cash flow.

I like the stock. It is reasonably priced and the company continues to grow. My concern is that I have no idea about the Chinese economy. Never been there. I have been to Hong Kong but do not have an opinion on that economy either. That will be the crux of what happens to this investment.

Disclosure: We do not own shares in Yum China.

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This article first appeared on GuruFocus.