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Leading restaurateur, Yum! Brands Inc. (YUM - Analyst Report) posted mixed first quarter 2014 results.

The company’s adjusted earnings of 87 cents per share beat the Zacks Consensus Estimate of 84 cents by 3.6% and the year-ago quarter earnings of 70 cents by 24.3%. The upside reflects strong year over year sales and margin gains, diminishing concerns related to the chicken supply chain issues.

In the first quarter, total revenue went up 5.0% year over year to $2.72 billion, thanks to strong comps at the China division. However, quarterly revenues fell short of the Zacks Consensus Estimate of $2.84 billion by nearly 3.9%, which we believe could be due to sluggish comps in the domestic market.

Comps Discussion

The company has restructured its business divisions effective this quarter. Its Yum! Restaurants International (YRI) and the U.S. geographic divisions have been merged to create three separate brand based divisions— KFC, Pizza Hut and Taco Bell. However, the company will continue to operate its other two divisions — Yum! Restaurants China and Yum! Restaurants India — separately on expectations of potential growth.

China Division’s comps increased 9.0%, far better than a decline of 20.0% in the year-ago quarter and 4.0% decline in the prior quarter.  The sequential increase in comps is attributable to growth of 11.0% in KFC comps and a 8.0% rise at Pizza Hut Casual Dining.

KFC is a new reporting division of the company that includes all KFC restaurants except the China and India divisions. Comps at this division were up 1.0%, same as in the last quarter. The upside reflects comps growth of 3.0% in emerging markets and 1.0% in developed markets, partially offset by a 3.0% decline in the U.S.

Comps at Pizza Hut, which is also a new reporting division, declined 2.0% during the reported quarter (excluding China and India) compared with a decline of 1.0% in the year-ago quarter. The downside reflects comps decline of 5.0% in the U.S. However, this was partially offset by growth of 3.0% and 1.0% in the emerging and developed markets, respectively.

Taco Bell, the third new reporting division, includes all Taco Bell results outside of the India division. Comps at this division were down 1.0%, worse than growth of 6.0% in the year-ago quarter.

Comps at the India Division declined 1.0% during the quarter. Beginning this quarter, results of 28 franchised stores located in Mauritius will not be accounted for in this division and will now be included in the KFC and Pizza Hut Divisions.

Margin & Costs

In the reported quarter, Yum! Brands witnessed 5.0% increase in total costs and expenses, net primarily due to a 6.6% increase in food and paper costs and 6.0% increase in occupancy and other operating expenses.

Company-restaurant expenses also went up 4.8% year over year to $1.85 billion due to higher restaurant costs in the China, KFC and Pizza Hut divisions, partially offset by lower expenses at Taco Bell.

Worldwide operating profit increased 21.0% in the quarter with majority of the growth coming from China.

Brand Restaging and Unit Growth

After being plagued by chicken issues for quite some time now, Yum! Brands has come up with an aggressive and comprehensive strategy to reinstate the KFC brand in China. The company had announced this strategy in Feb 2014. It recently unveiled a new menu for its 4,600 KFC restaurants across 900 cities and introduced innovative marketing strategies aimed at improving brand awareness and traffic. Given the strength at both KFC and Pizza Hut, the company expects to open at least 700 new restaurants in China in 2014.

Outside China, the company intends to open 1,250 international units mainly in the emerging markets. The company recently launched breakfast at all the Taco Bell divisions.

Guidance

Management expects its business to pick up speed in 2014 driven by its new sales-driven initiatives. The company maintained its guidance for 2014 and expects 20% earnings growth this year.

Our Take

China has been one of the key contributors to Yum!’s revenues over the years. While the China division has started to show signs of improvement, it is still not out of the woods. Avian flu hit China in early 2014 but has not hurt comps yet. However, we cannot completely rule out the possibilities of an adverse sales trend in the coming quarters due to the avian flu scare. Further, the economic growth rate of China has also moderated lately making consumers cautious of their discretionary spending. This can also restrain sales momentum in Yum!’s all-important China division.

Going forward, we are encouraged by the company’s efforts to bank on high-growth emerging markets like Russia, Southeast Asia, Africa and Latin America for future growth.

YUM! Brands presently has a Zacks Rank #3 (Hold). Some better-ranked stocks in the industry include Ignite Restaurant Group, Inc. (IRG - Snapshot Report), The Wendy's Company (WEN - Analyst Report) and Jack in the Box Inc. (JACK - Snapshot Report).  While Ignite Restaurant and Wendy's Company sport a Zacks Rank #1 (Strong Buy), Jack in the Box carries a Zacks Rank #2 (Buy).

 

Read the Full Research Report on YUM
Read the Full Research Report on WEN
Read the Full Research Report on JACK
Read the Full Research Report on IRG


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