YUM Downgraded to Neutral

We are downgrading Yum! Brands Inc. (YUM - Analyst Report) to Neutral from Outperform. Although the company reported strong third quarter results, the recession is impacting growth. With cash-strapped consumers dining out less, traffic has declined worldwide, prompting management to lower its same-store sales growth targets for 2009.

The restaurant industry is reeling under the current economic crisis in the U.S., which is exerting pressure on consumers’ disposable income. The company is reporting sagging same-store sales and declining traffic as cash-strapped consumers prefer to dine at home.

Further, the competition among Quick Service Restaurants is expected to remain fierce with respect to price, service, location and concept in order to drive traffic, which may adversely affect the company’s restaurant operating margins and profits.

However, Yum!’s China Division offers immense growth potential with its two leading brands KFC and Pizza Hut. Moreover, the company’s competitive advantage helped management to test additional restaurant concepts of East Dawning (Chinese food) and Pizza Hut Home Service (pizza delivery). Management’s earnings growth model includes annual operating profit growth of 20% in the China Division.

In addition, overseas expansion remains one of the key growth drivers. The company always seeks opportunities to expand in new markets including India, France and Russia.

YUM Brands Inc. owns, operates, and franchises major fast food concepts such as KFC, Pizza Hut, Taco Bell, Long John Silver’s and A&W All-American Food Restaurants in more than 110 countries.