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Yum! Brands Inc. (YUM - Analyst Report) reported third quarter 2012 adjusted earnings of 99 cents per share, ahead of the Zacks Consensus Estimate of 97 cents. Earnings surged 19% year over year. The better-than-expected results were driven by strong performance at all the divisions. On a reported basis, Yum! Brands’ quarterly earnings were $1.00 per share, up 25% year over year.

The company reported a 9% year-over-year increase in total revenue to $3,569.0 million. System Sales growth in China, Yum! Restaurants International (YRI) and the U.S. division were 22%, 4% and 1%, respectively, excluding foreign currency translation. Yum! Restaurants India witnessed a considerable growth of 29% in system sales.

Behind the Headline Numbers

Comparable-restaurant sales (comps) improved 6% in mainland China, 2% in YRI and 6% in the U.S. division. There were comps increases of 7% at Taco Bell, 6% at Pizza Hut and 4% at KFC. Comps increased 5% at Yum! Restaurants India.

In the quarter under review, Yum! Brands witnessed a dip in its overall cost structure. Company-restaurant costs and general and administrative (G&A) expenses fell 8% and 7%, respectively. China division was able to reduce its costs, but company-restaurant costs were up 18% at the U.S. division and 2% at the YRI division.

Consolidated operating profit expanded 38% year over year, considering foreign-currency translation. Three major geographic segments, China (up 24% year over year; and up 22% excluding foreign currency translation), YRI (up 7%; and up 14% excluding foreign currency translation) and the U.S. (up 13%) contributed to the growth. While foreign currency translation helped China’s operating profit by $5 million, it bore an adverse impact of $12 million at YRI. Operating profit at the U.S. division was affected by 2 percentage points due to the divestiture of Long John Silver's and A&W brands.

Restaurant margin witnessed an improving trend, as margin including foreign currency impact inched up 0.1% to 21.4% in China, grew 1% to 13.3% in the YRI division and climbed up 4.6% to 16.7% at the U.S. segment, backed by solid comps growth, supply chain efficiencies and less discounting.

Unit Growth

Strong performance in the China division during the quarter was primarily driven by 192 new openings. Further, Yum! Brands solidified its footprint internationally by opening 181 new units in the quarter under review, 69% of which are located in potentially strong emerging markets. Management has plans of opening 1750 new restaurants worldwide this year, out of which 750 locations will be in China. 

Liquidity

At quarter end, Yum! Brands had cash and cash equivalents of $942.0 million with long-term debt of $3,003 million, and shareholder equity of $2,294.0 million.

Share Repurchase

During the quarter, the company repurchased 6.5 million shares for $414 million at an average price of $64.

Outlook

The company raised its full-year 2012 adjusted earnings per share growth expectation to at least 13.0% from prior forecast of at least 12%.

Our Take

China remains a crucial player in Yum! Brands’ growth. The strong performance of this Asian nation has aided the company’s third quarter results. Moreover, other segments also performed well at both the lines. Solid third quarter results also compelled management to lift its earnings per share growth outlook by 1%. Hence, we expect the Zacks Consensus estimates to go up in the coming days. However, unfavorable currency impact and stiff competition from other quick-service restaurant operators remain an overhang.

Yum! Brands, which competes with McDonald’s Corp. (MCD - Analyst Report), currently retains a Zacks #3 Rank (short-term Hold recommendation). We reiterate our long-term Neutral rating.

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