Yum! Brands Inc.'s (YUM - Free Report) third-quarter 2013 adjusted earnings of 85 cents per share missed the Zacks Consensus Estimate of 93 cents by 8.6% and the year-ago quarter’s earnings of 99 cents by 15%. Earnings in the quarter were under pressure due to the decrease in top line, lower margin and higher tax rate.
On a reported basis (including special items), Yum! Brands’ quarterly earnings of 33 cents per share were down 67% year over year.
In the third quarter, total revenue declined 3% year over year to $3.47 billion and also fell short of the Zacks Consensus Estimate of $3.54 billion by nearly 2.0%. Once again, weak performance by the China division led to the lackluster results.
China has been the largest contributor to Yum!’s revenues. In Dec 2012, the company’s China Division – accounting for more than double of its U.S. revenues – faced an allegation regarding the quality of chicken supplied to its KFC restaurants. The resultant adverse publicity continues to negatively impact on the division’s performance since fourth-quarter 2012. To add to the woes, the outbreak of avian flu in China in early April also hurt the segment’s sales.
Geographically, Yum!’s business includes four reporting segments: the United States, the China Division, consisting only of mainland China, Yum Restaurants International (YRI) and India.
China Division’s comps declined 11% in the third quarter much lower than a 6% rise in comps in the year-ago quarter. Quarterly fall in comps was caused by a 14% drop in KFC comps owing to the unfavorable impact of the poultry supply issue, partially offset by a 5% rise in comps at Pizza Hut Casual Dining.
The U.S. Division posted flat comps for the third quarter much lower than growth of 6% in the year-earlier quarter. The flat comps resulted from a 2% growth at Taco Bell, offset by a 1% and 4% decline in the comps at Pizza Hut and KFC, respectively. Taco Bell has posted positive comps for the past seven quarters. Management expects Taco Bell to grow further in the U.S. with the ongoing investment in technology and equipment.
Comps at the India Division were flat versus 5% comps growth in the year-ago quarter.
Comps nudged up 1% in the YRI Division resulting from a 1% growth in comps at the emerging markets, offset by a 1% fall in the same at developed markets such as Japan and the U.K. The timing of Ramadan also adversely impacted the division’s comps by 1%.
Margin & Costs
In the quarter under review, Yum! Brands witnessed an 8% rise in its total costs and expenses, net mostly due to the 42% rise in its franchise and license expenses, partially offset by a 2% fall in total company-restaurant expenses. The year-over-year decline in company-restaurant expenses resulted from a significantly lower expenses in the company’s U.S. and YRI divisions. However, company-restaurant expenses were significantly higher in the China Division.
Worldwide operating profit declined 9% in the quarter, excluding foreign currency translation, mainly due to a 14% and 2% decrease in China and YRI Division’s profit, partially offset by a 1% profit growth at the U.S. division.
Restaurant margin fell 130 basis points (bps) to 17.6% as a result of a 190 bps, 60 bps and 70 bps decline in China, YRI and the U.S. Division’s restaurant margin, respectively. The company’s lower sales mostly affected the China division's margin. YRI Division witnessed a fall in its margin due to the weak performances at KFC UK and Turkey. Moreover, higher inflation and promotional efforts were held responsible for the declining margin in the U.S. Division.
Share Repurchase & Dividend
Year to date, the company has bought back 7.1 million shares worth $490.0 million. In late Sept 2013, YUM! raised its quarterly dividend by 10% to 37 cents per share.
The company has a solid development pipeline. Yum!, will unveil nearly 1,850 restaurants outside the U.S. in 2013 a large portion of which will be located in emerging markets. The company plans to unveil 700 restaurants exclusively in China in 2013.
The company had previously stated that it will post positive comps at its China Division in the fourth quarter. After witnessing poor sales performance of KFC China in September, YUM! now expects China comps to be down in the fourth quarter.
Owing to the expectation of lower sales results in China and higher tax rate, Yum! now expects its 2013 earnings per share to decline in the range of high-single to low-double-digit, higher than the prior estimate of mid-single digit decline.
However management expects its business to pick up speed from 2014 onward driven by its new sales-driven initiatives. The company expects to achieve a 20% earnings growth in 2014.
Management believes that Yum!’s acquired brand in China – Little Sheep – will drive growth in the years ahead.
The company also remains positive on the growth prospects of its YRI and India divisions as it has a solid development pipeline in the emerging markets including India in 2013.
We are concerned about the company’s weak third-quarter results due to the China division’s lackluster performance. Though management expects a strong performance in the years ahead, we believe that there is an uncertainty regarding the proper pace of recovery. A lower earnings outlook adds to the woes.
On a positive note, Yum!’s India and YRI segments are expected to perform well, going ahead.
Yum! holds a Zacks Rank #3 (Hold). Other players in the restaurant industry that look attractive at the current level include AFC Enterprises Inc. , Cracker Barrel Old Country Store, Inc. (CBRL - Free Report) and Domino's Pizza, Inc. (DPZ - Free Report) . All these stocks carry a Zacks Rank #2 (Buy).