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Yum! Brands Banks on Strategic Efforts, Industry Woes Stay

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On Sep 11, we issued an updated research report on the world's largest restaurant company in terms of system units, Yum! Brands, Inc. (YUM - Free Report) .

Currently, the company owns, operates and franchises nearly 44,000 restaurants in more than 135 countries and territories. In fact, its brands — KFC, Pizza Hut and Taco Bell — are regarded as the global leaders of the chicken, pizza and Mexican-style food categories.

Key Growth Drivers

Following China business spin-off, we are positive on Yum! Brands’ endeavors to drive growth by employing greater focus on the development of its three iconic global brands, increasing its franchise ownership, and creating a leaner, more efficient cost structure. In addition, the company is focusing on bold restaurant development as well as unrivaled culture and talent to drive continued growth.

While the Pizza Hut brand’s international division has been largely doing well, Yum! Brands is working on a number of areas to get its fair share of growth in the U.S. market and mark a turnaround. To this end, the company entered into an agreement with the Pizza Hut U.S. franchisees. Per the agreement, Yum! Brands will invest roughly $130 million to improve brand marketing alignment as well as accelerate enhancements to operations and technology. This is expected to increase convenience for customers and the company expects to see the results pay off in 2018 and beyond.

Moreover, Pizza Hut recently announced the launch of — Hut Rewards — its national loyalty program. Furthering its delivery-centric strategy, the brand also announced its plans to hire 14,000 drivers by the end of 2017.

At KFC, management is focused on convenience and expects to further increase brand engagement. Also, the brand expects to boost sales through a big push on the digital front in 2017 with self-ordering kiosks and a mobile site. Meanwhile, at KFC International, the company is aggressively pursuing its global delivery initiative, given the fact that the service is considered to be the fastest growing channel in the business.

In fact, nearly 20,000 restaurants across the entire Yum! Brands system offer delivery, which is almost 50% of the company’s total restaurants.

Markedly, management seeks to continue developing the Taco Bell brand through continued focus on innovation and value, expanding its delivery program, inventive marketing strategies and extended line of breakfast offerings. On international front too, Taco Bell continues to build momentum with new restaurant openings in various markets, given the growing enthusiasm for the brand and its improving economics.

The company’s digital efforts has increased manifold with all its three bands’ deploying technology to enhance guest experience. Also, the company is continuing its transformation process toward a single point-of-sale system in the United States by 2017-end.

Notably, the China division’s spin-off has largely made Yum! Brands a more asset-light company as many company-owned restaurants have been in the Chinese market. Moreover, Yum! Brands is committed toward becoming at least 98% franchised by the end of 2018. Thus, it expects to become a "pure play" franchisor with more stable earnings, higher profit margins, lower capital requirements and stronger cash flow conversion,

Going forward, Yum! Brands aims to revamp its financial profile and thereby improve the efficiency of its organization and cost structure, globally. To this end, management anticipates to cut capital expenditures to about $100 million by 2019, increase free cash flow conversion to 100% and also reduce General and Administrative (G&A) expenditure by approximately $300 million (or 1.7% of system sales).

Over the next three years, the company is also committed to return an additional $6.5 billion to $7 billion to shareholders through share repurchases and dividends. Resultantly, Yum! Brands expects an EPS of $3.75 or more in 2019, which is first clean year post-transformation.

In fact, the company’s efforts have already started to reap benefits as reflected by the positive stock price movement. Evidently, post-separation, shares of Yum! Brands have gained 28.2%, outperforming the 14.1% growth of the industry it belongs to.

Also, the current quarter and year’s earnings estimates moved up 3.2% and 1.1%, respectively, over the past 60 days, reflecting the ongoing optimism in the stock.

Concerns

Yum! Brands is highly exposed to various emerging nations in Latin America. In fact, these nations have been exhibiting decelerating growth for some time due to various macro headwinds, which might dent sales in the near term.

Foreign exchange translation is also a concern for the company, given its significant international presence.

Meanwhile, the second quarter of 2017 marked the sixth consecutive quarter of negative comp sales for the restaurant industry as a whole, thereby continuing the somber mood. Thus, a continued choppy sales environment in the domestic space is likely to keep the top line under pressure.

Zacks Rank & Stocks to Consider

Yum! Brands has a Zacks Rank #3 (Hold). Better-ranked stocks in this sector include Papa John's International, Inc. (PZZA - Free Report) , Restaurant Brands International Inc. (QSR - Free Report) and Bravo Brio Restaurant Group, Inc. (BBRG - Free Report) , holding a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

In the trailing four quarters, Papa John's, Restaurant Brands and Bravo Brio pulled off an average positive earnings surprise of 5.10%, 6.46% and 28.27%, respectively.

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