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Yum China (YUMC) Turns Down Buyout Proposal, Shares Gain

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Per Wall Street Journal, Yum China Holdings, Inc. (YUMC - Free Report) has rejected the buyout offer from a consortium led by a Chinese investment firm — Hillhouse Capital Group. The amount offered was $17.6 billion or $46 a share, which is nearly 24% above the Tuesday’s closing price. Following the news, shares of the company increased 5.5% on Aug 29. However, Yum China Holdings refrained from commenting on the matter.

Per sources, the company has not demanded a higher price as well. Thus, the rejection clearly shows the company’s confidence on a turnaround soon. According to the company’s representatives, Yum China has the potential to increase its store count to 20,000 in the long run. In fact, the company remains focused on relentless unit growth of its restaurants in order to drive incremental sales. In the first half of 2018, the company opened 272 restaurants, reflecting 63% year-over-year growth in new builds. In the second quarter, Yum China opened 164 restaurants and remodeled 365. Currently, it operates five restaurants per one million people in China, which is expected to grow to 15 stores per million.

What’s Hurting Yum China’s Performance in 2018?

Yum China separated from its parent company Yum! Brands in late 2016. Following the spinoff, the company opened more than 700 stores in 2017. However, the company’s shares in the recent past have declined due to soft its performance. In the past six months, the stock has declined 6.6% against the industry’s 5.3% growth.

Furthermore, this Zacks Rank #5 (Strong Sell) company is facing the structural high cost of labor and rentals. Apart from wage inflation, the company is bearing additional costs stemming from promotion, menu innovation and technological novelty. In order to curb labor cost, it is increasingly focusing on delivery channels, which is again expected to curb margins in the near term.

Notably, in the first half of 2018, the total costs and expenses increased 12.2% year over year due to an 18% increase in restaurant expenses and a 6% hike in franchise expenses. Restaurant margin in the second quarter was 16.8%, reflecting a 190-basis point (bps) decline from the year-ago quarter. The decline in restaurant margin was due to the investment in product upgrades and promotions along with inflation.

Also, Pizza Hut sales trend has been choppy in the recent quarters despite effective innovation across its products, marketing and promotions. In the second quarter of 2018, system sales were down 1% and comps 4% in the Pizza Hut restaurants.

Stocks to Consider

Some better-ranked stocks in the same space are Carrols Restaurant Group, Inc. (TAST - Free Report) , Dine Brands Global, Inc. (DIN - Free Report) and Darden Restaurants, Inc. (DRI - Free Report) . All the stocks carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Carrols Restaurant Group’s earnings have surpassed the Zacks Consensus Estimate by an average of 25%.

Dine Brands Global reported better-than-expected earnings in the trailing four quarters, with an average beat of 8.1%.

Darden Restaurants delivered better-than-expected earnings in the preceding four quarters, with an average beat of 3.1%.

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