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Here's Why Investors Should Steer Clear of Yum China (YUMC)

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Are you still holding shares of Yum China Holdings, Inc. (YUMC - Free Report) and waiting for a miracle soon? If yes, then you might lose more money as chances are very slim that the stock, which lost its value by 22% in the past six months, will take a U-turn in the near term. On the contrary, the Zacks Retail-Restaurants industry has increased 3.5% in the same period. Let’s delve deeper and try to find out what is taking this Zacks Rank #5 (Strong Sell) company down the hill.

Yum China Vs Industry Scorecard

High Costs Hurting Margins

Yum China is facing the structural high cost pertaining to labor and rentals. Also, the company is bearing additional costs stemming from promotion, menu innovation and technological novelty apart from wage inflation. In order to curb labor cost, it is increasingly focusing on delivery channels, which is again expected to dent margins in the near term.

Notably, in the first half of 2018, total costs and expenses rose 12.2% year over year owing 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 downside can be attributed to investment in product upgrades and promotions along with inflation.

Dismal Pizza Hut Performance

Despite innovations across its products, marketing and promotions, Pizza Hut sales trend has been choppy in the second quarter of 2018. Additionally, system sales and comps were down 1% and 4%,respectively, across the Pizza Hut restaurants. The company further said that despite short-term impact on sales as well as margins, it will continue to remodel and shut down underperforming stores to rejuvenate Pizza Hut.

Our Take

Yum China, which recently rejected the buyout offer from a consortium led by a Chinese investment firm — Hillhouse Capital Group, is confident about making a turnaround. According to the company’s representatives, Yum China has potential to increase its store count to 20,000 in the long run. In fact, this restaurant chain remains focused on relentless unit growth of its restaurants in order to drive incremental sales. In the first half of 2018, Yum China opened 272 restaurants, reflecting 63% year-over-year growth in new builds. In the second quarter, it opened 164 restaurants and remodelled 365. Currently, the company operates five restaurants per one million people in China, which is might increase to 15 stores per million.

Stocks to Consider

Better-ranked stocks in the same space include BJ's Restaurants, Inc. (BJRI - Free Report) , Darden Restaurants, Inc. (DRI - Free Report) and Dine Brands Global, Inc. (DIN - Free Report) . While BJ's Restaurants sports a Zacks Rank #1 (Strong Buy), Darden Restaurants and Dine Brands Global carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

BJ's Restaurants earnings have surpassed the Zacks Consensus Estimate by an average of 6.4% in three of the trailing four quarters.

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

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

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