Yum! Brands (YUM: Charts, News, Offers), with 37,000 restaurants in 110 countries, is the largest and fastest growing fast food company on the Earth. Yum! restaurants include KFC, Taco Bell, Pizza Hut, Long Jong Silvers, A&W and many more well known brands that have profited not only within the US but internationally as well. Most notably is that its dominating position in China, with twice the market share as its closest competitor, McDonald’s (MCD: Charts, News, Offers), is growing rapidly, as KFC and Pizza Hut have become synonymous with the economic development of urban regions in China. Any visitor to China in the past few years will have noticed the saturation of these two restaurants, dotting the Chinese landscape with stores under the Great Wall of China in Beijing and next to the Terracotta Warriors Site at Xi’an. Is Yum the safest stock to play on a developing Chinese market, without the hazards of a politically volatile stock like Google (GOOG: Charts, News, Offers) or Baidu (BIDU: Charts, News, Offers)?
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Stock Analysis
Yum’s sales are split between American (59%), Chinese (33%) and other international (8%) markets. Yum’s 18,000 US restaurants are catering to an already over saturated market, and like its industry peer McDonald’s, it is setting its sights on other emerging markets with growth potential. Yum China, which has been separated into its own division, currently only has 3,500 stores but is responsible for a third of the company’s profits. Yum’s company-wide margins have increased slightly to 11% this year while industry competitors Domino’s (DPZ: Charts, News, Offers) and Burger King (BKC: Charts, News, Offers) only squeezed out 6% and 7%, respectively. Yum still lags behind McDonald’s, though, which has a market-leading net profit margin of over 20%. Similarly to McDonald’s, Yum relies on franchisees to run most of its restaurants in order to maximize profits and reduce overhead.
Yum currently forecasts a target 20,000 stores in China to serve a population four times as large as America. This, combined with the appreciation of the Chinese yuan, is sure to fatten Yum’s bottom line, which is reported in US Dollars. Yum currently dwarfs McDonald’s 1,100 stores in China. McDonald’s plans to open 2,000 within the next three years, which are conservative growth prospects compared to Yum’s ambitious plans. Due to this potentially explosive growth, Yum has poured its resources into integrating itself into Chinese society much more than its competitors by sponsoring sports and dance competitions at high schools and meeting with the China Health Council in order to produce healthier menu items more likely to be accepted by the Chinese consumer. Yum’s first attempt at producing an exclusively Chinese fast food restaurant, East Dawning, currently only has eight stores operating in the country, but it can be regarded as the first step in an experiment to gauge the probability of Yum launching China-exclusive restaurants to expand deeper into the mainland.
With Russia’s recent decision to ban grain exports from August 15 to the end of the year, Yum and its rivals in the QSR (Quick Serve Restaurants) industry all face the danger of declining margins due to more expensive wheat, soybean and corn. These grains are not only used in their flour products but as hog and chicken feed, which will in turn raise the cost of pork and poultry, the latter of which will severely affect KFC’s bottom line. For now, KFC and Pizza Hut could follow McDonald’s “belt tightening” plan, by focusing on expanded high margin, low commodity drink and dessert menus to lure business away from Starbucks, which also has a large Chinese urban presence.
As with many of the companies in the QSR industry, Yum has come under increasing criticism from health advocates for its unhealthy products and environmental groups for a business model that promotes factory farming of poultry, especially in the United States. However, since these are primary focused on the American market, and most of Yum’s growth is coming from overseas, the effect of such criticisms is likely to be minimal. In addition, many consumers in emerging markets don’t have the same unhealthy view of QSRs as the American consumer does; rather, their perception is often one of convenience and cheapness. Yum’s preemptive strike in China by working hand in hand with the Health Council is an obvious attempt to cultivate its cultural image carefully in its most valuable market.
If we have learned anything from the past economic downturns, it’s that cash-strapped consumers flock towards cheaper food products – and fast food is one of the favorites. YUM currently trades with a forward P/E of 15.12 and earns a healthy .21 quarterly dividend, a 2% yield. The PEG ratio is 1.38 and the stock is trading near its 52 week high of $44, but the long term chart shows yearly growth and a possible breakout on signs of a global recovery. Like McDonald’s, Yum has traded near its highs despite continued bearish sentiment in the market, which signals that it could not only be a good defensive stock against a bear market, but a bull play on China’s emerging middle class.
- Investors Take an Indirect Route to China – Yum is one of the best indirect routes
- Now that China Beats Japan, What’s Next? – Growth opportunities for Yum (YUM: Charts, News, Offers), McDonald’s (MCD: Charts, News, Offers) and Starbucks (SBUX: Charts, News, Offers)
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Leo Sun is long-time market follower and finance writer. He regularly contributes to the Stock of the Day analysis.
