Yum! Brands, Inc. (US) Is Transforming Into a High-Growth Company Again
22 Dec 2017 - That may seem weird to say. The fast-food giant behind KFC, Pizza Hut and Taco Bell is often written off as less exciting than the likes of hyper-growth tech companies like Facebook Inc (NASDAQ: FB ), Amazon.com, Inc. (NASDAQ: AMZN ), Netflix, Inc. (NASDAQ: NFLX ) and Alphabet Inc (NASDAQ: GOOG , NASDAQ: GOOGL ).
But here's a fun fact: YUM's projected earnings growth over the next several years ( 14.6% ) isn't that much lower than Facebook's ( 17.4% ).
How is that possible? YUM is innovating, adapting and transforming like never before. More specifically, the company is fully embracing a revolutionary transformation of its business model, which could handsomely reward long-term shareholders.
So whats the takeaway?
Buy and hold YUM stock. This one is going up in the long term.
Re-Franchising Efforts Are Paying Off Late last year, YUM announced a massive business transformation plan which management believes will dramatically improve profitability.
In short, YUM is turning into a "pure-play" franchisor. The company is re-franchising essentially all of its locations (98%, to be exact, up from 77% franchise ownership in 2015). Yes, that kills revenues, but this revenue slicing is like getting rid of all the unwanted fat. Through re-franchising, YUM plans to create a business with low costs, few capital investments needs, small lease obligations, big margins, lots of free cash flow and huge earnings.
This transformation is already paying off.
YUM is currently at 95% franchise ownership. The huge re-franchising over the past 12 months has allowed for tremendous cost savings. Company restaurant expenses are down 10% year to date. General and administrative expenses are down 9% year to date. Operating margins are up 410 basis points at KFC, 600 basis points at Pizza Hut and 340 basis points at Taco Bell.
Consequently, even though YUM revenues year to date are down 4%, operating profits are up 33%. Meanwhile, capital expenditures are at only $228 million year to date, versus $292 million through the first nine months of 2016. Capex is expected to be just $325 million this year, a near-25% reduction year over year.
The most exciting part of this transformation plan is that the best is yet to come. The G& A expense rate is expected to drop to 1.7% by 2019, versus 2.5% in 2015. Capex is expected to fall to $100 million by 2019.
With all those costs coming out of the system, the net result will be lots of profits and lots of cash flow. Most that cash flow will be returned to shareholders via dividends and buybacks, which will, in turn, fuel earnings growth and increase shareholder value (management expects to return between $6.5 and $7 billion to shareholders from 2017 to 2019).
Meanwhile, YUM's brands are actually performing quite well, likely due to management's ability to focus on same-store sales growth (as opposed to volatile China numbers). For the first time in multiple quarters, same-store sales growth was positive last quarter at KFC, Pizza Hut and Taco Bell. Moreover, system sales growth hit 6% for the second consecutive quarter, showing that the company has the ability to accelerate system sales growth to 7% in the near future.
Put it all together, and you have a company with an accelerating top-line growth narrative and a really big margin growth narrative. Why sell a stock with such strong growth drivers?
Valuation Is Still Reasonable You don't, unless valuation is a concern.
But it isn't here. YUM is looking at greater than $3.75 in earnings per share by fiscal 2019. Historically, YUM stock has traded around 28 times trailing earnings. Given that YUM, in 2019, will have higher profit margins and more predictable cash flows than the YUM of the past 5 years, its almost a guarantee that 2019 YUM will warrant at least a 28 trailing-earnings multiple.
Throw a 28 mulitple on $3.75 earnings, and you get a 2-year forward price target of $105. Discount that by 10% per year and you arrive at a current fair value of about $87.
And that is without tax reform.
Bottom Line on YUM Stock
This is a big-moat company successfully undergoing a massive transformation, which will dramatically boost profitability and cash flows.
You don't sell that story unless the stock is overvalued.
But YUM stock remains reasonably valued. Consequently, I think this is a name you buy and hold for the long term.