Has Yum Bitten Off More Than It Can Chew in China?

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Yum! Brands, Inc. (NYSE:YUM) was down over 4% on January 8th after the company assured investors that its 2012 earnings would indeed come in within its forecasted earnings range but lowered its guidance for Chinese same-store sales. The company claimed that this revision was primarily due to a government investigation of chicken which hurt demand; however, even before this announcement Yum had been expecting lower same store sales in the region.

Yum! Brands, Inc. has followed a strategy of growth in China; in the third quarter of 2012, 56% of company revenue came from China as opposed to 49% a year earlier. A similar share of operating profit came from business in the country. Chinese sales were up 24%; revenue in the rest of the world declined 6%. So any sign of bad news in China, or even less than good news, has the potential to be a problem for the company. Overall, revenue and earnings were up 9% and 23%, respectively, from their levels in the third quarter of 2011.

SAC CAPITAL ADVISORS

After the pullback in the stock price, Yum trades at 19 times trailing earnings. That is a bit high from a value investing perspective, but it is actually cheap compared to many other quick service restaurants. Pizza Hut, Taco Bell, and KFC- the three core brands at Yum- can be (more or less) compared to Domino’s Pizza, Inc. (NYSE:DPZ), Chipotle Mexican Grill, Inc. (NYSE:CMG), and Buffalo Wild Wings (NASDAQ:BWLD). The trailing earnings multiples at these three companies are 26, 35, and 26 respectively. Chipotle and Domino’s do have high earnings growth rates, and Chipotle can certainly be said to offer a more premium product than Taco Bell, but the valuation gap between these three stocks and Yum is still quite high. Even the forward P/Es of these three peers are 20 or higher, while Yum is valued at 18 times consensus earnings for 2013. We don’t think that Yum is a good value, particularly given how exposed it is to macro conditions in China, but it’s important to note that the quick service restaurant industry in general trades at high multiples.

McDonald’s Corporation (NYSE:MCD) is cheaper at a trailing P/E of 17, but its revenue and earnings were about flat in its most recent quarterly report compared to the same period in 2011 with sales not holding up particularly well recently either. It does have a low beta at 0.3, and pays a dividend yield of above 3%, so perhaps a more defensive-minded investor would find it interesting.

Which hedge funds owned Yum in their most recent 13F filings?

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