When a stock is popular, and enough investors believe in its future, sometimes it takes more than just one piece of bad news to get people’s attention. When that same company has iconic brands and has been around for a while, multiple problems might pop up before investors react appropriately. I wrote about the challenges facing Yum! Brands, Inc. (NYSE:YUM) in January (more about that in a minute), and as of the company’s recent earnings, things have only gotten worse. The stock is only down slightly in the last month, even though the company and analysts are saying there is a problem.
Great Expectations Meet Reality
Investors in YUM Brands Inc. (YUM) have seen their company report surprisingly good earnings growth over the last few years. Same-store sales have been strong, particularly in China. For a restaurant chain with over 30,000 restaurants, this type of performance is almost unheard of.
When you add in the fact that YUM Brands competes with names like McDonald’s Corporation (NYSE:MCD), Starbucks Corporation (NASDAQ:SBUX), and Chipotle Mexican Grill, Inc. (NYSE:CMG), this performance is even more impressive. The company’s history of good performance has unfortunately created unrealistic expectations going forward.
Near the end of last year, the challenges for YUM Brands began to set in. The company reported worse same-store sales in China than investors were expecting, and the stock dropped about 10%. While it’s true the stock is still about 13.5% below its short-term high, it’s not enough. When I looked at the situation in January, YUM Brands looked overvalued relative to its peers. The company’s price-to-book value was particularly telling with shares fetching 13.82 times their stated book value.
Since investors could buy Starbucks for 7.96 times book, McDonald’s for 6.49 times, or Chipotle for 6.97 times, YUM Brands seemed rich by comparison. However, the company’s EPS growth rate was expected to be 14.27% for the next few years, and that helped to offset the concerns a bit.
What’s In That Chicken?
Since my last post, the company’s problems in China have gotten worse. The company’s KFC division has been the target of charges that, “excessive levels of antibiotics” were found in some chicken that KFC China purchased. This negative news caused same-store sales at KFC China to drop 8% in the fourth quarter. The company went as far as to place a statement in bold in their news release saying, “The current negative sales trend in our China KFC business will adversely impact 2013 EPS.”
Since the Chinese division represents over 50% of YUM Brands revenue, and same-store sales will be down for most of the year, this is a very big deal. I’m sure some investors are thinking this is a short-term challenge, and the company will recover. While that might be true over the next few years, there are three issues that suggest the stock is overvalued at the current time.