With fall looming, yet another NFL season is under way. The thrills of opening day weekend are enjoyed by fans worldwide, but this past week’s action was really a testament to the hard work done by NFL scouts.
After months of scouting, combine workouts, and exhibitions, the scouts and GM’s finally got to see their draft picks perform. In some ways, NFL scouts are very similar to investors.
Scouts look at fundamentals and, like investors, can be swayed by hype, fear, and biases. Sometimes, scouts and investors alike, ignore a star in the making, even as its flashing signs of brilliance right before their eyes.
The Tom Brady of the chicken game: Popeye’s
In the 2000 NFL draft, future hall of fame quarterback Tom Brady fell hard on draft day. Despite setting records during his time at Michigan, Brady somehow fell to the Patriots in the sixth round, as the 199th pick.
The relationship between Brady, Griese, and Henson, kind of reminds me of the relationship between chicken “front runner” Yum! Brands, Inc. (NYSE:YUM) and AFC Enterprises, Inc. (NASDAQ:AFCE).
While everyone expects Yum! Brands, Inc. (NYSE:YUM)’s KFC to continue to dominate the world of chicken internationally, especially China where it’s been since the 80’s, a new star may finally be ready to emerge.
While Yum! Brands, Inc. (NYSE:YUM) boasts nearly 6,000 Chinese locations, they’ve suffered mightily over the past two years, due to a food quality scare that has been based both on fact and rumor. This is all a by-product of Chinese outrage and fears that started with tainted milk, as far back as 2008, and the bird flu. In 2012, following gains in excess of 20%, Yum! actually reported a drop in Chinese sales.
Yet, even with recent struggles, Yum! Brands, Inc. (NYSE:YUM) has shown the world that a huge opportunity for chicken exists in emerging markets. Yum! still only has 2 restaurants for every 1 million people in emerging markets, compared with 58 per 1 million in the U.S.
Which brings us to Popeye’s, the Tom Brady of the chicken game. Popeye’s parent company, AFC Enterprises, Inc. (NASDAQ:AFCE), recently reported second quarter earnings to die for; they handily beat consensus EPS expectations by 6.1%, and they grew earnings 29.6% year over year.
Popeye’s is Tom Brady in 1999. It has all of the upside of KFC, without the negative public relations. Popeye’s management also seems ready to take KFC head on, by launching taste tests and pushing press releases out when they win.
If Yum! Brands, Inc. (NYSE:YUM) can garner 42% of its KFC profits from China, even with such a small per-person footprint compared to the U.S., you have to wonder what could Popeye’s do in a few years time?
The blocking and tackling of restaurant expansion
Is now the right time for AFC Enterprises, Inc. (NASDAQ:AFCE) to take Popeye’s international? Sure, it gained 4.4% of market share in dollars of chicken last year, but taking on Yum! Brands, Inc. (NYSE:YUM)’s size and scale abroad could be a different story.
In a recent interview on Mad Money with Jim Cramer, AFC Enterprises, Inc. (NASDAQ:AFCE) CEO Cheryl Bachelder said that Popeye’s could “double” its footprint in the U.S., and had big plans overseas. Popeye’s will attempt to expand aggressively, but I won’t pretend to know if it will be successful.
All we can do is look at the keys to successful restaurant expansion, see how AFC Enterprises, Inc. (NASDAQ:AFCE) is doing currently, and closely monitor it as they expand.
Cash flow, profitability, and same-store growth, are the blocking and tackling of retail expansion. As you can see by the table below, this chicken maker is on a big win streak.
| AFC FY totals | Same store sales growth | Total restaurants | Free Cash Flow* | |
| 2012 | 6.9% | 2,104 | $36.7 | |
| 2011 | 3.1% | 2,035 | $28.5 | |
| 2010 | 2.6% | 1,977 | $26.3 |
*Dollar amounts in millions
The biggest danger in restaurants, or all retail for that matter, is over-expansion. Too many CEO’s focus on making EPS numbers look good, by opening droves of new stores, even as cash flow and comparable’s fall.
The best part of AFC Enterprises, Inc. (NASDAQ:AFCE)’s blow-out second quarter was that operating margins were still able to increase, to 18.3%, which justifies further expansion. Sales grew 21% for AFC, which was great, but they also had same-store sales growth of 4.4%.
Popeye’s is growing store count and earnings but, more importantly, they’re doing it in a sustainable way. That gives me some comfort that Popeye’s is making enough money, with every new store, to justify expanding overseas.
Think of Popeye’s as Tom Brady as a rookie. It just got its shot, it’s shown tremendous upside, but there’s still a lot to prove.
If profitability, same-store sales, or cash flow decline with expansion–then you’ll know it’s time to “cut” AFC Enterprises, Inc. (NASDAQ:AFCE) from your portfolio.
China: The red zone
The truth is that Yum! Brands, Inc. (NYSE:YUM) has a long road to go for a Chinese recovery.While the company expects Chinese sales growth to resume in the fourth quarter, August sales were still down 10% and they’ve dropped over 50% from pre-crisis levels.
I like Yum! Brands, Inc. (NYSE:YUM), mostly because of Taco Bell’s refocused brand image, and they’ll grow again in China. Recent figures out of China have shown comparable sales declines, but those declines have slowed, from -19% in May to -10% in June, which could signal stabilization. But their latest set back, combined with Popeye’s healthy growth, has me thinking they could have some competition in China soon.
If AFC Enterprises, Inc. (NASDAQ:AFCE), through Popeye’s, can grow as efficiently overseas as they have in the U.S.–watch out!
Foolish investing tip: Scouting matters
In the stock market, the “obvious picks” are typically the worst ones.
Tom Brady, Randy Moss, and countless other All-Pro’s slipped in the NFL draft because they were either overlooked or carried headline risk. The same is true in the stock market; unknown or un-followed stocks can turn into “All-Pro’s” with just a little time and patience.
In my opinion, Popeye’s is a higher quality version of KFC without the negative PR. They currently have a scant 2,000, profitable, locations and are only just beginning to test the waters overseas. While I like both stocks, if we’re talking chicken, I prefer Popeye’s as a growth play.
If Popeye’s can grow overseas as profitably as they have in the U.S., then the sky truly is the limit.
The article Fried Chicken, Tom Brady, and 1 All-Star Stock originally appeared on Fool.com and is written by Adem Tahiri.
Adem Tahiri has no position in any stocks mentioned. The Motley Fool owns shares of AFC Enterprises.
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