Yum Brands (YUM) reported third-quarter results Wednesday that showed strong international expansion, especially within China, but very poor results in the US. We are maintaining our $44 fair value estimate.
Total revenues jumped 14% on a similar growth rate of sales in company stores and licensing fees, though higher food and paper costs drove operating profit lower from the same period a year ago. Same-store-sales jumped nearly 20% in China (and about 3% across Yum’s international portfolio), but fell about 3% in the US (Taco Bell, KFC, and Pizza Hut each declined more than 2% domestically). Operating profit was particularly weak in the US and suffered a 16% decline. However, we’re big fans of Yum’s expansion in China, which saw over 130 new units opened during the quarter and will likely absorb 600 total stores during 2011. With same-store sales of KFC and Pizza Hut Casual Dining expanding 19% each in China, we think the growth runway there is long.
The firm’s earnings-per-share expanded roughly 13% from last year’s quarter, and Yum reaffirmed its full-year EPS forecast of at least 12%. We note, however, that almost all of the earnings growth was driven by a lower tax rate, which fell about 13 percentage points from prior year’s quarter, a source of earnings growth we view as very poor quality. Still, cash flow from operations remains very healthy, and free cash flow has jumped 14% through the first three quarters of the year, supporting the identical increase in its quarterly dividend announced during the period.
All told, we agree with management that Yum’s opportunity in China is among “the best in retail,” but we fall short of getting excited about the stock at this time. We’d consider adding Yum to the portfolio in our Best Ideas Newsletter in the low $30s per share, which reflects the low end of our fair value estimate range.