There was a time when Yum! Brands’ (YUM) KFC dominated the US chicken market, but those days are over.
Privately-held Chik-fil-A’s roots date back to the 1960s in Atlanta, but the company has gradually become the largest (yes, the largest) quick-service chicken restaurant chain in the US, based on domestic annual sales over $5 billion (with over 1,850 locations in 41 states and Washington D.C.). Chik-fil-A’s sales levels are better than Popeyes’ (PLKI) comparatively-modest ~$200 million in revenue and Yum! Brands’ ~$3 billion in revenue at its entire US division. Very few investors know about privately-held Chik-fil-A’s continued success in the states, and the firm’s growth is not slowing.
From Chik-fil-A’s adorable cow campaign, ‘Eat Mor Chikin,’ where self-interested cows encourage people to eat more chicken and thereby less of them (image source: Chik-fil-A), to refreshing customer service to family-friendly attractions utilizing the talents of the staff to community fund-raising, Chik-fil-A has carved out an impressive niche in the quick-service chicken-sandwich-making department. And perhaps more trendy are that its offerings are healthy and delicious. For calorie-counters, health information is available on the overhead menu, and meal options range from 12-piece grilled nuggets (bit-sized pieces of boneless breast of chicken) with just 200 calories and 34 grams of protein to other healthy options across classics, breakfast, wraps and salads. It appears that Chik-fil-A is doing as many things right as Yum! Brands is doing wrong.
The owner of KFC now estimates mid-single-digit full-year earnings per share growth for 2014, down from previous expectations of at least 20% expansion at the beginning of the year. Given all the troubles in 2014, we think guidance for at least 10% earnings growth in 2015 is achievable, however. Most of Yum Brands’ 2014 performance has been wrecked by negative publicity related to improper food handling in China by a former supplier, and while sales in the country continue to recover, the pace has been slower than in previous episodes. What could be considered one-time events could now be considered recurring items as KFC is rattled every few months by some adverse event in China from avian flu scares to food scandals and beyond.
As we’ve stated time and time again, we expect consumers to return to the #1 foreign brand in China, KFC, but should the firm continue to be hit by unforeseen events, there is a point where permanent brand impairment is possible. We’re not there yet. In the US, however, we think the shift to the new chicken-sandwich king Chik-fil-A is a more permanent problem. Unless KFC reinvents itself, its menu, and customer service, we would expect Chik-fil-A to continue to gain share with really nothing to stop it. Yum! Brands is trying out a number of new concepts, including Super Chix (a chicken sandwich concept), but Chik-fil-A’s marketing success will be difficult to overcome by anyone, in our view.
Our fair value estimate of Yum! Brands’ shares remains unchanged at $70. Our favorite long-term idea in the restaurant space is Buffalo Wild Wings (BWLD), though its valuation continues to run. A couple under-the-radar dividend growth ideas in the restaurant industry include Bob Evans (BOBE) and Cracker Barrel (CBRL).