Image Shown: An overview of Yum! Brands Inc’s operations. Image Source: Yum! Brands Inc – Investor Fact Sheet
By Callum Turcan
On January 6, quick-service restaurant chain Yum! Brands Inc (YUM) (which owns the KFC, Pizza Hut, and Taco Bell brands) announced that it was acquiring fast causal burger joint Habit Restaurants Inc (HABT) for $14 per share in cash for a total cash consideration of $375 million. Habit Burger’s footprint includes ~265 restaurants in total across more than a dozen US states and China under its namesake brand, Habit Burger Grill, and please note roughly 90% of those locations are company-owned.
While Habit Restaurants’ footprint is relatively small compared to Yum! Brands’ footprint of over 49,000 locations in more than 145 countries worldwide, please note that ~98% of those are franchised and its company-owned footprint stood near 850 locations at the end of 2018. Acquiring Habit Restaurants will substantially grow that figure, keeping in mind Habit Restaurants has more than doubled its store count since the end of fiscal 2014 as the firm is undergoing a major growth phase.
Covering the Move
At the end of Habit Restaurants’ third quarter of fiscal 2019 (period ended September 24, 2019), the firm had no debt on the books and a cash balance of $37 million. Due to the firm currently being in growth mode, Habit Restaurants generated negative free cash flow in fiscal 2017 and fiscal 2018. Having the financial firepower and expertise of Yum! Brands should enable the Habit Burger Grill chain to keep growing substantially going forward. That includes pushing deeper overseas with an eye towards Canada, the UK, and Europe at-large.
Habit Restaurants is forecasting for 3.0%-3.5% same-store sales growth at its company-owned stores in fiscal 2019, which clocked in at 3.4% during the first nine months of its fiscal 2019. Adding another growth lever to Yum! Brands’ portfolio seems like a good decision, in our view, especially as Habit Restaurants has a tried-and-true concept here that’s been popular enough to support strong same-store sales and store count growth on a historical basis. The deal is expected to close by the second quarter of calendar year 2020.
Yum! Brands’ Pizza Hut brand has been facing weak same-store sales growth of late (particularly after taking foreign currency headwinds into account), which is largely why the company bought QuikOrder in 2018 for under $0.1 billion in total cash considerations (to support its Pizza Hut operations by enabling the firm to learn more about its customers). On a year-over-year basis, Yum! Brands’ worldwide same-store sales grew by 3% in the third quarter of 2019 (a growth rate that grows to 8% when removing foreign currency headwinds). Adding Habit Restaurants shores up Yum! Brands’ growth trajectory.
In many ways, this deal is how Yum! Brands seeks to take on McDonald’s Corp (MCD) more directly as Habit Burger Grill is strong in both burgers (McDonald’s bread-and-butter) and chicken sandwiches (where McDonald’s and others have been aggressively expanding/promoting their offerings in a bid to take market share). To read more about the chicken sandwich wars, check out this article here.
Financial Overview
Unlike Habit Restaurants, Yum! Brands is very free cash flow positive due to its capital expenditure light franchise-oriented business model. However, also unlike Habit Restaurants, Yum! Brands carries a hefty net debt load. Yum! Brands exited September 2019 with $0.7 billion in cash and cash equivalents on hand versus $0.1 billion in short-term borrowings and $10.5 billion in long-term debt. While its free cash flows are quite strong, its dividend obligations also need to be kept in mind. Yum! Brands’ free cash flow stood at ~$0.95 billion in calendar year 2018 (also Yum! Brands’ fiscal year), and the firm paid out ~$0.45 billion that year. Share buybacks have been a major use of cash as Yum! Brands repurchased ~$2.4 billion of its common stock in 2018.
We view the trajectory of Yum! Brands’ dividend payout as quite weak due to competing future uses of free cash flow (buybacks, dividend obligations, expansion plans, debt obligations). The firm’s Dividend Cushion ratio sits near 0, implying less-than-idea dividend coverage as well on a forward-looking basis (the Dividend Cushion puts a greater emphasis on balance sheet net cash as a source of safety than other dividend health evaluations). In the graphic below, from our two-page Dividend Report (can be accessed here), we highlight the state of Yum! Brands Dividend Cushion ratio.
Image Shown: While Yum! Brands is very free cash flow positive, a product of its capital expenditure light franchise-oriented business model, its hefty net debt load prevents the firm from having good dividend coverage and a promising payout growth trajectory.
Concluding Thoughts
Shares of YUM have come down sharply since September 2019 (arguably due to shares being quite overvalued at the time). Additionally, shares of YUM ~1.7% as of this writing. There are integration and expansion risks to be aware of when Yum! Brands attempts to roll out the Habit Burger Grill concept in new markets, however, the firm has plenty of experience and expertise when it comes to situations such as these. Having the benefit of Yum! Brands global marketing and advertising wing will support future growth endeavors at the Habit Burger Grill brand. We still aren’t interested in shares of YUM here as the top end of our fair value range estimate sits at $106, or just a few dollars ahead of where YUM is trading at as of this writing.
Restaurants (Fast Food & Coffee/Snacks Industry) – ARCO DPZ DNKN JACK MCD PZZA SBUX WEN YUM
Related: QSR
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Callum Turcan does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.