On Monday February 4th, 2013 we purchased a half position (55 shares) in YUM! Brands, Inc. ahead of earnings expecting better than anticipated results. Although the company beat on revenue and EPS, the stock gapped down due to negative guidance for FY’13 EPS. Although the company has posted five years in a row of double digit EPS growth, the company expects EPS to decline in the mid-single digits in 2013 y/y. This will be driven by lower sales in China in 1H’13.
China saw a sharp decline in sales in the last two weeks of December. On December 18th, an investigative report similar to “60 Minutes” on CCTV (a state owned enterprise) aired related to higher than allowed antibiotic levels for chickens in some of YUM!’s suppliers. Further investigation into January and negative social media lower consumer confidence on KFC in the region. After six weeks of media coverage Shanghai asked supervisory recommendations to YUM China to improve. Going forward, management is trying to restore confidence in their customers. YUM will be starting a quality assurance program and marketing campaign starting after the Chinese New Year (February 10th).
In the conference call, management noted the previous adverse PR incidents that the company has survived through including SARS, avian flu, and ecoli at U.S. Taco Bell restaurants. For example, in 2005 YUM’s China business was adversely affected by the avian flu, leading to a SSS decline of 40% and operating profit decline of 5%. In 2006, SSS rebounded 26% and profit grew of 40%. Similar to their strategy in 2005, management has elected to move forward with LT growth projections. They are not changing new unit growth for any brands in the China region. But, there is no question they will fall short of 10% EPS growth in 2013. Management expects a mid-single digit EPS decline in 2013. Double digit EPS growth targets in 2014 and 2015.
Management has strong FY’13 expectations for YRI (YUM! International), due to strong development momentum, higher economies of scale in certain markets and a leading share of global emerging market restaurant exposure. SSS growth in 2013 should be similar to the 12% growth in 2012 for YRI. Russia is a prime example of strong growth in FY’12. Russia has had highest SSS growth of any other area, benefiting from some company owned restaurants with good returns. YUM has begun to reach scale in France and Germany (150 and 100 total units at the end of 2012).
Results from 4QFY’12: 10% EPS growth excluding items. SSS of YRI of 3% excluding Japan and continental Europe. Russia, Africa, Thailand, and Korea (Pizza Hut) were standouts during the quarter. Operating profit grew 15%, excluding the effects from foreign currency and extra week. U.S. operating profit grew 5% y/y. U.S. restaurants are firmly positioned for more profit growth going forward. China operating profit declined 5% prior to FX driven by 6% decline in SSS. KFC was negative in October and November, which management affirms was due to hard y/y comps. KFC was sharply negative in December due to the last two weeks of the month. During the quarter, KFC opened 3 new restaurants per day (370).
January SSS decline of 41% KFC and 15% Pizza Hut. The timing of Chinese New Year had a negative mid-teen impact on SSS. Management expects this trend to reverse in February after the New Year. But, they estimate China SSS decline of 25% by first quarter. After a rebound post-new year, Pizza Hut SSS should be flat. China’s quarter only includes January and February to account for the irregular sales around the Chinese New Year. In the first quarter of 2013, EPS will decline by 25% before special items. YRI and U.S. businesses will remain a steady source of cash flow to the company. Excluding China, in 2013 management expects 7-8% EPS growth driven by these regions.