Yum! Brands Inc. (YUM) reported third quarter 2011 adjusted earnings of 83 cents per share, which beat the Zacks Consensus Estimate of 74 cents. Earnings increased 13% year over year mainly on the back of strong performance at its China division and other emerging markets as well as a lower tax rate.
On a reported basis, Yum! Brands’ quarterly earnings were 74 cents per share, up 8% year over year.
The company reported a 14% year-over-year increase in total revenue to $2,854 million. System Sales growth was a respective 29% and 8% in China and Yum! Restaurants International (YRI) division (excluding foreign currency translation), partly offset by an 3% decline in the U.S division.
Behind The Headline Numbers
Comparable-restaurant sales (comps) improved 19% in mainland China. YRI division witnessed a 3% rise in comps. However, comps slipped 3% in the U.S. due to declines of 2% decline at Taco Bell, 3% at Pizza Hut and 3% at KFC.
In the quarter under review, Yum! Brands saw a spike in its overall cost structure. Company-restaurant costs and general and administrative (G&A) expenses increased 17% and 9%, respectively. China and the YRI division were unable to reduce their cost structures. However, these were partially made up by a respective 10.3% and 10% cut in company-restaurant costs and G&A expenses at the U.S. division.
Consolidated operating profit dipped 10% year over year. Performance in the U.S. division (down 16%) took a toll. However, two geographic segments, China (up 13%; and up 7% excluding foreign currency translation) and YRI (up 15%; and up 3% excluding foreign currency translation) contributed to the growth. Operating profits at China and YRI divisions saw positive foreign currency influences of $16 million each.
At the China division, Pizza Hut Casual Dining same-store sales grew 19% and Pizza Hut UK system sales grew 5%. Third quarter operating profit growth was hindered by a 5 percentage point impact from a $6 million non-cash expense related to expected Pizza Hut UK restaurant closures at the YRI division.
As expected, restaurant margin slipped 3.9 percentage points in China due to wage and commodity inflation. New menu pricing was taken after the quarter ended. Restaurant margin dipped 0.2 percentage points at the U.S. segment it dipped 2.3 percentage points.
Unit Growth
Robust performance in the China division during the quarter was primarily driven by 138 new openings. Further, Yum! Brands solidified its footprint internationally by opening 193 new units 50 countries, including 127 new units in emerging markets, the majority by franchisees. Yum! Brands expect to open a record 600 new units in China in 2011 and 900 new units in YRI.
Financials
At quarter end, Yum! Brands had cash and cash equivalents of $1,236 million with long-term debt of $2,940 million, and shareholder equity of $1,993 million.
Outlook
YUM! expects profit performance to improve in the fourth quarter of 2011 at the US division. The company expects full year 2011 restaurant margins of 20% at the China division.
Our Take
We still see China as playing the major role in Yum! Brands’ growth story. However, commodity inflation could continue to play foul worldwide. The YRI division is comparatively immune to inflation as majority of the operations are franchised. We believe that the company’s overseas expansion remains one of its key growth drivers. The company’s well-diversified growth model also includes rapid unit expansion throughout the globe.
Stiff competition from other quick-service restaurant operators also remained an overhang. Yum! Brands currently retains a Zacks Rank #3 (short-term Hold recommendation). We also reiterate our long-term Neutral rating. Yum! Brands’ close competitor McDonald’s Corp. (MCD) is slated to report its third 2011 earnings on October 21, 2011, before the closing bell.
