Yum! Brands Inc. (YUM) reported first quarter 2012 adjusted earnings of 76 cents per share, which beat the Zacks Consensus Estimate of 73 cents. Earnings increased 21% year over year mainly on the back of outperformance at its China division and other emerging markets. On a reported basis also, Yum! Brands’ quarterly earnings were 96 cents per share, up 76% year over year.

The company reported a 13% year-over-year increase in total revenue to $2,743.0 million. System Sales growth was a respective 28%, 8%, and 1% in China, Yum! Restaurants International (YRI) and the U.S. division, excluding foreign currency translation. The divestiture of Long John Silver’s and A&W brands adversely affected worldwide System Sales growth by 2 percentage points, including an effect of 5 percentage points to the U.S. and 1 percentage point to YRI.

Behind the Headline Numbers

Comparable-restaurant sales (comps) improved 14% in mainland China. YRI and the U.S. division each witnessed a 5% rise in comps. Comps went up 5% in the U.S., with increases of 6% at Taco Bell, 5% at Pizza Hut and 2% at KFC. Comps increased 8% in Yum! Restaurants India.

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 13% and 7%, respectively. China and the YRI division were unable to reduce their cost structures. However, their increases were partially made up by a respective 13% and 4% cut in company-restaurant costs and G&A expenses at the U.S. division.

Consolidated operating profit upped a handsome 61% year over year. Major three geographic segments, China (up 19%; and up 14% excluding foreign currency translation), YRI (up 7%; and up 9% excluding foreign currency translation) and the U.S. (up 27%) contributed to the growth. Foreign currency translation helped operating profit by $8 million.

As expected, restaurant margin slipped 1.5 percentage points to 23.6% in China due to wage and commodity inflation. Restaurant margin slid 0.6 percentage points to 12.2% in the YRI division hurt by decreases in KFC UK, Pizza Hut Korea as well as increased costs incurred due to last year’s flooding in Thailand. However, margin saw an improving trend increasing 3.7 percentage points to 14.4% at the U.S. segment.

Unit Growth

Strong performance in the China division during the quarter was primarily driven by 168 new openings. Further, Yum! Brands solidified its footprint internationally by opening 123 new units in the quarter under review. On the whole, Yum! opened 250 new restaurants in the fast growing emerging markets. Management expects to open 100 new restaurants in India this year.

Financials

At quarter end, Yum! Brands had cash and cash equivalents of $1,099.0 million with long-term debt of $3,006 million, and shareholder equity of $2,279.0 million.

Outlook

The company expects full-year 2012 earnings per share growth of at least 12.0% (versus 10.0% projected earlier).

Our Take

We still see China as playing the major role in Yum! Brands’ growth story. The U.S. segment is also rebounding slowly but at a steady pace. The cloud over Taco Bell, which is the most important brand in the U.S., seems to have dispersed. As a point of reference, last year Taco Bell was hit with the allegation related to the content and quality of its beef products. To mitigate all negativity, the company planned three breakthrough innovations so as to reignite the brand.

However, commodity inflation could continue to play foul worldwide. Additionally, slowdown in economic growth in China, which accounts for a major portion of consolidated operating profit, concerns us. Stiff competition from other quick-service restaurant operators also remains an overhang. Yum! Brands, which competes with McDonald’s Corp. (MCD), currently retains a Zacks #2 Rank (short-term Buy recommendation). We reiterate our long-term Neutral rating.

To read this article on Zacks.com click here.

Zacks Investment Research