2023-10-20 11:18:51 ET
Summary
- Yum! Brands, the parent of brands KFC, Taco Bell, and Pizza Hut, gets a neutral/hold rating today, in line with the quant system consensus.
- Positive mentions are the YoY revenue & earnings growth, 3-year dividend growth, positive cash flow, and strong sales growth in the KFC brand specifically.
- Headwinds are underperformance vs. the S&P500 index.
- A downside risk remains the debt load and negative equity.
Research Note Summary
In today's research note, you can literally smell the pizza baking and chicken frying!
The company in the restaurant sector behind global quick-serve brands like KFC , Taco Bell , and Pizza Hut is none other than Yum! Brands ( YUM ) , which I am covering today.
For this note I gave the stock a neutral/hold rating.
I am impressed by the YoY growth in sales and earnings, cheap share price, and 3-year dividend growth.
However, a major downside risk that remains is the $11B debt load and negative equity, as well as headwinds such as underperformance vs the S&P500 index.
Methodology Used
I will utilize my WholeScore Rating methodology which looks at this stock holistically across 6 categories including potential downside risks, and assigns a rating score.
Some of the data in this note will come from the earnings data released Aug. 2nd (for fiscal 2023, Q2, ended Jun 30), and some forward estimates may relate to the upcoming Nov. 1st earnings release (FY23, Q3, ended Sep 30).
Industry Outlook
As mentioned, Yum! Brands owns three major global fast food brands such as KFC, Taco Bell , and Pizza Hut , but also a lesser known brand called Habit Burger .
Though some restaurants might be company-owned, a very large amount are owned by franchisees and this business model has lasted quite a while. For example, a restaurant investor will develop a restaurant and pay a franchise fee to Yum! brands to use one of its brand names, recipe, and systematic process, among other things.
Any reader who has ever worked seasonal jobs in fast food probably knows the importance of sales and customer volume, since it is a capital-intensive business requiring much overhead to run physical restaurants. The three brands mentioned may have American roots, but since then have taken on a global footprint.
In fact, not long ago I got to visit a KFC in southeast Europe, which seems to get quite a bit of volume.
In comparing this stock with the restaurant sector , I chose 9 stocks to compare against each other on YoY revenue growth, since as mentioned the focus being top-line sales.
I picked stocks that are well-known, have a large fast-food/quick-serve restaurant footprint, and some similar types of products like pizza, burgers, American Tex-Mex, etc.
If you look at my table below, Yum is somewhere in the middle on revenue growth, coming in almost 4% below the peer group average of 8.61%.
With that said, it got a score of 0 here because it did not meet my target of outperforming the peer average by 5%.
However, I expect improvement in revenue going forward, based on the company reporting an increase in restaurants opened and momentum showing full year guidance being positive.
According to CEO David Gibbs in his quarterly earnings commentary:
I remain confident we are well positioned to thrive in any consumer spending environment given the broad consumer appeal of our iconic brands, including our craveable products, compelling value, and easy experiences. With our strong year-to-date results and continued momentum, we expect to deliver full year 2023 results well above our long-term growth algorithm for system sales and core operating profit growth.
Financial Statements
Now, let's talk briefly about the financial statements and what they tell us.
From the income statement , we can see that both revenue and net income/profit saw a YoY growth, however, revenue missed my target of a 5% YoY growth. My forward sentiment is positive on both, due to the company's positive FY23 outlook I mentioned earlier.
From the cash flow statement , the company beat my target and achieved 28% YoY growth in free cash flow per share. I expect a continued positive trend going forward.
I would point out also that free cash flow saw significant YoY gains, and the trend since June 2022 shows an improvement each quarter since then.
Lastly, the balance sheet unfortunately continues to show negative equity, although it has improved on a YoY basis. In fact, the company has not had positive equity at all in the last year, and so my forward sentiment on their equity situation is negative.
Later, I will discuss the downside risk of this company's high debt load that I think is what is impacting equity.
All in all, in this overall category of financial statements I gave the stock a total score of 2.
Dividends
When it comes to dividends , I created the following table to track actual performance vs my target.
In the results, when comparing dividend growth across 3 years I compared Aug. 2023 with Aug 2020, and saw a 28% dividend growth in this period, beating my 5% target.
I expect the $0.60 dividend rate to continue forward until hiked again by the company.
In terms of yield, the company came short of the sector average of 2.50%, so it missed my target there as I am looking for a yield that beats the average. Looking forward, I think the share price will show improvement, so this could cause a decrease in the dividend yield.
My cash flow estimate on 100 shares is an annual dividend income of $244, beating my target of $100 in annual dividend income and a minimum quarterly dividend rate of $0.25.
The total score I gave this stock in the dividend category is 2.
Share Price
The share price as of the writing of this article, during Thursday midday trading, was $120.63, a sizeable 8% below the 200-day simple moving average I am tracking over the past year.
If you look at the following table I created, this buy price meets my portfolio goal which is a buy price no higher than 5% above the moving average.
Though this strategy may not fit every investor's portfolio goals, I will mention briefly why I use it and have in the past while trading from my home office and with personal capital. Rather than trying to "time" a magical buy or sell price, I found it more practical over a longer term to focus on limiting downside potential and increasing upside potential, by tracking the longer-term moving average.
If a stock is trading significantly above that average, it does not mean it will not continue to go up and up, however I also believe it presents a greater downside risk in the event of a sudden price dip.
I think this summer's crossover below the moving average you can see in the YCharts has now presented a value buying opportunity. It does not mean it will not continue to fall, and it could, but I think that opportunistic investors will recognize the growth in revenue, profitability, and cash flow and try to snatch up shares at this price range.
Performance vs. S&P500
In looking at this stock's market momentum , which I think is important because it compares this stock to a major index that is being tracked by the market such as the S&P500.
In this case, this stock has shown significant underperformance vs this index up until now, so it did not meet my target.
However, I believe going forward there will be an improvement to this metric, driven by increasing share price as mentioned earlier.
As you can see in the chart below, the price return (orange line) on this stock is rebounding upward again, while the S&P500 index (blue line) is reversing.
Yum - price vs S&P - improvement (Seeking Alpha)
Valuation
When it comes to valuation, we can only really look at the forward P/E ratio since the P/B ratio is essentially impacted by the company's negative equity, so cannot really track anything there.
When it comes to P/E, it is highly overvalued as you can see in the table below, being 54% above the sector average.
As for the reason for this, in my opinion, it is driven by the market reaction to the 86% YoY growth in earnings, as mentioned a few sections ago.
Further, if you look at the following table from the company's Q2 results, we can see that key metrics across its three major brands have had a positive % change, the strongest seemingly being the KFC brand. This table also shows momentum in not just sales and new store openings but also profitability, and I think the market is responding to that by expecting forward earnings to continue heating up.
Forward-Looking Risks
The key risk I identified, which is clearly a downside risk , and decreases this stock's WholeScore rating, is the excessive debt and negative equity.
The table below I created shows a high impact of probability of this risk, which exceeded my risk tolerance on this stock, and added a -1 score to the WholeScore.
The supporting evidence below shows that this company has had over $11B in long-term debt for the better part of the year, which is quite a high number.
While I am quite aware that capital-intensive companies have to take on debt to grow, for this company it is a high number in relation to the assets, which amount to just $5.8B. So, long-term debt is 1.9x total assets!
In addition to the company debt load, as mentioned earlier a lot of its business is tied to its brands being used by independent franchisees, who also may have to take on debt to develop the restaurants themselves since they own them. So, individual franchisees may also fall underwater as well, which could impact Yum! brands if too many of their franchisees start going underwater.
Consider that this issue was highlighted by an Aug. 2023 article in the Times of UK, calling out the "future" of the Pizza Hut brand in the UK due to debt issues.
By comparison to another stock in its peer group I highlighted earlier, Chipotle Mexican Grill ( CMG ) shows positive equity on its balance sheet for every quarter in the last year, yet it is also a similar model of having hundreds of quick-serve physical restaurants which are capital-intensive.
Another peer in this situation is Darden Restaurants ( DRI ), also having positive equity with assets well-exceeding liabilities. For readers less familiar with this sector, Darden is the parent of brands like Olive Garden and Longhorn Steakhouse, among others.
So, in terms of risk, I would consider those two peers a much better risk profile when it comes to debt.
WholeScore Rating
In today's rating, the stock got a WholeScore of 4, giving it a hold / neutral rating.
Yum - WholeScore (author analysis)
In comparison to the ratings consensus found on Seeking Alpha, this time around I am agreeing with the quant system which shows a consensus of "Hold".
Yum - rating consensus (Seeking Alpha)
For further details see:
Yum! Brands Rated Neutral As Sales Growth Overshadowed By Debt And Negative Equity