2023-06-01 11:03:49 ET
Summary
- Yum Brands has exhibited consistent growth and strong business momentum, with promising prospects for future earnings growth.
- The stock is attractively valued from a long-term perspective, trading at 16.7 times its expected earnings in 2026.
- Despite a modest current dividend yield, Yum Brands has a low payout ratio and a history of fast dividend growth, making it an attractive investment for the long run.
About nine months ago, I recommended purchasing Yum Brands (YUM), which was highly attractive near its 52-week lows back then thanks to its nearly 8-year low valuation level and my expectations for a recovery of its business. The restaurant chain was temporarily affected by inflation, staffing shortages and supply chain disruptions. Since then, the stock has rallied 13% and thus it has outperformed the S&P 500 (+5%) by a wide margin. The rally of the stock may entice some investors to take their profits. However, Yum Brands remains attractive from a long-term perspective.
Business overview
Thanks to its exceptionally popular brands and its solid business execution, Yum Brands has exhibited a consistent growth record. The company has grown its earnings per share in 8 of the last 9 years, at a 7.6% average annual rate. Even better, the company has ample room for future growth.
Yum Brands has had a strong start to the year. In the first quarter, it grew its revenue 13% over the prior year’s quarter, thanks to 8% same-store sales growth and 5% growth of store count. The focus of the company on its digital strategy has been a significant growth driver for several quarters in a row. Digital sales reached an all-time high of $7 billion in the first quarter and thus they exceeded 45% of total sales.
Thanks to its solid business performance, Yum Brands grew its core operating profit 11%. Management also noted that inflationary pressures, staffing challenges and supply chain disruptions have begun to abate, with further improvement expected in the upcoming quarters. As a result, the company is expected by analysts to grow its earnings per share by 14% this year.
The strong business momentum is likely to remain in place for the foreseeable future, primarily thanks to favorable trends in the KFC and Taco Bell divisions. KFC, which generates 50% of the total operating profit of Yum Brands, posted an impressive sales growth rate of 15% in the first quarter, driven by 9% same-store sales growth and 7% unit growth. The strong performance resulted from menu innovation, value offerings and digital initiatives.
KFC is likely to maintain its strong momentum thanks to the introduction of boneless offerings, such as the return of the DoubleDown sandwich, the launch of two for $5 wraps in the first quarter as well as the national launch of chicken nuggets in the running quarter.
Taco Bell, which generates 34% of the total operating profit of Yum Brands, posted 12% system sales growth thanks to 8% same-store sales growth and 6% unit growth. Taco Bell is likely to keep thriving thanks to the introduction of new product offerings and its everyday value through its menu. It is also remarkable that Taco Bell grew its digital sales by 60% over the prior year’s quarter.
Growth prospects
Yum Brands has exhibited a consistent growth record thanks to multiple growth drivers. The restaurant chain has been growing its store count at a fast pace during the last three years and aims to continue growing its store count by 4%-5% per year for years. In addition, the company has grown its same-store sales for several years in a row, except for 2020, which was marked by unprecedented lockdowns due to the coronavirus crisis.
Moreover, Yum Brands has been repurchasing its shares consistently over the last nine years and thus it has reduced its share count by 5% per year on average throughout this period. Overall, the company has three major growth drivers in place; 4%-5% annual growth of store count, meaningful growth of same-store sales thanks to attractive new offerings and enhanced digital capabilities and share repurchases.
Thanks to all these growth drivers and its unabated business momentum, Yum Brands is likely to keep growing its bottom line meaningfully for many more years. Analysts agree on the promising prospects of this popular restaurant chain, as they expect it to grow its earnings per share by nearly 15% per year on average, from $5.12 this year to $7.69 in 2026.
Valuation
Yum Brands is currently trading at 25.1 times its expected earnings this year. This price-to-earnings ratio may seem excessive to some investors but they should realize that Yum Brands has almost always traded with a premium valuation thanks to its performance record, its reliable growth trajectory and its popular brands. Therefore, investors should not expect to buy this high-quality restaurant chain at a price-to-earnings ratio below 20. In fact, the current price-to-earnings ratio of 25.1 is a nearly 8-year low level for this stock.
It is also important to note that Yum Brands is trading at only 16.7 times its expected earnings in 2026. This earnings multiple is 31% lower than the historical 10-year average price-to-earnings ratio of 24.2 of the stock. It is thus evident that the stock is attractively valued from a long-term point of view, as its future growth of earnings per share will easily offset the effect of the somewhat rich initial valuation level on the future return of the stock. To cut a long story short, those who can wait patiently for the growth trajectory of Yum Brands to unwind are likely to be highly rewarded in the long run.
Dividend – Capital allocation
Yum Brands has a clear capital allocation strategy. First of all, it reinvests some of its earnings in its business, in the form of opening new stores and contributing to the improvement of its franchised restaurants. Thanks to its lean and highly profitable business model, its capital expenses consume just a small portion of operating cash flows. In the last 12 months, capital expenses have consumed just 20% of operating cash flows.
Moreover, Yum Brands targets a dividend payout ratio around 45%-50%, which it has maintained throughout most of the last decade. In addition, as mentioned above, the company has consistently repurchased its shares in order to enhance shareholder value. Overall, Yum Brands has a disciplined capital allocation policy, which has benefited shareholders over the long run.
Yum Brands is currently offering a 1.9% dividend yield, which is lackluster, at least on the surface, for most income-oriented investors. However, it would be a mistake to dismiss this high-quality stock for its modest current dividend yield.
To be sure, Yum Brands has grown its dividend by 9.7% per year on average over the last decade and by 12.2% per year on average over the last five years. Moreover, the stock has a solid payout ratio of only 52% and is likely to keep growing its earnings per share at a meaningful rate for many more years.
Furthermore, Yum Brands has a healthy balance sheet. Its net interest expense consumes only 23% of its operating income while its net debt (as per Buffett, net debt = total liabilities – cash – receivables) is standing at $13.5 billion . As this amount is about 9 times the annual earnings of the company and only 38% of the market capitalization, it is certainly manageable. Overall, thanks to its promising growth potential, its low payout ratio and its healthy balance sheet, Yum Brands is likely to continue raising its dividend at a fast pace for many more years.
Risk
A potential risk factor is the adverse scenario of persistently high inflation for years. In such a case, cost inflation would probably weigh on the earnings of the company. Due to 40-year high-cost inflation, Yum Brands grew its earnings per share by just 1% in 2022.
However, management recently stated that it has noticed great improvement in cost inflation. Moreover, most central banks are raising interest rates at an unprecedented pace in order to restore inflation to normal levels. As a result, they are likely to achieve their objective sooner or later. Overall, if inflation surged again, it would take its toll on the growth rate of Yum Brands but this unlikely scenario would only be temporary in nature.
Final thoughts
Thanks to the popularity of its brands and its easy-to-understand business model, Yum Brands does not pass under the radar of most investors. Nevertheless, as the stock almost always trades with a premium valuation, many investors hesitate to initiate a position. This is a shame, as the company can offer a double-digit total annual return in the upcoming years. Despite its outperformance since my last article, Yum Brands can still offer attractive returns in the long run thanks to its double-digit earnings growth, its dividend growth and its reasonable valuation.
For further details see:
Yum Brands Remains Attractive