Is Yum! Brands (YUM) a Strong Conviction Buy?

Justin Zhen |

The restaurant group Yum! Brands (YUM) reported earnings on Tuesday, which beat analyst expectations, even though revenue numbers fell short. Yum reported fourth-quarter earnings of $0.86 cents per share on sales of $4.2 billion, an improvement over estimates of $0.80 per share on sales of $4.26 billion. Despite the revenue miss, the stock rose 4 percent as the company reiterated their 2014 guidance.

Over half of Yum’s revenue comes from China, where they operate over 4,000 KFC franchises and almost 1,000 Pizza Hut locations. In 2013, Yum’s sales there were hit hard by the avian flu, and the company has devoted a lot of energy to advertisements telling the public that their chicken is safe to eat. Ultimately, Yum’s same-store sales were down 4 percent in China for the quarter. 

Yum is continuing their aggressive expansion into emerging markets, and after China, their next major target is India. On the earnings call, Yum’s CEO David Novak said that they expect to open 700 additional stores in China and 150 stores in India in 2014. In non-US markets, Yum has a total of 1,000 stores. 

Yum trades around 30 times earnings, higher than McDonald’s (MCD) P/E of 20 but cheaper than upstart Chipotle Mexican Grill (CMG) , which trades around 50 times earnings. At first glance, Yum appears to be appropriately priced as a growth stock.

So is Yum! a buy now? We can use Thinknum’s financial analysis platform to get a better idea. One easy way to value a company is to create a Cashflow Model with the Quick Builder, where you adjust key corporate valuation drivers:    

-Gross Profit Margins of 32 Percent: Yum has increased their gross profit margins consistently, but they still trail the industry average of 37 percent and are far behind McDonald’s gross profit margins of 40 percent. Expect Yum to continue to improve this metric as they gain a larger foothold in China and India.  

-Revenue Growth of 20 Percent: Yum’s CEO projects 20 percent growth in 2014. This is reasonable given the company’s aggressive penetration of emerging markets. 

-Capital Expenditures as percentage of revenue, Depreciation and amortization as percentage of revenue: We can get an idea of what metrics to use by looking at past corporate filings, and plot them easily with Thinknum. In this case, we use 7 percent and 6 percent respectively.

 

 

Now by adjusting all these metrics, we can see the implied value per share move in real time while the actual model runs in the background. It is interesting to see how different inputs affect the final result, similar to the sensitivity analysis that you can implement in Excel.

To gain further insights into the model, we can create it for a more specific overview of the inputs used to arrive at the intrinsic value. Inside the model, all the inputs are visible and editable, and Thinknum’s models update automatically when new data becomes available. One of the benefits of the platform is the fact that it is semantic in nature, where one can take the same model for YUM and apply it to its competitors in the space, such as MCD.

We can see that the model arrives at a price target of $86.56, or around a 20 percent upside from current prices. Thus, we are bullish on Yum’s growth prospects and would be a buyer of the stock at present levels. You can access the YUM model here: Thinknum YUM Cashflow Model.  

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
CMG Chipotle Mexican Grill Inc. 370.00 0.94 0.25 1,286,670
YUM Yum! Brands Inc. 64.49 0.13 0.20 2,395,020
MCD McDonald\'s Corporation 121.26 0.81 0.67 2,623,713
BEAZF Beazley Plc Ord n/a n/a n/a 0

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