Morningstar

Yum China Operating Improvements Encouraging Ahead of Spin-Off

Our positive long-term outlook remains intact, but we think the shares are currently fairly valued.

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Yum Brands Inc
(YUM)

Our positive long-term views on wide-moat

While flat China division second-quarter comps came in a shade below our expectations, it's more than offset by comments about current trends--division comps up low-double-digits quarter-to-date--as well as updated guidance calling for at least 17% restaurant margins this year (up from 16% previously) due to favorable commodity costs and restaurant operating efficiencies. While Yum China's double-digit pace will likely tail off due to more difficult comparisons as the quarter continues, we're comfortable forecasting back-half comps in the mid-single-digit range and putting the division ahead of its full-year 2%-3% outlook (and driving enough operating leverage to reach its 17% target). While Taco Bell and Pizza Hut continue to face a highly promotional U.S. QSR industry, we're encouraged by signs that Yum's other divisions are finding ways to balance value with innovation (as evidenced by implied positive comps from each brand division thus far in the third quarter).

We find Yum's updated full-year outlook calling for constant-currency operating income growth of 14% (up from 12%) realistic, and plan to increase our $92 fair value by a few dollars. With the strong stock price performance (up 21% year-to-date), we find Yum's valuation less compelling at current levels but still an intriguing capital allocation play ahead of the China spin-off in October.

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About the Author

R.J. Hottovy

Sector Strategist
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R.J. Hottovy, CFA, is a consumer strategist for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He is responsible for consumer discretionary and staples research. He has covered the consumer sector as an analyst and director of global consumer equity research for Morningstar since joining the company in 2008, and specializes in a broad range of consumer categories including restaurants, footwear and apparel retailers, consumer electronics retailers, fitness clubs, home improvement and furnishing retailers, and consumer product manufacturers.

Before joining Morningstar, Hottovy was a director and senior stock analyst for Next Generation Equity and an analyst for William Blair & Co., specializing in a wide range of retail and consumer product companies. He also spent two years at Deutsche Bank, covering waste management, water utilities, and equipment rental stocks.

Hottovy holds a bachelor’s degree in finance and a second degree in computer applications from the University of Notre Dame, where he graduated magna cum laude. He also holds the Chartered Financial Analyst® designation and is a member of the CFA Institute and the CFA Society of Chicago.

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