Yum Needs a Post-China Recipe

It's vague on details of how to grow its core business.
At Closing, May 25th
82.53 USD

Yum! Brands may soon learn find that home cooking is harder than it looks.

The fast-food operator is promising to reinvigorate its Taco Bell, Pizza Hut, and KFC restaurants after it spins off its China business later this month. 

The question is whether Yum can not only pull off the financial finagling to slim itself down, but also figure out how to grow what will soon look like a very different business in a difficult environment.

The High Road

Yum's shares are up 28% in the past year, as investors cheer an upcoming split from its China business

Source: Bloomberg

Yum shares rose by 3 percent on Tuesday, as the company announced at its investor meeting that it plans to return as much as $13.5 billion to shareholders by 2019 via dividends and share buybacks. 

Shares were already up 24 percent so far this year in anticipation of the China split, agitated for by activist investors more than a year ago.

At the time, Corvex Management said the split could add $16 a share in value to Yum's $91 share price. The stock currently trades around $90. 

If all goes according to plan, then by 2019 Yum will be free of its China business, which had accounted for half its revenue. It will still get 15 percent of revenue from China through licensing fees, but won't have the headaches of managing the 7,000 stores it once owned there.


Sensitivity of Yum! Brands' operating profit to a 10% change in China same-store-sales growth

Source: Company presentation

Yum will also sell another 3,000 stores to franchisees, meaning 98 percent of its 43,000 locations will be owned and operated by franchisees who pay Yum a percentage of sales. McDonald's and other competitors have been taking a similar approach.

The idea is that Yum can then focus on new food offerings, marketing, the supply chain and digital capabilities such as online ordering and delivery. It also means a steadier revenue stream: Forty-two percent of Yum's revenue could come from franchise frees, according to Bernstein analyst Sara Senatore.

Yum's asset sales will bring $2 billion upfront. And the company estimates it will save $400 million a year of capital spending. It also expects to cut general and administrative expenses by a cumulative $300 million by the end of 2019. It plans to cut 1,500 corporate restaurant jobs by the end of 2018. 

Yum, which currently has $9.2 billion debt, said it plans to keep its leverage elevated, at around five times Ebitda.

So what's Yum going to do with all that extra cash? First, hand it over to shareholders. But then the much harder part comes: fulfilling its promises to boost sales at existing locations, while continuing to build more stores.

Yum said it would consider buying other brands but is more committed to growing Taco Bell, Pizza Hut and KFC globally. And this is where the company got a little fuzzy on specifics. More than once executives at the investor meeting declined to expand on details and asked analysts to trust them, while trotting out vague goals like more innovation and focus. 

Trouble is, Yum didn't convey a sense of focus at all. Lofty new store-opening goals -- such as reaching 60,000 KFC restaurants worldwide from 18,000 today -- don't make much sense at a time when markets such as the U.S. and U.K. are over-saturated with restaurants and demand for meal delivery is only increasing. 


Restaurant growth has been outpacing U.S. population growth, causing oversupply

Source: Hedgeye

And while re-franchising certainly smooths out Yum's cash flow, it could also make it harder for Yum to get its Pizza Hut business on track. Pizza Hut is struggling to adapt its sit-down restaurant model to the delivery demands of millennials, who want to be able to order a pizza via text message or Amazon's voice-activated speaker, like they can do at competitor Domino's. 

Meanwhile, Taco Bell's efforts to expand globally seem distracting at a time when U.S. restaurant sales need all the help they can get and growth elsewhere is wobbly. Arguments that Taco Bell, the crown jewel in Yum's arsenal, would fare better on its own are only bolstered by the distracting array of priorities the company laid out Tuesday.

Spinning out China is good for the company's long-term health, and returning $13.5 billion to shareholders will certainly make investors happy. But financial management alone won't be enough to push the stock past $90 a share. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Shelly Banjo in New York at sbanjo@bloomberg.net

    To contact the editor responsible for this story:
    Mark Gongloff at mgongloff1@bloomberg.net

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