Why Yum dropped on a McDonald's disappointment
It has to do with Yum's business in China, which is seeing an economic slowdown.
Disappointing news from McDonald's (MCD) Friday took down shares of -- Yum Brands (YUM).
For the day, McDonald's shares fell 0.07% while shares of competitor Yum Brands tumbled 3.3%.
The drop came after McDonald's announced disappointing same-store sales for May -- with especially disappointing results from its Asia/Pacific, Middle East and Africa unit.
Post continues below.
Comparable store sales in the United States climbed 4.4% in May -- more than fine given evidence that the U.S. economy is slowing. Sales in Europe increased by 2.9% -- better than expected, considering that much of Europe is in a near or actual recession. (Better-than-expected sales in the United Kingdom, Russia and France offset weaker results from Germany.)
Comparable store sales in the company's Asia/Pacific, Middle East and Africa unit, however, fell by 1.7% in May -- and that was worse than expected. (Analysts had been looking for 3.2% same-store sales growth in the region.) The worst sales decline came in Japan but sales in China also lagged expectations. Margins at company-operated restaurants in the region fell to 17.5% from 16.9% as McDonald's promoted its value menu to drive traffic to stores.
Company-wide comparable store sales grew by 3.1% in May. System-wide sales grew by 1.2% or 5.6% in constant currencies.
It's actually perfectly reasonable that McDonald's disappointing sales numbers in Asia would hit Yum Brands harder than they hit McDonald's itself: Asia, specifically China, is a much bigger piece of the pie at Yum than at McDonald's. McDonald's aims to grow rapidly in China, but the company has just 1,500 restaurants in the country against 4,600 for Yum Brands' Pizza Hut and KFC units. The company got 44% of 2011 sales from China and 50% of 2011 profits.
But let's be clear that what we're talking about here is "relative" disappointment off some tough-to-beat numbers. In the first quarter of 2012, for example, Yum Brands showed 14% gains in comparable store sales. In the second quarter Wall Street analysts are looking for comparable store sales growth in the low double-digits for Yum in China. That would decline to high single-digit comparable sales growth in the second half.
That's hardly a disaster.
McDonald's also seems to be going through one of those occasional resets. According to the Wall Street consensus, earnings growth will dip to a 2.5% annual growth rate in the second quarter before rebounding in the third quarter to 6.6% in the third quarter on the company’s way to 6.2% earnings growth for 2012. The analyst consensus calls for 10.5% earnings growth in 2013.
The weakness in share prices that comes with a reset like that -- in McDonald's and in Yum Brands -- is a buying opportunity as long as you believe that the growth opportunities in front of these companies haven‘t changed radically. McDonald’s shows a trailing 12-month return on invested capital of 20.6%. Yum's for the trailing 12-months is 27%. With China and India and the rest of the emerging world still representing opportunities for growth, those returns on invested capital look reasonably safe for the future. In a world where 10-year Treasuries yield less than 2%, a company that can get better than 20% on its capital is very interesting to me indeed.
I've got a 12-month target price of $109 for McDonald's in my Jubak's Picks portfolio. Yum Brands is, as of June 13, on my watch list.
At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. The fund did own shares of McDonald's and Yum Brands as of the end of March. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here.
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