Inside Wall Street: Expect Yum's stock to pump up

Despite its gloomy near-term take on China, the major global fast-food chain remains appetizing.

By Gene Marcial Dec 10, 2012 11:32AM

AlamyYum Brands (YUM) is one of the major stocks that failed to ride this year's vigorous market rally. After the world's largest quick-service restaurant system warned on Nov. 30, 2012, that China isn't looking so hot, the stock plunged from a 52-week high of $74.75 to a depressed $66 a share -- where it's languishing today.


But shareholders who didn't bail out of Yum have little reason to worry: The stock is very much alive and kicking -- and is bound to snap back. And investors who don't own Yum should take the opportunity to buy shares in the battered stock.

 

The reason: China, Yum's largest foreign market that generated revenues of $5.6 billion and operating profits of $908 million in 2011, will continue to be a huge source of sales and earnings growth for Yum.

 

In fact, Yum is so confident about the China market -- despite the worry over the near-term outlook -- that it plans to open more than 700 new restaurants next year in that most populous nation where it already operates 4,500 restaurants. In all, Yum operates and franchises 37,000 restaurants worldwide under the KFC (Kentucky Fried Chicken), Pizza Hut and Taco Bell brands.

 

And Yum's operations in other foreign countries (excluding China) have also been in an upswing. Its 14,000 restaurants produced in 2011 revenues of $3.3 billion and operating earnings of $673 million. India appears to be the next growth area overseas. The densely-populated and expanding country's vast consumer base is expected to partially offset any drop in Chinese demand.

 

In the U.S., Yum recorded in 2011 revenues of $3.8 billion and operating earnings of $589 million, business is also humming along, helped in part by the new offerings at Taco Bell, Yum's leading brand in the country.

 

"We believe the company has improved its U.S. operations, with same-store sales rising 6% in the third quarter of 2012," says Jim Yin, analyst at S&P Capital IQ, who rates the stock a "buy."

 

"Our buy recommendation reflects our view of Yum's strong fundamentals," he says, in spite of concerns about a slowdown in China, "which we think offers long-term growth potential, given its large population and the rise of the middle class." The analyst is maintaining his 2012 operating earnings forecast of $3.24 a share. For 2013, he has trimmed by one cent a share off his earnings expectations, to $3.58 a share vs. 2011's $2.74.

 

But Yin is sticking with his 12-month price target of $79 a share, even though he has lowered his sales outlook in China because of a projected slowdown in economic growth and possible near-term margin pressure. However, most of the continued growth he expects will come from new store openings in the international markets, where Yum expects to have opened a total of about 1,760 new units this year, including 750 in China.

 

"Although growth has slowed in China, we see same-store sales increasing at a mid-single digit rate in 2013, reflecting a rise in that country's wealth," says the analyst.

 

In the meantime, shareholders are getting a healthy serving of Yum's strong free cash flow, notes Robert M. Greene, analyst at investment research firm Value Line. Yum recently hiked its quarterly dividend by 18%, to $0.335 cents a share, or an annual dividend yield of 2.02%.

 

Even with that, says Greene, Yum's cash flow should comfortably exceed the spending on dividends and capital projects and still allow the company to continue buying back its own shares.

 

In the fiercely competitive global quick-service restaurant business, Yum stands out as one of the fundamentally strong -- but very undervalued -- stocks.


marcial


Gene Marcial wrote the column "Inside Wall Street" for Business Week for 28 years and now writes for MSN Money's Top Stocks. He also wrote the book "Seven Commandments of Stock Investing," published by FT Press.

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