Yum! Brands (YUM) continues to transform its business through refranchising, and has raised its percentage of franchised restaurants to 98%, explains John Staszak, equity analyst with Argus Research.
Yum! owns three of the most popular fast-food brands in the world: KFC, Pizza Hut and Taco Bell. The company and its franchisees operate more than 48,000 restaurants in 125 countries and territories.
The company is a leader in multibranding, offering combinations of its KFC, Taco Bell and Pizza Hut brands at single locations. It recently spun off its China business into a separately traded company. The company plans to lower capital spending to $100 million annually in 2019 from $422 million in 2016, and to reduce annual G&A expense by $300 million.
In February, Yum reported 4Q18 operating EPS of $0.40, down from $0.96 in the prior-year period and $0.57 below the consensus forecast. The decline reflects a large mark-to-market loss on the company’s investment in GrubHub (GRUB). Excluding the GRUB write-down, earnings were $0.81 per share.
Lower earnings were also driven by higher G&A costs and an increase in the tax rate. Overall revenue decreased 1%, to $1.57 billion, below the consensus estimate of $1.59 billion, while comp sales rose 3%. We had projected a 2.8% comp gain and the consensus had called for a 2.5% increase.
Management is targeting 2019 EPS of $3.75 and believes that it can deliver average annual returns of 15% over the next two years. We expect the company to reach these goals through refranchising and cost-cutting, and look for at least mid-teens EPS growth in 2019 and 2020.
GrubHub has teamed up with Yum! to be the exclusive delivery service for KFC and Taco Bell. Yum purchased $200 million of GrubHub stock and the president of Pizza Hut has joined the GrubHub board.
Management has hired consultants to identify ways to reduce delivery time and increase digital transactions at Pizza Hut restaurants. In addition, under a recent agreement with Pizza Hut franchisees, the company plans to invest in new restaurant equipment and remodeling in return for greater marketing control.
Management also believes that it has an opportunity to increase KFC deliveries. Approximately 5,000 KFC restaurants currently deliver orders. Management is also seeking to increase the number of Taco Bell restaurants that deliver meals.
Including the dividend, YUM shares returned 14% in 2018, nearly meeting the company’s two-year target of 15% total returns in a year in which the S&P 500 lost more than 6%. The shares are trading at 23.7-times our revised 2019 forecast, compared to a five-year average of 25.0. We believe this multiple is inadequate given our expectations for mid-teens earnings growth in 2019 and 2020.
We also think the recent investment and marketing agreement with franchisees could lead to stronger results at Pizza Hut. As such, we are maintaining our "buy" rating and raising our target price to $116 from $104. At current prices, our target, if achieved, offers investors the prospect of a 20% total return.
