The company could hit its financial goals in the second half of 2012 despite its recent profit decline
Though Yum! Brands Inc. recently acknowledged that China’s slowing economic growth led to the restaurant company’s rare decrease in quarterly operating profit for its China division, a securities analyst who met with Yum’s financial officials last week wrote in a research note that the company’s initiatives should produce a near-term rebound and continued growth over the long haul.
After meeting with Yum president Rick Carucci and chief financial officer Patrick Grismer, senior analyst for Bernstein Research, Sara Senatore, wrote that recovery for Yum China’s same-store sales and restaurant margins should be “very achievable” in the second half of 2012.
Louisville, Ky.-based Yum, the operator or franchisor of nearly 38,000 KFC, Pizza Hut and Taco Bell restaurants in 120 countries, said during its second-quarter earnings call that it would accelerate development in China to more than 700 restaurant openings in 2012. The division’s operating profit uncharacteristically fell 4 percent in the June 16-ended second quarter. Same-store sales rose 10 percent during the period.
Yum has 4,785 restaurants in China, comprising mostly KFC units and several hundred Pizza Hut Casual Dining units, as well as some outlets of Pizza Hut Home Service, East Dawning and Little Sheep.
Senatore noted that Yum’s strategy to raise prices gradually in China likely would keep consumer demand from falling precipitously, meaning the company should be able to hit its goals in the second half of 2012 for same-store sales and restaurant margin growth.
Yum’s restaurants in China have a total menu price increase of about 7 percent compared with a year earlier, she wrote. However, that effect will drop to between 4 percent and 5 percent in the fourth quarter, when Yum laps a menu price increase from late 2011.
“In the absence of a dramatic worsening of the demand environment, we therefore believe Yum should have little difficulty in meeting its targeted mid-single-digit [same-store sales targets],” Senatore wrote.
She added that Yum might be able to offset any declines in traffic with a shift in menu mix toward items with more favorable profit margins. Yum is set to lap last year’s launch of value menus in China with a “narrower value offering,” Senatore noted.
“As Yum China benefits from commodity deflation and lapping easy labor comparisons,” she wrote, “we believe the targeted ‘modest’ improvement in core margins is not a stretch.”
The company also would benefit from booming development in China’s interior, where Yum’s “first-mover” advantages of greater brand recognition over McDonald’s and Starbucks would allow it to snatch the best newly available real estate sites, Senatore noted.
“We believe Yum’s decision to increase its unit growth additions, first to 600 and then to 700 for 2012, reflects the rapid growth of city clusters under the auspices of the Chinese government’s development strategy,” she wrote. “We believe new-unit returns remain attractive — though, as is typically the case, they open at lower volumes and ramp up a maturity curve. … Going forward, we believe Yum has the capacity to identify and develop new sites, with site attractiveness and managerial talent the gating factors.”
She added that Yum officials reaffirmed their commitment to investing in operations improvements for China, “an area where the company has been less consistent relative to product development and marketing.” That effort should enhance store profitability over the long term, during which Yum would shift its growth capital even more toward China and other emerging global markets.
In addition to its 4,785 restaurants in China, Yum also operates or franchises more than 18,000 locations in the United States, nearly 500 units in India and more than 14,000 restaurants in its Yum Restaurants International division.