Yum! Brands Inc. (YUM) reported first quarter 2011 adjusted earnings of 63 cents per share, which fell short of the Zacks Consensus Estimate by a penny. Earnings increased 7% year over year mainly on the back of strong performance at its China division. On a reported basis, Yum! Brands’ quarterly earnings were 54 cents per share, up 10% year over year.
The company reported a 3% year-over-year increase in total revenue to $ 2,425 million which handily beat the Zacks Consensus Estimate of $ 2,379 million. Sales growth was fueled by a 28% increase in the China division, partly offset by 9% and 5% declines in the U.S and Yum! Restaurants International (YRI) division, respectively.
Behind The Headline Numbers
Comparable-restaurant sales (comps) improved 13% in mainland China. Comps slipped 1% in the U.S. due to a 3% decline at Pizza Hut, partially compensated by a modest 1% increase at KFC and flat sales at Taco Bell. However, YRI division witnessed a 2% rise in comps.
In the quarter under review, Yum! Brands saw a decline in its overall cost structure. Company-restaurant costs and general and administrative (G&A) expenses fell 2% and 4%, respectively. China was unable to reduce its cost structure. However, these were partially made up by cuts of 10% and 8% in overall expenses at YRI and U.S. divisions, respectively.
Consolidated operating profit grew 10% year over year. Two geographic segments, China (up 22%; and up 18% excluding foreign currency translation) and YRI (up 12%; and up 8% excluding foreign currency translation) divisions contributed to the growth, dampened somewhat by U.S. (down 13%).
Taco Bell at U.S. suffered in the quarter from the negative publicity due to the lawsuit related to the content and quality of its beef products. Taco Bell kicked off the quarter with a strong sales momentum and saw a 4% rise in comps initially.
Since the filing of the lawsuit, Yum! noticed a trend reversal in Taco sales, which declined 2%. Anyway, on April 18, Alabama-based Beasley Allen law firm, which filed the case in a California court on behalf of a Taco Bell customer, voluntarily withdrew the allegation.
Weak performance was noticed at Pizza Hut UK and KFC Australia in the YRI division. Foreign currency influenced this quarter with operating profits at China and YRI divisions being positively impacted by $ 7 and $ 5 million, respectively.
As expected, restaurant margin slipped 1.5 percentage points in China due to wage and commodity inflation as well as the imposition of a new business tax, effective December 2010. Restaurant margin dipped 1.6 percentage points at the U.S. segment while at YRI it was up 1.4 percentage points attributable to strong performances in Thailand, France and KFC UK. Commodity inflation, a decline in comps and the impact of a value-oriented menu mix shift hurt results at U.S. segment.
Unit Growth
Robust performance in the China division during the quarter was primarily driven by the large number of new unit growth. The company has strengthened its position in China by adding as many as 92 new restaurants during the first quarter. Further, Yum! Brands solidified its footprint internationally by opening 131 new units, the majority by franchisees.
Financials
At the quarter end, Yum! Brands had cash and cash equivalents of $ 1,529 million with long-term debt of $ 2,918 million and shareholder equity of $ 1,859 million.
Guidance
Management expects Chinese commodity costs to scale up to 7% year over year in 2011.
Our Take
The Chinese division of Yum! offers significant prospects with its two leading brands KFC and Pizza Hut. Recently, the company also announced its intention to sell two of its brands –– Long John Silver’s and A&W –– so as to focus on the expansion of the remaining three brands KFC, Pizza Hut and Taco Bell in the U.S, China and other international markets. Management does not expect the sale of its two chains to materially impact its earnings or cash flow.
However, the most crucial headwind the company will face is higher commodity inflation worldwide. Additionally, near-term pressure on Taco Bell, which has a 52% U.S. market share in Mexican quick service restaurant sales, still remains a concern.
Already poor sales in-early April will prove to be challenging for Taco Bell in the second quarter. Management at Taco Bell has plans to launch a national ad campaign to assert that it has not changed any of its products and woo back customers.
Stiff competition from other quick-service restaurant operators also remained an overhang. Yum! Brand currently retains a Zacks #3 Rank (short-term Hold recommendation). We also reiterate our long-term Neutral rating. Yum! Brand’s close competitor McDonald’s Corp. (MCD) is slated to report its first quarter 2011 earnings today before the closing bell.
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