Yum! Brands Inc. (YUM) reported second quarter 2011 adjusted earnings of 66 cents per share, which beat the Zacks Consensus Estimate by a nickel. Earnings increased 13% year over year mainly on the back of strong performance at its China division and other emerging markets as well as a lower tax rate. On a reported basis, Yum! Brands’ quarterly earnings were 65 cents per share, up 10% year over year.
The company reported a 9% year-over-year increase in total revenue to $2,816 million. Sales growth was a respective 33% and 9% in China and Yum! Restaurants International (YRI) division, partly offset by an 11% decline in the U.S division.
Behind The Headline Numbers
Comparable-restaurant sales (comps) improved 18% in mainland China. YRI division witnessed a 2% rise in comps. However, comps slipped 4% in the U.S. due to declines of 5% at Taco Bell, 2% at Pizza Hut and 5% at KFC.
In the quarter under review, Yum! Brands saw a spike in its overall cost structure. Company-restaurant costs and general and administrative (G&A) expenses increased 10% and 8%, respectively. China and the YRI division were unable to reduce their cost structures. However, these were partially made up by a respective 9% and 7% cut in company-restaurant costs and G&A expenses at the U.S. division.
Consolidated operating profit dipped 0.5% year over year. Performance in the U.S. division (down 28%) took a toll. However, two geographic segments, China (up 31%; and up 25% excluding foreign currency translation) and YRI (up 19%; and up 11% excluding foreign currency translation) contributed to the growth. Operating profits at China and YRI divisions saw positive foreign currency influences of $9 million and $10 million, respectively.
Taco Bell, which accounts for around 60% of the total U.S. revenues, suffered in the quarter from the negative publicity due to the lawsuit related to the content and quality of its beef products. Although, Alabama-based Beasley Allen law firm, which filed the case in a California court on behalf of a Taco Bell customer, voluntarily dismissed the allegation in April, the negative perception among consumers about the brand lingered.
Weak performance was noticed at Pizza Hut U.K. in the YRI division, which was more than made up by solid show at Thailand and France. Japan was a dampener due to the earthquake and tsunami. Excluding China and Japan, Asia system sales grew 6% in the quarter.
As expected, restaurant margin slipped 0.5 percentage points in China due to wage and commodity inflation. Restaurant margin dipped 4.4 percentage points at the U.S. segment while it upped 2.0 percentage points at YRI. Commodity inflation, a decline in comps and underperformance at Taco Bell hurt results at the U.S. segment.
Unit Growth
Robust performance in the China division during the quarter was primarily driven by 99 new openings. Further, Yum! Brands solidified its footprint internationally by opening 142 new units, the majority by franchisees. Yum! Brands remains on track to open 1,400 new units outside the U.S. this year.
Financials
At quarter end, Yum! Brands had cash and cash equivalents of $955 million with long-term debt of $3,269 million, and shareholder equity of $1,888 million.
Guidance
Management expects Chinese commodity cost to scale up to 9% year over year in 2011 and U.S. food inflation to crawl up to 7% year over year. However, full-year earnings per share growth target increased to at least 12%.
Our Take
We still see China as playing the major role in Yum! Brands’ growth story. However, commodity inflation could continue to play foul worldwide. The YRI division is comparatively immune to inflation as the majority of operations are franchised. Yum! Brands’ performance in the U.S. will depend on the extent to which Taco Bell rebounds.
Stiff competition from other quick-service restaurant operators also remained an overhang. Yum! Brands currently retains a Zacks Rank #3 (short-term Hold recommendation). We also reiterate our long-term Neutral rating. Yum! Brands’ close competitor McDonald’s Corp. (MCD) is slated to report its second 2011 earnings on July 22, before the closing bell.
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