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China Will Power Yum! Brands, Inc. Growth


This fast food company is becoming a global powerhouse, with China its clear primary target

Yum! Brands, Inc. (NYSE:YUM) is the parent company behind KFC, Pizza Hut, and Taco Bell. The company has 39,000 restaurants in more than 130 countries. Yum's poster child is KFC, which operates in 120 countries and represents 65% of the company's total restaurants.

Of the $13.5 billion of revenue generated in 2012, 51% came from China, compared to just 25% from the US. As emerging market countries mature, so too will their burgeoning middle classes, much like the US during the 1950s. This wealth effect should dramatically bolster the global consumer base.

Yum operates more than 4,250 KFCs and 850 Pizza Huts in 700 Chinese cities. The company controls 39% of the Chinese fast food industry. Still, the opportunity in China remains huge, and in the early stages of growth as well.

The expansion in China taught the company how to adapt products to local markets, aggressively boost location presence, and give decision-making power to local managers. Yum will leverage that experience to expand in other markets where restaurant penetration rates are lower, but potential profit gains are high.

As a result of this, capital spending has become increasingly directed toward new markets in Africa, Russia, Germany, France, and most especially India.

An explosion of growth is being planned in India, with 500 KFC restaurants expected by 2015. Overall, Yum's activities in India are expected to bring an additional $100 million in annual profit by 2015, as the established store count doubles from 590.

International sales are critical to Yum's success, as the US is saturated with an abundance of fast food options. Moreover, the population isn't that large, representing merely 5% of the planet. A growing middle class abroad should also boost international returns.

But the US region provides much needed financial stability, and US profits can finance international expansion. Additionally, Taco Bell is much more popular in America versus the rest of the world. The long-term goal is for Taco Bell to go from about 5,000 to 8,000 units, and Pizza Hut to expand from 6,000 to 8,000 units in the US.

Despite the strong global presence, annual sales grew at only a 9% pace. However, this soft growth rate is mostly attributable to a food scare in China and a reality check in the US, where consumers face high unemployment, lower pay, and higher gas prices.

We believe the troubles in China are behind the company, while the resilience of the US consumer will shine through the rest of the year.
Net income increased to $1.6 billion from $1.3 billion in 2011, while EPS increased to $3.25 from $2.87. Management targets 10% annual profit growth, and has surpassed their goal by exceeding 13% for 11 consecutive years.

Most importantly, Yum remains committed to investors. The company is known for repurchasing its shares and increasing its dividend. The dividend has increased at a double-digit rate during the past eight years. The company has a target annual payout ratio of 35% of net income.

Analysts expect the stock to earn $3.06 per share this year and $3.75 next year. The shares currently trade at 23 times EPS and 18 times forward EPS. While that multiple seems high, its peer group trades at 21.5 times earnings.

Also, investors are likely going to pay a premium for Yum because of its international growth potential. And that premium should be at least 20 times forward EPS, or $75. While it may be advisable to wait to enter the shares below $65, anyone that enters before such a pullback will be able to collect a 1.9% annual dividend in return.

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Editor's Note: This article was written by Tyler Laundon.

Twitter: @TopProsTopPicks
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No positions in stocks mentioned.
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