The Chinese Say Yum Yum To KFC

October 8, 2007 at 10:05 pm  ·  Category: China, Stocks

For all of you geting swept up in the euphoria over all these speculative Chinese stocks, forget about it.  I have a better alternative for you: Yum! Brands (YUM) (website).

Yum is the operator of Taco Bell, Pizza Hut and KFC.  But the kicker is that they have a large and growing business in China that is driving the stock.  Yum! reported results after the close today and almost 25% of their revenue now comes from China (3Q Press Release).

And it’s growing quickly.  Same store sales in their China division increased by 11% from the year ago period.  Like I said: The Chinese love their KFC!

Yum!’s international business is strong too.  International sales make up about 30% of Yum’s overall revenue and international plus China makes up a bit more than 50%.  International same store sales grew by 7% – very strong.

The weakest part of their business is their lagging US division, dragged down by weak sales at Taco Bell after that e. coli breakout freaked everybody out a while back.  Same store sales increased by 1% and overall revenue was down 6%.

But their strategy is to sell company owned stores to franchisees in the US, cut costs, and focus on international and China where the real growth is and their business is firing on all cylinders.

*****

The stock has been on fire, up about 25% year to date, as many investors think of Yum as a great way to play China.  It was up almost 6% during regular trading today (Monday) and figures to get a nice pop at the open tomorrow on the back of its strong 3rd quarter announcement.  But once that blows off, the stock will likely see some profit taking as it will have had a huge move in a two day period.

At $37 it would trade for about 22 times this year’s expected earnings of $1.65 – not cheap.  But if you absolutely must play China this is a much smarter way to do it.  And if you can be patient, and it might require a bit of patience, a pullback to $31, around its 200 day moving average, would give Yum! a 19 forward P/E which I think represents a good entry point.

UPDATE (Tue 10/9, 8:15am PST): I was thinking last night about how to value YUM and I think a better way then thinking about an overall P/E ratio is to think about a P/E ratio on each of its segments (US, International, China) and then come up with an overall P/E that way.

For ex, let’s say the China business deserves a 30 multiple, International a 20 and US a 12 – to reflect their differing growth.

Then you look at expected operating income this year (2007):

US  $763 million

International  $438 million

China  $348 million

Give each of those their respective multiples:

US  $9156 million

International $9361

China $10440

So, essentially, each part of the business is worth about a third of the overall business.  So you give the overall business a weighted P/E: (12 + 20 + 30)/3 = 21.

So I think 21 is probably a fair P/E for the whole operation. 

When we use that on this year’s expected earnings of $1.65 we get $34.  But they also have about $3 net debt per share so again that gets us to $31.

When we use that multiple on next year’s earnings, say 11% growth to $1.83, we get $38 a share – $35 when we back out the net debt.

In this way YUM’s intrinsic value might be seen as around $33-$34.

Posted by Greg Feirman  ·  Trackback URL  ·  Link
 

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