Recommendation: Buy December 12 th , 2012 Yum! Brands, Inc. (NYSE: YUM) Consumer Discretionary Company Overview: Yum! Brand, Inc, in terms of system units, boasts to be one of the largest in the world. With its 38,000 restaurants in 120 countries, it beats McDonalds by approximately 4000 restaurants. Strategically, it has focused its attention on China with great success and its revenue in China has grown at a compounded rate of 27% for the last 5 years. Stock Performance Highlights: 52 week high: 74.75 52 week low: 57.09 Beta: 0.49 Average Daily Volume : 3.83 Million Shares Highlights: Market Cap 30.23 OS Shares 451.81 Million Book Value per share 4.86 P/E Ratio 19.68 Dividend Yield 2.00% Current Price: 66.92 Target Price: 88.7 Yummy? • The buy recommendation for YUM is due to the company’s consistent growth, its service diversification, and its presence overseas. Its largest presence is in China, and YUM has strategically assimilated itself into their food culture. • Same store sales have been increasing yearly at a double digit rate in China. China’s 1.3 billion populations, with a middle class citizen equivalent to the US population, will ensure that this will be kept up for the coming years 10 . • What makes Yum a bigger buy is that their dividend and earnings grew consistently even through financial downturns. Thus greatly shows how well managed the company is. whats
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Recommendation: Buy
December 12th, 2012
Yum! Brands, Inc. (NYSE: YUM) Consumer Discretionary
Company Overview: Yum! Brand, Inc, in terms of system units, boasts to be one of the largest in the world. With its 38,000 restaurants in 120 countries, it beats McDonalds by approximately 4000 restaurants. Strategically, it has focused its attention on China with great success and its revenue in China has grown at a compounded rate of 27% for the last 5 years.
Stock Performance Highlights: 52 week high: 74.75 52 week low: 57.09 Beta: 0.49 Average Daily Volume : 3.83 Million Shares Highlights: Market Cap 30.23 OS Shares 451.81 Million Book Value per share 4.86 P/E Ratio 19.68 Dividend Yield 2.00%
Current Price: 66.92 Target Price: 88.7
Yummy? • The buy recommendation for YUM
is due to the company’s consistent growth, its service diversification, and its presence overseas. Its largest presence is in China, and YUM has strategically assimilated itself into their food culture.
• Same store sales have been increasing yearly at a double digit rate in China. China’s 1.3 billion populations, with a middle class citizen equivalent to the US population, will ensure that this will be kept up for the coming years10.
• What makes Yum a bigger buy is that their dividend and earnings grew consistently even through financial downturns. Thus greatly shows how well managed the company is.
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Economic Outlook As we are moving off to 2013, Yum will become more reliant on China’s future economy growth. The industry’s economic outlook for the next two years in China is looking strong and positive. America also have positive outlook for the next two years, and its consumers are showing signs of recovery from its economic indicators and GDP growth. Overall economic data in China and America is showing a promising future for both economies. Real GDP: The RGDP is one of the most widely used indicators to determine the general health of a country’s economy. RGDP is important to the investors and the discretionary sector because its growth is positively correlated to consumer’s income and willingness to spend on nonessentials products. USA’s GDP has shown signs of recovery ever since the financial crisis in 2008. It shows recovery and its 2012 RGDP will be the third straight year with positive growth. It is estimated that in 2013 and 2014, the annual growth would be 2.4% and 2.8% respectively1.
China’s GDP has been growing at a rate of 10.5% for the past 5 years. Their 2012 first to third quarter GDP growth is already at 5.4% when their annual growth is expected to be at 7.7%. It is estimated that their 2013 and 2014 GDP growth will be 8.6% and 8.4% respectively. By consistently having the RGDP growth rate up, China will also be able to keep the disposable income, employment, and consumer confidence up. Consumer Disposable Income: A growing household disposable income per capital is defined as the income that households can utilize after tax. It is very vital to restaurants, because consumers with thicker wallets will be more willing to eat out.
Disposable income in China has been growing at an average ate of 16% for the past five years. In America, the 2008 financial crisis has done little to deter the growth of household income. Disposable income only decreased by a total of -‐1.18% in 2009 and it has been increasing at a rate of 2.97% for the past five years2. In 2011, disposable income has the highest growth for the past 3 years for both USA and China3. -‐5.0%
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Unemployment: Unemployment is another economic indicator that looks into the health of the economy. A high unemployment rate would be detrimental to the discretionary sector, because consumer would be discouraged from spending on nonessentials. There seems to be a misconception that unemployment and financial downturns will work favorably for Yum due to it providing an inferior good.
In America, annual average unemployment rate spiked from 5.5% to 9% in 2008 to 2009, but same store sales dropped by 5%. Unemployment did not help increase sales, but it does imply that fast food restaurants have a more inelastic demand. As of now, unemployment rate has greatly declined from the peak of 10% in 2009 to a 7.9%2. China’s Unemployment rate has risen from a 4.2% in 2007 to a current rate of 6.5%. This unemployment doesn’t seem to be correlating much with Yum’s earnings, because from 2007 to 2011, their revenue increased by a total of 164%3.
Consumer Confidence Index: The consumer confidence index reflects how the average consumers are viewing the economy. The more confidence, the more likely consumers expenditure would rise.
America’s consumer confidence has hit rock bottom in 2009, but as of current month, it has climbed to a 3 year high of 73.7. This shows that the economic data matches up with the general sentiment of the population. General households are feeling more secure about their total family incomes for the next six months, which encourage them to spend instead of save4. Consumers in China are also having high expectations of the economy. November’s rate reached the highest in 2012 of 106.1, showing that consumers still are confident about the source of their income and thus is more likely to keep their spending up. For the last twelve months, the average was 101.455. Currency Exchange: Foreign exchange plays an influential role in YUM’s net income. Profits will always be converted into USD. A weakening USD against a strengthening foreign currency will be favorable to the net income and revenue of YUM.
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China’s currency has been declining since 2005 in which international diplomats has been pressuring China for being a currency manipulator. Due to international pressure, the Yuan has grown 10% in value relative to the dollar since 2010. In the 3rd quarter of 2012, Yum received a favorable 2% increase in foreign currency conversion. As of now, the Obama administration has not yet labeled China as a currency manipulator, but the Treasury still thinks that the Yuan is still undervalued when compared to the dollar. Industry and Sector Analysis The Discretionary Food Sector America’s discretionary spending accounts for two-‐thirds of the US GDP. In 2011, Americans spent 48% of their total food expenditure per capita on dining out. There wasn’t much change from 2007 to 2011, since there was only a 0.134% growth in dining out spending in their total food expenditure. Americans have already set a consistent allocation of income on eating out6. In China, discretionary spending in 2010 only accounts for 33% of China’s annual household income. It has grown from the 24% from 2000. As of 2009, Chinese people spend 22% of their total food
expenditure per capita on dining out. It grew by a total of 4% ever since 20039. McKinsey’s model expects the dining out expense of households to grow at a rate of 10.2% for the next decade7. As of 2012 the middle class, or households who allocates 1/3 of their income in discretionary spending, has grown to be bigger than the population of USA. The increase percentage of dining out spending and the rising middle class will provide sustaining environment for the restaurant industry to grow in. Food Service Industry: Comparing to the US restaurant industry, China has a more hostile environment. In USA, the top 100 restaurants hold about 45% of the market share, but only 9% in China. Western food restaurants only account for 1% for the Chinese restaurant industry and only 8% of the total market shares are chain restaurants. Even with such small market share, chain restaurants are growing at faster pace than independent restaurants. From 2006 to 2009, chain restaurant’s revenue grew at an average rate of 21%, while independent restaurants only grew at average rate of 15.25%8. Company Specific Analysis Strategy: Directly from its annual report, Yum has 4 main strategies and judging from their current performance, they have been following through with their plan with efficiency.
Their main objective of “building leading x`brands in China in every significant category" is nothing short of success. As of November 29th, Yum has opened 800 restaurants in China alone. Operating profit grew by 15% in the 3rd quarter of 2012 and it also indicated a 16% growth in restaurant unit growth. Its second strategy of building strong brands by having an aggressive international expansion has a slow start, but they are still making a lot of progress. In the 3rd quarter of 2012, It had a net profit growth of 10% internationally, and also a same store sales growth of 2%. Also, India is now Yum’s second leading country for opening new restaurants. They opened 100 restaurants in 2011 and it is expected that another 100 will be opened by the end of 2012. Their third strategy is to tend to the home front of improving brands in the US while having consistent returns. Although total revenue in USA has been decreasing on an average of -‐9.7%, this is partly due to Yum’s plan of focusing on expansion and refranchising. Refranchising company restaurants will decrease their total revenue, but it will also decrease the G&A costs. Even with declining revenue, same store sales growth and operating profit growth for 2012 is expected to be 2% and 5% respectively. The fourth strategy is to help push the company into having a long-‐ term value for the shareholders and franchisees.
Yum has been consistent in creating financial value for their stockholders ever since it first paid out dividends. It has grown at a rate of 5.3% since the inception of dividends. The payout ratio of 2011 was 36.7% which is on track with the management’s goal of having a 35-‐40% payout ratio. Assimilating: On February 1st, 2012 Yum gained 93% ownership of Little Sheep. Little Sheep is a Chinese hotpot restaurant that Yum acquired for strategic reasons. It hopes to develop brands that will fit into China culturally. After the assimilation, it is expected that Little Sheep will increase the total revenue by 5%. Eastern Dawn is another brand that Yum is trying to develop into being one of the leading quick Chinese service restaurants. S.W.O.T Analysis Strength: One of Yum’s biggest advantages is its diversity and the flexibility in the quick service restaurant that it offers. It allows them to have expertise in different kinds of cuisines. Not only do they have western and Mexican food, but they are also slowly making a foothold in Asian cuisines. This allows them to have the option of focusing and expanding on the restaurant chains that works the best with the population thus making it easier for them to penetrate into foreign markets.
Weakness: Yum’s revenue and stores in America have been declining. From 2007 to 2011, Yum’s revenue and number of restaurants in USA declined by an average of 7.64% and 80.6 stores annually. Also, Yum has not been diversifying its revenue source. 70% of its revenue is from China, so it has become more and more reliant on the Chinese economy. Opportunity: Yum has grabbed the opportunity to expand its market share in the restaurant industry. With the top 100 owning only 1% of the total Chinese restaurant market share, there is still plenty of space for them to expand. Also, Yum will have plenty of places for Little Sheep to expand, since they only have approximately 450 restaurants in China. Threat: Yum faces the threat of other more established Chinese restaurants within China. With 5.9 other million restaurants to compete with, Yum will have to provide food that fits into the Chinese culture. In America, Yum also have to fight market shares and differentiate their products from similar restaurants, such as Del Taco, and Dominos. Also, Yum’s biggest threat is still McDonalds. In 2010, McDonald’s market share in the quick service restaurant industry was 12.70%, followed by Yum with 9.7% and Wendy’s/Arby’s at 6.6%.
Valuation Analysis Operating Margins: The margins of Yum were relatively consistent when divided against Sales. From 2007 to 2011, restaurant expense decreased by 2.1% and this was due to Yum expanding to China and having a lower payroll overseas. However, it is estimated that payroll will rise to a 22%, since the Chinese government have started to establish more labor laws. Revenue: The revenue in the future should stay strong and consistent, since it will take a long time for Yum to reach maturity or run out of customers in China. It is estimated that their revenue in China that they grows at a pace of 21% for the next 5 years. Their 2010-‐11 Sales YOY in China was 34% and 2009-‐10 was 21%. There objectives in the international market didn’t have as much impact on their revenue, even though they are now focusing in India. As of America, their revenue has been declining at a rate of 9.7% from 2007-‐11. During this time frame, there was only a 3% increase in the number of restaurants in America. Beta: The beta of 0.49 was determined by doing a regression analysis between the last 24 monthly price movements of Yum against the S&P500.
WACC: Two separate cost of debt were determined by dividing net interest by net debt and by finding the current yield on BBB non-‐callable bonds. The average of the two were taken and came out to be 4.48% Two separate cost of equity were determined by the Gordon growth model and the CAPM and they were 7.16% and 5.5% respectively. However, 7.16% was chosen to be more on the conservative side. After determining the weight, the WACC came out to be 6.68% Risk Free: The risk free rate was determined by using the 30-‐year Treasury Bond because they are essentially free of all business risks. DCF: The intrinsic value of $88.7 per share was found. This is 32.5% higher than the current stock price. The main reason for this optimistic outlook is because of their potential and current earning power in China. Even though they have an total annual growth of 5% and an average growth of 15% in China, a more conservative long-‐term growth of 2.5% was chosen for Yum.
References Cited: 1 GDP per Capita (current US$)." Data. World Bank, n.d. Web. 3 Dec. 2012 .<http://data.worldbank.org/indicator/NY.GDP.PCAP.CD> 2 "Databases, Tables & Calculators by Subject." U.S. Bureau of Labor Statistics. U.S. Bureau of Labor Statistics, n.d. Web. 15 Dec. 2012.: <http://www.bls.gov/data/#unemployment> 3 "National Bureau of Statistics of Chinaã��ã��Statistical Data." National Bureau of Statistics of Chinaã��ã��Statistical Data. N.p., n.d. Web. 3 Dec. 2012.<http://www.stats.gov.cn/english/statisticaldata/> 4"United States Consumer Confidence." United States Consumer Confidence. N.p., n.d. Web. 3 Dec. 2012. <http://www.tradingeconomics.com/united-‐states/consumer-‐confidence> 5"China Consumer Confidence." China Consumer Confidence. N.p., n.d. Web. 3 Dec. 2012. <http://www.tradingeconomics.com/china/consumer-‐confidence> 6 "USDA ERS -‐ Food Expenditures." USDA ERS -‐ Food Expenditures. N.p., n.d. Web. 3 Dec. 2012. <http://www.ers.usda.gov/data-‐products/food-‐expenditures.aspx#26636> 7McKinsey Research Report <http://www.mckinseychina.com/wp-‐content/uploads/2012/03/mckinsey-‐meet-‐the-‐2020-‐consumer.pdf> 8 Alix Partners Research Report <http://www.alixpartners.com/en/LinkClick.aspx?fileticket =pkSbIqKMcpI%3D&tabid=899> 9 Discretionary Sector and Food <http://www.fool.com/investing/general/2012/09/14/consumer -‐ discretionary-‐sector-‐101.aspx> 10Years, NEW YORK (CNNMoney) -‐-‐ As China's Economy Has Exploded over the Last 30. "China's Middle-‐class Boom." CNNMoney. Cable News Network, 26 June 2012. Web. 3 Dec. 2012. <http://money.cnn.com/2012/06/26/news/economy/china-‐middle-‐class/index.htm>
Financial Models Created with the help of: Benninga, Simon, and Oded H. Sarig. Corporate Finance: A Valuation Approach. New York: McGraw-‐Hill, 1997. Print. Rosenbaum, Joshua, and Joshua Pearl. Investment Banking: Valuation, Leveraged Buyouts, and Mergers & Acquisitions. Hoboken, NJ: John Wiley & Sons, 2009. Print.
debt -‐262 261 261 261 261 261 261 Repurchase shares of Common Stock -‐752 -‐1028 -‐1028 -‐1028 -‐1028 -‐1028 -‐1028 Excess tax benefit from share-‐based compensation 66 62.5 62.5 62.5 62.5 62.5 62.5 Employee stock option proceeds 59 91.5 91.5 91.5 91.5 91.5 91.5 Dividend paid on Common Stock -‐481 -‐501 -‐448 -‐494 -‐543 -‐602 -‐666 Other, net -‐43 -‐23 -‐23 -‐23 -‐23 -‐23 -‐23 Net Cash used in Financing Activities -‐1413 -‐1137 -‐1084 -‐1130 -‐1179 -‐1238 -‐1302
Cash and Cash Equivalents -‐ Beginning of Year 1426 1198 889 1078 1296 1608 1952 Cash and Cash Equivalents -‐ End of Year 1198 889 1078 1296 1608 1952 2387
WACC CAPM Risk Free Rate 2.79%
Risk Premium 5.44% Beta 0.497 Cost of Equity 5.50%
Current price 73.89 OS Shares 451,808,634
Total Debt 8,692,000,000
Equity 33,384,139,966
Total 42,076,139,966
Weight of Debt 20.66% Weight of Equity 79.34% Cost of Equity 7.16% Cost of Debt 4.84%