Yum! Brands Q2: China drives profit, promising US sales growth

In recent years Yum! Brands (YUM) has significantly increased its exposure in China, which has been the main driver of both revenue and profit growth. A slowdown in Chinese economic growth is one of the company’s main worries going forward, especially as Europe continues to be a drag.

Yum!’s home market showed signs of a comeback in the first quarter as the company reported 5 percent growth in same store sales. This is expected to be the range for the second quarter as well. However, for the second half of the year, China is expected to be the region which will bolster the company’s revenues. Investors should therefore keep a close eye on Chinese developments as the company expects it to count for 50 percent of profits for the full year.

As restaurants have seen Chipotle Mexican Grill (CMG) eating up market share in recent quarters with its offering of ‘healthier’ fast food, Yum is expanding its product range in the same direction under its Taco Bell brand. This product extension worked well in Q1 and will continue to support US growth, as will further 'healthier' additions to the menu.

Input prices and wage inflation will continue to be a threat within the industry, which could result in margins being squeezed. So far, Yum! has been able to avoid any drastic drop in margins. After a successful first quarter, analysts are expecting a net profit margin ranging from 10 to 11.4 percent this quarter.

With sales estimates ranging from USD 3,050 m to 3,160 m, analysts are expecting 8.5 to 12.5 percent revenue growth y-o-y this quarter.

During the last twenty quarters Yum! has only once reported earnings below street expectations. That was its Q1 earnings report last year. Last quarter, however, the company reported earnings which were 4.3 percent above expectations. We expect this quarter's earnings to be in line with expectations.

As can be seen in chart 2, analysts have not been active on revising this quarter’s EPS estimates in recent months. However, the stock's target price was revised upwards by 5 percent after the first quarter’s results. Analysts expect Yum! to have an upside potential of roughly 24 percent, as it trades at 18 times FY1 earnings. In comparison, some of its main competitors, McDonald’s (MCD), Chipotle Mexican Grill (CMG), Dunkin’ Brands Group (DNKN) and Starbucks (SBUX) trade at 16.4, 42.9, 28.4, and 28,3 times FY1 earnings respectively.

Yum! Brands will report its second quarter earnings on Wednesday, 18-07-2012.