Franchising Is The Key To Yum Brands Success

  • Yum Brands will spin-out its China operation later this year.
  • Both sides of the company will focus exclusively on franchising.
  • The dividend looks safe, but investors will have a decision to make after the split.

Yum Brands stock had nearly doubled on the strength of China during the decade. Yum Brands (NYSE:YUM) Pizza Hut, KFC and Taco Bell restaurants expanded rapidly throughout China, and the profits sent the Yum Brands stock up 168% from the start of the decade through the middle of 2015.

But as the China story began to unravel, helped along by a 2014 food safety scandal that still impacts the results, the company made a big decision. Most analysis of its decision focused on the fact that Yum China will become a separate company after the spin-off later this year.
YUM stock chart

Source: Yum Brands Stock Price Data by

But if you are thinking of buying Yum Brands stock now, you should evaluate it based on a different criteria, namely that both sides of the company are becoming purely franchised operations.

Running a franchise is different from running a chain. Less of the gross revenue comes to the company, but more of the profit does. Essentially both Yums will now operate more like McDonalds (NYSE:MCD), but with a focus on growth. As franchisors, both sides of the company have ambitious growth goals. Yum itself plans to open 2,000 new outlets each year. Yum China plans to open 700 outlets per year, bringing the Taco Bell concept to that country for the first time.

Over time, Yum plans to become a “pure play” franchisor, with 95% of the stores owned by other people. The hope is that both companies can deliver sales growth of 15% per year.  And as the split approaches late this year the company plans to return $6.2 billion to shareholders, $1 billion in the form of stock buybacks.

However, Yum Brands decision to buy back its stock has resulted in a rating downgrade for it's bonds. Standard and Poor (S&P) recently downgraded Yum Brands bonds to junk status from 'BBB'. The three notch reduction was based on the fear that stock buy back will increase its leverage. S&P stated that Yum Brands leverage of 5X puts it in "highly leveraged" category. However, the rating agency continues to remain bullish on Yum Brands business profile.

These decisions have kept Yum Brands stock less volatile than one would expect, given what is happening in the Chinese stock market. Over the last month Yum Brands stock has lost just 10% of its value, in line with the general market correction, despite losing Chairman David Novak to retirement. Vetr, which does its ratings based on how crowds of small investors feel about a company, now gives the stock four stars, with 85% of its investors feeling bullish about the company.

If you buy Yum Brands stock now, you are going to get a yield of 2.66%, based on the 46 cent/share dividend it gave in October, raising it from 41 cents. During 2015 that dividend was well-covered by earnings. The next earnings release is due on February 3. You will experience some volatility based on China, and you will need to make a decision on whether to hold that part of the company after the split, but most of your small investor peers think you will do well here.

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  • I am not an investment advisor, and my opinion should not be treated as investment advice.
  • I am not being compensated for this post (except possibly by Amigobulls).
  • I do not have any business relationship with the companies mentioned in this post.
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