Menu Fatigue and Strong Dollar Weigh on Yum’s Sales

Taco Bell reports second consecutive quarter of sales slowdown

Source: Company's Website
Source: Company’s Website

Fast food giant YUM! Brands Inc. (NYSE: YUM) announced its Q2 FY16 financial results on July 13th, 2016. The Louisville, Kentucky-based company, through its subsidiaries, operates quick service restaurants. It operates in four segments: YUM China, the KFC Division, the Pizza Hut Division, and the Taco Bell Division. The Company operates, franchises, and licenses a system of restaurants, which prepare, package, and sell various food items. As of April 21st, 2016, it operated approximately 43,000 restaurants in 130 countries, primarily under the KFC, Pizza Hut, and Taco Bell brands, which specialize in chicken, pizza, and Mexican-style food categories. Worldwide, the Yum! Brands opens an average of over six new restaurants per day. Read more about YUM! Brands’ financial results below.

Q2 FY16 financial highlights

YUM! Brands’ Q2 FY16 overall net sales fell 3% to $3.01 billion, as the Company was hurt by a strengthening U.S. dollar. During the quarter under review, YUM! Brands reported flat same-store sales growth system-wide.

Y2

The sales break-up of each division is given below.

China Division: China is the largest division in terms of revenue, garnering $1.59 billion in Q2 FY16. During the quarter, system sales increased 3%, excluding foreign currency translation. The China Division’s same-store sales remained flat. On the bright side, China KFC restaurants, the majority of the 7,246 stores in the division, reported a 3% rise in same-store sales, offset by a decline of 11% at Pizza Hut Casual Dining. The China Division opened 72 new units during the quarter under review. Foreign currency translation negatively impacted operating profit by $7 million.

KFC Division: During Q2 FY16, system sales increased 6%, excluding foreign currency translation. The KFC Division opened 132 new international restaurants in 42 countries, including 90 units in emerging markets. About 88% of these new international units were opened by franchisees. The division’s operating margin inched up 0.5% driven by new-unit development. However, foreign currency translation negatively impacted operating profit by $9 million, as approximately 90% of the division profits are generated outside the U.S.

Pizza Hut Division: During Q2 FY16, system sales increased 1%, excluding foreign currency translation. The division opened 84 new international restaurants in 38 countries, including 45 units in emerging markets. About 94% of new international units were opened by franchisees. During the quarter under review, operating margins increased 3.3%, driven by reduced general and administrative expenses. Foreign currency translation negatively impacted operating profit by close to $1 million.

Taco Bell Division: During Q2 FY16, system sales increased 2%, driven by 3% unit growth. On the other hand, same-store sales at Taco Bell’s more than 6,400 U.S. restaurants fell 1% during the quarter, the second consecutive quarterly sales slowdown for Taco Bell. The division opened 48 new restaurants, of which 88% of these new units were opened by franchisees. Restaurant margins declined 0.6% to 22.3% owing to higher labor costs and store level investments, partially offset by favorable commodities pricing. Operating margins inched up 0.6% driven by new-unit development and reduced general and administrative expenses. For Taco Bell, the second straight quarter of sluggish sales reflects a broader industry slowdown, intense price competition from other burger companies, menu stagnation, and the continued popularity of McDonald’s Corp.’s (NYSE: MCD) all-day breakfast menu.

Overall, foreign currency translation dented operating profit to an extent of $16 million during Q2 FY16. Despite this impact, the Company delivered core operating profit growth of 7% during Q2 FY16. Q2 FY16 earnings, excluding one-time items, rose 9% from the prior year to $0.75 per share, while GAAP EPS came in slightly higher at $0.81.

Restaurant count

During Q2 FY16, YUM! Brands opened 373 new restaurants worldwide; 72% of international restaurant openings were in the emerging markets.

Separation of China unit

YUM! Brands remains on track to finalize the separation of its China business with a targeted completion date around October 31, 2016, aimed at creating two independent, focused growth companies. In October 2015, YUM! Brands had agreed to hive off its China business from its U.S. operations to better focus on the Asian markets.

The Company is looking to sell just 20% of its China unit, which includes 7,200 stores, and more of the unit’s shares through an IPO later this year in Hong Kong or New York. The entire China unit is valued between $8 billion-$11 billion. The divestment is part of the Company’s plan of gradually reducing exposure in a business with shrinking market share and move from owning restaurants towards pure franchising. According to CEO, Greg Creed, the Company plans to have at least 95% of its restaurants worldwide owned and operated by franchisees by the end of 2017.

Other highlights

During Q2 FY16, YUM! Brands incurred a charge of $10 million related to the planned separation of its China business and recapitalization, which was offset by refranchising gains of $53 million.

Share repurchase

Y3As of July 12th, 2016, YUM! Brands has repurchased 31.4 million shares amounting to $2.4 billion at an average price of $77. Since the announcement of its plans to hive off its China unit, YUM! Brands has repurchased approximately $3.3 billion worth of shares at an average price of $76, reducing its overall share count by 42.9 million shares. This is part of the Company’s plans to give back $6.2 billion of capital to shareholders before its China unit separation.

Forecast for FY16

Yum! Brands revised upwards its full-year operating profit growth forecast from 12% to at least 14% due to improved economic trends in China.

Stock Performance

Y4YUM! Brands’ stock stood at $85.74, inching up 0.57% at the close on Wednesday, July 13th, 2016, having vacillated between an intraday high of $86.26 and a low of $85.06 during the session. The stock’s trading volume was at 6,104,108 for the day. The Company’s market cap was at $35.67 billion as of Wednesday’s close.

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