(By R.Chandrasekaran) More than ten days have passed since the chain of restaurant operator Yum Brands
) announced that its second quarter earnings failed to meet Street expectations. However, investors wonder whether improved U.S. performance can offset the sluggishness in China or will the company's opening of more stores in the second half allow it to come back with flying colors.
A look at the first half results indicates that the U.S. division's revenue of Pizza Hut operator represented 27.4 percent, whereas China's and International contributions represent 46.9 percent and 25.0 percent respectively. There was no doubt that China's weakness prevailed over the company's Q2 results; although, improving U.S. operations played a major role in the company's first half show.
Yum improved its operations not only in services in the U.S. but the quality of food too. This is possibly due to the various launches such as Doritos Locos Tacos and Cantina Bell, which contains high quality ingredients like whole black beans and cilantro. This is expected to widen the brand appeal among the affluent consumers. The company might also stand to gain from its value appeal since consumers are more budget conscious during tough economic times.
While the U.S. division's performance will lift the overall growth of the company, China's performance is crucial. Revenue advanced about 33 percent from Chinese operations during the first half and International segment added 6.5 percent revenues, but the U.S. contributed 6.8 percent fewer revenues due to store closure or re-franchising.
The driving force for China in 2012 is going to be opening more stores. Yum opened 160 new restaurants in Q2 to take the total to 4,150 at the close of the first half. Despite economic weakness, same store sales from China recorded 10 percent upside. The company earmarked adding 700 restaurants in 2012 and the first quarter witnessed the opening of 168 new restaurants. This indicates that about 372 restaurants will be added during the second half.
China is a big market and opening of more restaurants could lead to long term growth prospects. Currently, there are approximately 300 million potential consumers in China, and is predicted to double in the next 8-9 years on population growth. Interestingly, S&P Capital IQ Equity Research Analyst Jim Yin viewed in a research note, "We believe most of the slowdown is concentrated in Tier 1 cities, the most populous and wealthiest ones, while the slowdown is less pronounced in lower-tiered cities. Unlike its nearest peer, McDonald's, which built most of its China restaurant locations in Tier 1 and 2 cities, YUM has expanded throughout the country. YUM had same-store sales growth of 10% in the second quarter, compared to 2.2% for McDonald's."
Yum's EPS growth for 2012 is also estimated to be above its closest rival McDonalds
). S&P Capital IQ sees operating EPS of $3.22 and revenues of $14.03 billion for 2012. While the EPS is lower than Street predictions of $3.60, revenues estimation is above consensus' expectations of $13.89 billion. Yet, the EPS growth of 12 percent is higher than the estimation for McDonald's EPS upside of merely 1.3 percent for 2012.
S&P Capital IQ's EPS projection on Yum seems to have taken the margins pressure being faced in China following wage increase and commodity inflation. Importantly, Yum had reaffirmed its EPS growth outlook of 12 percent or $3.22 for 2012.
Meanwhile, S&P had raised its rating on Yum Brands to Buy from Hold on valuation with a 12-month price target of $76.00. The stock closed Monday's trading at $66.40.