Strategic spin-off an option for Yum! Brands?

by Monica Watrous
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Pizza Hut breadsticks crust
Time to pull the plug on Pizza Hut?

LOUISVILLE, KY. — Yum! Brands, Inc. saw its share price tumble nearly 19 percent on Oct. 7 after the parent company of Taco Bell, Pizza Hut and KFC released another dismal quarterly earnings report and lowered its full-year earnings growth target from double digits to low single digits. Foreign currency headwinds and a slower-than-expected recovery in China following a food safety scare last year led to the disappointing performance, prompting speculation Yum! may reconsider its current corporate structure.

Greg Creed

“The fact is we have a great collection of businesses, and they have produced excellent results over the long term,” said Greg Creed, chief executive officer, during an Oct. 7 earnings call with financial analysts. “As I’ve said before, the Yum! board of directors regularly reviews strategic options to optimize long-term shareholder value, including those involving our corporate structure. We are not going to comment today on any strategic options with our company.”

For the third quarter ended Sept. 5, Yum! had net income of $421 million, equal to 97c per share on the common stock, up 4 percent from $404 million, or 91c per share, for the prior-year period. Excluding special items, earnings per share grew 14 percent for the quarter, the company said. Total revenues advanced 2 percent to $3,427 million from year-ago revenues of $3,354 million.

“Delivering 14 percent e.p.s. growth in today’s environment would normally be considered a very good result,” Creed noted. “But these are not normal times, and our performance is anything but satisfactory.”

Taco Bell breakfast burrito
Taco Bell remains the bright spot in Yum! Brands' portfolio.

The bright spot in Yum!’s portfolio is Taco Bell, which drove a 7 percent increase in system sales during the quarter, driven by a strong combination of value and innovation.

“We have to get that in all five divisions,” Creed said. “When we get that in all five divisions, then we will obviously earn the right to have the share price that we believe this business deserves…. Having said that, we are always open to looking at alternatives.”

Asked whether such an alternative may be an exit from the China market, where macroeconomic challenges and foreign currency pressures, along with marketing missteps on Yum!’s part, have been stifling sales growth, Creed made his stance clear.

“We are always going to believe in China, and we are always going to participate in its growth,” he said, citing the recent appointment of Micky Pant, a longtime executive of Yum!, as CEO of the China division. “We’ve got a new leader. He is bringing massive action to bear, which is great, because he ran the global KFC and Pizza Hut businesses in his prior job. He knows what works. He knows what’s resonating with customers. He knows how to adapt certain tastes to local tastes. And that guy is doing everything he can do.”

During the quarter, China division operating profit advanced 62 percent to $327 million, and system sales rose 7 percent, driven by a 2 percent increase in same-store sales and the addition of 108 new units in the quarter.

“And while there is clearly a macro softening going on, including headwinds from unexpected foreign exchange pressures and, yes, the on-line ordering aggregators who are delivering for mom-and-pops are in a death battle for supremacy with heavy discounting, and the malls look more like fancy food courts than shopping centers, the simple facts are that the economy there is still growing, and there is every reason and no excuses for why we should not perform better,” Creed said.

The KFC division’s operating profit fell 11% to $150 million, and system sales fell 6 percent, reflecting the negative impact of foreign currency translation. Excluding foreign exchange, profit was up 3 percent and system sales climbed 6 percent.

“While KFC in the U.S. is still a small component of the global brand, it continued its steady progress with transactions plus 4 percent to the category, as the innovation pipeline is now starting to be a force,” Creed said.

The Pizza Hut division’s operating profit fell 3 percent to $67 million, and system sales dropped 3 percent. Excluding foreign exchange, profit was even with the prior year and system sales rose 2 percent.

“Pizza Hut was relatively flat, which we could argue was pretty much in line with expectations,”  Creed said. “But let’s be honest. We are still significantly lagging the performance of our nearest competitors, and we clearly have much urgent work to do for this brand to fulfill its potential.”

Taco Bell division operating profit advanced 6 percent to $132 million, and system sales increased 7 percent, driven by 4 percent same-store sales growth and the opening of 62 new restaurants.

“Year-to-date, this is double the number of new units from last year, and margins are now over 21 percent,” Creed said. “This brand is doing all the right things in all the right places.”

The India division posted an operating loss of $8 million, which compared with an operating loss of $3 million in the prior year, and a 9 percent decline in system sales prior to foreign currency translation, reflecting 10% unit growth offset by an 18 percent same-store sales decline.
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