Highlights From YUM's Q2 Conference Call: Continued Overseas Growth

July 14, 2011 11:25 AM EDT
Yum! Brands, Inc. (NYSE: YUM) reported Q2 EPS of $0.66, $0.05 better than the analyst estimate of $0.61. Revenue for the quarter came in at $2.82 billion versus the consensus estimate of $2.7 billion.

Highlights From YUM's Q2 Conference Call:

  • (David C. Novak) I'm pleased to report we raised our full-year EPS growth forecast to at least 12% from our initial guidance of at least 10%. We take satisfaction that 2011 will mark our tenth consecutive year of double-digit EPS growth...Year-to-date U.S. results have taken some of the luster away from what otherwise would be a great year.
  • Through the first half of this year, nearly 75% of our operating profit has come from China and Yum! restaurants international. Our development pipe line is as strong as ever and we continue to expect about 1,400 new units outside of the United States this year.
  • Operating profit grew 25%, prior to foreign currency translation benefit same-store sales jumped an impressive 18%. Combined with the 13% increase in units, system sales grew 28% for the quarter. Same store transactions increased 21%.
  • Our KFC China business is on a roll. Same-store sales grew 17% in the quarter and we continue to make good progress growing average unit volumes with 24-hour operations, delivery service and building a solid breakfast business. We have breakfast in nearly all of our KFCs in China, generating 13% of total transactions. We have delivery service in 1,600 restaurants and 24-hour operations now in over 1,300 units.
  • Importantly, we continue to aggressively expand our KFC brand and we've opened 157 units in the first half of this year. We now have nearly 3,400 KFC's in China and we're growing more than twice as fast as our nearest competitor.
  • Pizza Hut casual dining in China is absolutely on fire We had another fantastic quarter delivering 22% same store sales growth. This marks our sixth consecutive quarter of double-digit same-store growth at Pizza Hut casual dining. Leveraging an expanding variety platform and semiannual refresh, we continue to drive results. We have 544 restaurants in over 140 cities and we've opened 17 new locations in the second quarter.
  • We also continue to make progress developing our emerging brands. Pizza Hut home service now has 121 units in 11 stays and generating steady margin improvement. East awning, our Chinese fast food brand has 21 units in 4 cities and continues to improve unit economics with the goal of developing into a successful national brand. In summary, our China business continue's to be the top growth story.
  • Young restaurants had strong growth with system growth of 6% and operating profit growth of 11% prior to the benefit of foreign currency translation. Same store sales increased 2% and restaurant margin improved two full percentage points. New unit development is a key driver of growth for this business and continued with 142 new units this quarter. Nearly 90% of these units were open bid our strong network of franchisees and we expect to open about 900 units at Yum! Restaurants International for the full year.
  • We intend to make a lot of money in France. With over 700 units, our KFC business in the UK has been one of our most consistent performance in Yum! restaurants international. We have put together 21 consecutive quarters of same-store sales growth with solid operations, new product innovation and vibrant assets. The KFC team was also recently recognized as one of the top 50 places to work in the UK.
  • We're pleased with the progress we're making with same-store sales growth and restaurant margins. Longer term, we expect our category-leading position in emerging markets to fuel continued strong growth. I'll be visiting Russia and Germany in the next couple of months and I look forward to giving you an update on these two exciting opportunities as well.
  • (Richard T. Carucci, Chief Financial Officer) Our second quarter was still a tale of two cities only amplified. As David described, we had simply outstanding results in China while U.S. performance was poor. Yum! restaurants international performance was solid and we also benefited from a lower tax rate than last year. When you add it all up, EPS growth totaled 13% excluding special items. China produced simply an outstanding quarter with 25% operating profit growth fueled prior to foreign currency translation.
  • System sales increased an impressive 28% driven by new unit development of 13% and same-store sales growth of 18%.
  • Overall, restaurant margins improved by two full percentage points are now 12.7%. Margins benefited from the strong performance in France and Thailand. Additionally, the portfolio actions we took last year including the refranchising of our Mexico business and the acquisition of our Russian business also benefited margins.
  • While we previously communicated the second quarter would be challenging and the low point of the year for our U.S. business, believe me, a 28% decline in operating profit is still disappointing. Transactions fell 8% in the quarter. Commodity inflation was $15 million and self-insurance costs were 11 million higher than last year related to an unfavorable overlap from the second quarter of 2010.
  • Our commodity inflation forecast is now 9% for the full year and including 11% in the second half. We will also be overlapping the $16 million profit benefit from our participation in the 2010 world Expo in Shanghai. This event improves sales, profits and restaurant margins primarily in the third quarter last year.
  • However, we do have confidence our margins will remain very healthy and we currently expect full-year margins of over 20%. From a longer term perspective, the statistic that impresses us a lot is the middle class growth in China. The consuming class is expected to expand by anywhere from 200 million people to 500 million people over the next 10 years depending on the source you look at, which ever number you use, it's a big number and a lot of people.
  • Not long ago, we projected 75% of our operating profit would come from China and YRI by 2015. As of the second quarter this year, we're nearly there already. Admittedly, we didn't get to this point the way we wanted to as the U.S. profit decline drove some of the shift. However, having more of our profit generated in the high growth businesses makes our growth prospects stronger going forward. Our exposure to emerging markets continues to rise dramatically.
  • We raised our guidance to 12% full-year EPS growth despite a very soft year in the U.S. The Yum! growth equation is in the only strong but is gaining strength. With our combined strength in emerging markets, we believe we are well positioned for growth for many years to come.
  • (Q&A) A couple questions. First on China, these value layers that you are introducing, first breakfast and now lunch. Are these permanent new introductions into the layers in the business and it is this akin to what we think of as a dollar menu, or are these more limited in time in nature? Can you talk about holding commodity inflation aside, is there a net negative margin impact in this? When we think about margins long term, is there a change given on that given this new combination of sales and traffic? (A) Let me take the first crack and David may want to add a few things. First of all, when I say the theme of the initiatives on the KFC side would be more day part oriented. So for example, David mentioned we have a six RMB value at breakfast. We also have a six RMB snacking offer in the afternoon and we also have the lunch offer we're talked about. We're trying to give the right value offering to the right day part versus across-the-board product value offerings. We think that's a more profitable way of attacking value. So my sense or belief is we'll always have value initiatives, but we'll change them from time to time. But probably the theme of values for different day parts will stay there for a while. Regarding in terms of the impact on profitability in margins, first of all, a lot of the-- a lot of these current value initiatives really drove incremental traffic. Breakfast transactions now make up, I think, 13% of transactions in the quarter, which is well up from what it had been previously. So we're definitely getting some incremental growth from it and you saw the transaction growth that we posted so the good news is and these offerings a lot of them were incremental. In terms of the overall margins, again, there's obviously a lot of moving parts there that we took modest pricing at the end of January and you see that the combination between that and these targeted value initiatives really worked from an overall P & L perspective. We're very comfortable with our longer term margins in China. (A) Yeah, I think the big thing with KFC is we're focused on building all the big components that build your image, build the big brand and take us into the future and you know, we basically, lead our competitors across every major dimension you could look from a brand building perspective. The one thing that we believe that is very strategic for us is just to make our brands very affordable on an ongoing, every day basis. Because as Rick mentioned in his speech, depending on the survey that you're looking at, you have the consuming class going from 200 million to 500 million and we have a lot of people who will be coming into the marketplace. So every day affordability and access is really the name of the game, and the China team has found a very successful way to do that by focusing on the day parts as Rick pointed out. So I think what-- when you can have the leading brand and competitive pricing, it gives you a pretty unasaleable position in the marketplace. So we have up to three value items at each of our day parts to really leverage our asset throughout the day.
  • Just unrelated and-- just one unrelated follow-up. On Taco Bell,there any sign that business has stabilized? Last quarter, you said it hadn't. I wonder if the 5% represents a stabilization. I understand your view on how it may be the incidents earlier in the year may have set off a chain reaction of the light user abandoning the concept. Is there any evidence throughout your three brands you had negative same store sales and really it's the QSR consumer that's finally reacting or reacting at an accelerated rate to the economy? How much of it is macro underlying it? It would seem to me that's probably the bigger issue. I don't know if you have any specific insights is just the change in what the consumer behavior is versus a brand-specific issue? (A) why don't I talk about what I said about sales and I will hand it to David to talk about the brand going forward. What we said about sales, you saw the number, minus 5% in the second quarter. We said that would be the low point of the year. We haven't seen a turnaround. So you know, I've also said that total U.S. would be negative in the third quarter. You can read that in there and Taco Bell would be negative in the third quarter but not as bad as the 5%. David also said in his speech, we should expect sales to get better when we were hopefully dramatically better when we launch a product which is right targeted toward the end of the first quarter next year. So with that, I will let David talk about what he sees with the brand.

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