"I think now is a particularly opportune time to buy the world's largest fast-food company, YUM! Brands (NYSE: YUM) ," says Louis Basenese.
The associate investment director and contributing editor to The Oxford Club observes, "YUM Brands operates 35,000 restaurants under the KFC, Taco Bell and Pizza Hut brands." Here's his review of the firm's outlook, including its expanding role in China.
"For starters, YUM keeps extending its streak of impressive results. For the seventh quarter in a row it beat expectations. Earnings per share increased 16% for the quarter and 28% year-to-date. Not to be overlooked either is the fact YUM raised guidance. Again.
"This quarter, fewer than 5% of companies in the S&P 500 can boast this triple whammy (beating earnings and revenue estimates and raising guidance). Ironically, while most of the other triple-whammy stocks enjoyed hefty single- and double-digit run-ups on the announcements, YUM sold off.
"And here's where I think most investors are missing the boat, and once again focusing too heavily on the short term. Yes, YUM's in a pinch. Food costs are rising and consumers are spending less.
"In other words, margins are getting squeezed. And the company (like most others) isn't about to raise prices for fear of destroying more demand. But margins are only off about 1% across all divisions. Hardly an amount to panic about.
"Moreover, sales are still increasing at double-digit rates. So even if YUM's making a little less on each one-pound burrito at Taco Bell or Variety Bucket at KFC, net profits are still increasing.
"Not to mention, this margin contraction is a short-term phenomenon. We've already seen commodity prices pull back. And this will continue the more demand lightens up. Bottom line – sooner than later YUM will get out of this pinch.
"Even if the margin pressure persists a little longer than we expect, it will do little to undermine the long-term fundamentals working in the company's favor. Namely, international expansion. For six years running, YUM's added at least a thousand new international locations.
"CEO David Novak expects 2008 to be no different. In fact, worldwide, he expects the company to open 1,600 new units. That's 4.4 per day, making YUM the fastest growing retailer in the world.
"Of course, growth in China is propelling this massive expansion. (Operating profits for YUM's China division alone jumped 38% in the most recent quarter.) And it will continue to do so into the foreseeable future.
"With only 2,726 China locations, YUM's still in the first inning (with the bases loaded and no outs) of a tremendous growth story. Management estimates that China can conservatively support 20,000 locations. That's the equivalent of 36 more years of growth at current rates.
"And when you tack on a massive $4 billion stock repurchase program, a five year average return-on-equity of 60%, a dividend that's quadrupled in four years, a non-cyclical industry, world-class leadership and new efforts to reignite same-store sales in the United States, I have little reservations recommending this stock. No matter what's going on in the broad markets.
"To be clear, YUM will not be the market's next rocket stock, jumping 100% or 200% higher in a short period of time. But we can count on it to conservatively deliver annual returns of 20% to 25%. And in this market, we shouldn't downplay such reliability. So by all means keep buying."
Each day, Steven Halpern's TheStockAdvisors.com offers the latest market commentary and favorite investment ideas from the nation's leading financial newsletter advisors.
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