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Can Yum! Brands’ Q2 Earnings Justify Its Stock Performance?

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Analysts’ expectations

Yum! Brands (YUM) plans to report its second-quarter earnings before the market opens on August 1. For the quarter, analysts expect the company’s revenue to fall, while its adjusted EPS are projected to rise.

Yum! Brands’ revenue to fall

For the second quarter of 2019, analysts expect Yum! Brands to report revenue of $1.28 billion. Year-over-year, the company’s revenue is projected to fall 6.7%. The refranchising of company-owned restaurants is likely to lower the company’s revenue. However, the opening of new franchised restaurants and growth in same-store sales could offset some of the declines.

By the end of the first quarter of 2019, Yum! Brands operated 857 company-owned restaurants. Compared to the second quarter of 2018, the unit count of company-owned restaurants had declined by 445 units. However, during the same period, the company has added a net 3,336 franchised restaurants. These new restaurants, along with restaurants opened in the second quarter, could drive the company’s revenue.

Yum! Brands’ management is focusing on menu innovations, expansion of its delivery service, value offerings, and distinctive marketing campaign to drive its sales. In partnership with Grubhub, the company had expanded the delivery service to 2,200 KFC restaurants by the end of the first quarter. Also, 3,200 KFC restaurants are offering a click-and-collect service on the Grubhub marketplace. Taco Bell provided delivery service from approximately 4,000 of its restaurants by the end of the first quarter.

Yum! Brands’ EPS to rise

Analysts are projecting Yum! Brands to report adjusted EPS of $0.87. Year-over-year, the company’s EPS is forecasted to grow 6.1% from $0.82 in the second quarter of 2018. The improvement in EBIT margin and decline in the number of shares outstanding could drive the company’s EPS.

For the second quarter, the EBIT margin of Yum! Brands are projected to improve from 30.7% to 37.1%. The growth in the higher-margin franchise business, sales leverage from positive SSSG, and lower G&A (general and administrative) expenses could drive the company’s EBIT margin. From the beginning of Q3 2018 to the end of the first quarter of 2019, the company had repurchased 15.2 million shares for approximately $1.34 billion. At the end of the first quarter of 2019, the company had roughly $1 billion available under its share repurchase program. Share repurchases will lower the number of shares outstanding, thus driving the company’s EPS. However, the decline in revenue, an increase in interest expenses, and a higher effective tax rate could offset some of the gains in EPS.

YUM’s stock performance

As of July 26, Yum! Brands was trading at $114.02, close to its 52-week high of $114.37. The company’s stock has increased by 9.2% since the announcement of its first-quarter earnings on May 1. In the first quarter, the company had outperformed analysts’ EPS and overall SSSG expectations. Its revenue was in line with estimates. However, the SSSG of Taco Bell and Pizza Hut came in below analysts’ expectations leading to a fall in Yum! Brands’ stock price.

However, on June 6, Nation’s Restaurant News had reported that there was an increase of 1.1% in May’s same-restaurant sales across restaurant brands. In April, same-restaurant sales had declined by 1.6%. On July 25, the company had announced the appointment of new CEOs for its Taco Bell division and Pizza Hut division. Along with these announcements, the lower unemployment rate, wage inflation, and improvement in consumer sentiment have led to an increase in YUM’s stock price.

YTD, YUM’s stock has increased by 24.0%. This year, the company has outperformed its peers and the broader equity market. During the same period, its peers, Domino’s Pizza and Papa John’s, have returned 4.5% and 17.6%, respectively. The S&P Index has increased by 20.7% YTD.

Valuation multiple

The increase of 24% in Yum! Brands’ stock price has also raised its valuation multiple. As of July 26, YUM was trading at a forward PE multiple of 28.1x compared to 24.2x at the beginning of this year. Also, the company is trading at a premium compared to Domino’s Pizza, which is trading at a forward PE multiple of 25.2x. On the same day, Papa John’s was trading at a forward PE multiple of 34.0x.

Also, on July 26, Yum! Brands was trading at 29.8 times analysts’ 2019 EPS estimate of $3.82, and 26.9 times analysts’ 2020 EPS estimate of $4.24. Analysts project YUM’s EPS to rise by 20.5% in 2019 and 10.9% in 2020.

Analysts’ recommendations for YUM

Ahead of Yum! Brands’ second-quarter earnings, analysts are favoring a “hold” rating. Of the 24 analysts that follow the company, 54.2% have given it a “buy” rating, 37.5% are recommending a “buy,” and the remaining 8.3% are advocating a “sell” rating. On average, analysts’ 12-month price target stands at $106.75 for Yum! Brands, which implies a fall of 6.4% from its stock price of $114.02.

Since the beginning of June, J.P. Morgan and Cowen and Company have raised their price targets. J.P. Morgan has hiked its price target from $97 to $102, while Cowen and Company has increased its price target from $108 to $118. On June 25, Credit Suisse had initiated its coverage on Yum! Brands with a “neutral” rating, and a price target of $106. However, on July 1, Longbow Research downgraded the company from “neutral” to “underperform.”

YUM’s peer, Domino’s Pizza, reported second-quarter earnings on July 16. You can read our analysis in Domino’s Stock Falls on Weak Q2 Sales.

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