Source: Yum! Brands.
Fast-food giant Yum! Brands has seen its stock price rise roughly 11% year to date and recently received a significant analyst upgrade, implying even more upside potential. But the company's fundamental performance hasn't backed up the overarching positivity. Yum! continues to see problems across several of its major markets, including China and India.
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As a result, investors should view such a bullish stance on Yum! with skepticism.
Emerging-market woes persistAnalysts at CLSA recently raised Yum! Brands to a "buy" rating and gave the stock a $107 price target. The analysts are most optimistic about Yum!'s growth potential in China, as well as a possible move by the company to accelerate franchising activity there. In addition, the analysts allude to the possibility of an outright spinoff of the China business entirely.
Indeed, Yum!'s China operations are a major part of the overall company. China itself accounts for half of Yum!'s total revenue. The problem I see is that things aren't going very well in China right now for Yum. Total sales declined 3% in China over the first half of 2015, year over year. Earnings per share in that region declined 17% in the same time.
Yum! is still spending aggressively to turn around its performance in China, after a highly publicized scandal in China in late 2014, in which KFC was found to be selling tainted meat. This situation raised fears over the quality and safety of Yum!'s food, and recent numbers are a bad sign that consumers in China still haven't come back to Yum!'s restaurants. Comparable-restaurant sales, which measure sales at locations open at least one year, fell 10% in China last quarter, year over year. Restaurant margin deteriorated by 2.2 percentage points in the period.
Moreover, Yum! continues to see problems in the emerging markets more broadly. Yum!'s comparable-restaurant sales fell 11% last quarter in India. Yum! swung to a $3 million operating loss in India last quarter.
Yum! continues to invest aggressively in opening new restaurants in China and India. Yum! opened 80 new restaurants in China last quarter and expanded its unit count in India by 16%. But spending so much on new restaurant openings is a concern in light of the fact that established restaurants in these nations are seeing sales deteriorate.
An upgrade seems a little too optimisticThe new CLSA price target for Yum! represents a 34% premium to its Sept. 10 closing price. Considering Yum!'s performance in China continues to deteriorate, it's hard to see that much upside potential. Adding to my skepticism is that Yum! stock isn't cheap: The stock trades for 40 times trailing-12-month earnings per share and 20 times forward EPS estimates. The analysts' price target of $107 per share would give Yum! a valuation multiple of more than 50 times trailing EPS.
Part of the reason investors are so optimistic is that Yum! management maintains a promising forecast. The company expects strong growth in China over the second half of the year and expects at least 10% earnings-per-share growth for the full year. But Yum!'s earnings per share declined 17% through the first half of the year. Considering Yum!'s poor performance in two of its most important markets -- China and India -- along with its weak overall performance so far this year, it's hard to see how Yum! meets that forecast.
If Yum! falls short of its projections, investors may not be so willing to pay such a high multiple for the stock.
The article Why Investors Should Avoid This Fast-Food Giant originally appeared on Fool.com.
Bob Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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