Morningstar | Franchisee Health and Technology Enhancements Poise Yum for System Sales and Cash Flow Acceleration
Yum Brands' 2018 investor day event was largely an affirmation of the key tenets underpinning our wide moat rating, with CEO Greg Creed emphasizing several moat sources such as strong brand intangible assets, a cohesive franchisee base, and scale advantages. However, the key message coming out of the event was that Yum not only remains on pace to hit its 2019 targets (including EPS of $3.75) but also has clear ways to drive at least 2%-3% comps and 3%-4% unit growth in the future.We see two levers in particular. First, Yum's franchisees rank among the strongest in the quick-service restaurant space with cash-on-cash returns in the mid-20s. Given that its franchisees tend to have larger balance sheets versus peers--its 2,000 global franchisees average almost 25 locations--Yum should maintain 1,500-plus net new units the next five years at a fraction of capital expense historically required (annual run rate of $100 million versus an average of $400 million for 2015-17). Second, Yum is ahead of most operators regarding consumer technology adoption, which should be key to unlocking transaction growth. The Taco Bell/KFC partnership with GrubHub delivery is the obvious example (especially with transactions structured so that franchisees aren't responsible for commissions), but we expect systemwide online/mobile ordering leadership to be augmented by the acquisition of QuikOrder, which processed half of Pizza Hut's sales in 2018.
There is no change to our $90 fair value estimate, and we remain comfortable with our five-year targets, including average annual system sales growth of 6%-7% (including system comps of 3%) and core operating margin growth in the high single digits, which implies approaching EPS of $5.75 by 2022. While it strikes us as fairly valued, we still view Yum as a core holding offering a balance between global growth and capital allocation; its 2017-19 cash return goal of $6.5 billion-$7.0 billion remains on track, with several upside opportunities.
Yum! Brands franchises or operates a system of quick service restaurants through its KFC, Pizza Hut and Taco Bell brands. The company's operating segments consist of the KFC Division, the Pizza Hut Division and the Taco Bell Division. KFC restaurants provides fried and non-fried chicken products such as sandwiches, chicken strips, chicken-on-the-bone and other chicken products marketed under a variety of names. Pizza Hut is engaged in the sale of ready-to-eat pizza products. Pizza Hut operates in the delivery, carryout and casual dining segments. Taco Bell is engaged in Mexican-style food products, including various types of tacos, burritos, quesadillas, salads, nachos and other related items.
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