EUR 850.00 For Business Accounts Only

Morningstar | Tough Industry Conditions Persist, but Yum Continues to Adapt to Evolving Consumer Preferences

Our positive long-term thesis and wide-moat rating on Yum Brands remain intact as it continues to weather a highly promotional environment while continuing to align its infrastructure to better accommodate evolving consumer pressures. While we'll tweak our full-year consolidated comp targets from 3% to 2% (consistent with management's guidance calling for the low end of its previous 2%-3%) range due to disruption from a distribution partner in the U.K. and expectations of continued promotional activity in the back half of the year, it won't be material enough to impact our $86 fair value estimate. We remain comfortable with our five-year targets, including average annual system sales growth of 6%-7% and core operating margin growth in the high-double-digits (which also assumes Yum meets its 2019 EPS target of $3.75).

In the past, we've discussed four pillars that make for a moatworthy restaurant company into today's environment: One: a value proposition that spans price, convenience, flexibility, and restaurant design; two: adapting to evolving views on authentic/more healthful food options; three: scalable supply chain; four: connecting with consumers outside the restaurant. Although the company's current transformational strategies are at different stages, it's clear that the company recognizes and is adjusting to many of these themes. KFC (2% comps) continues to benefit from more focused menu innovations and marketing, while Taco Bell (2% comps) enjoyed success from new products (Nacho Fries), effective bundling promotions, and speed of service enhancements. Pizza Hut International remains a laggard, but we believe digital, operational, and marketing investments at Pizza U.S. are having positive contribution for online conversion and delivery times and should offers a blueprint for an international market turnaround (aided by a new master franchisee partnership with Telepizza, which will emphasize smaller-format delco openings across Latin America).

We're also intrigued by longer-term potential of the GrubHub partnership, where the company continues to integrate its point-of-sales systems with the GrubHub platform to optimize the delivery platform. While early, management noted that it's seeing incremental transaction growth and average ticket increases from Taco Bell and KFC orders through GrubHub, and we expect this platform to become a more meaningful contributor to our five-year consolidated Taco Bell and KFC comp forecast of 3%-4%.

Management's updated 2018 guidance strikes us as reasonable, including comps at the low end of its previous 2%-3% range, unit growth at the high end of its 3%-4% targets, and 5%-6% system sales growth. The aforementioned U.K. distribution partner disruption may pose some downside risk to management's target of flat reported core operating profit (which continues to include a 6-7-point hit for G&A timing tied to refranchising and 2-3 points due to franchisee fees revenue recognition changes), but continue to see high-single-digit growth as reasonable expectations over the next five years.