YUM! Brands

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

YUM! Brands, Inc. is a global quick-service restaurant company, operating through a franchise model with a well-known portfolio of brands, including KFC, Taco Bell, and Pizza Hut. The company’s primary focus is on the development and management of the franchise model.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

YUM! Brands’ most recent 10-Q from September 30, 2023, shows a significant growth in revenue over the previous year, up to $1.7 billion (with YTD at $5.1 billion, vs $4.9 billion). The company also reports positive numbers in all of its segments with the KFC division growing the fastest (but all divisions grew well.) The overall company system sales saw 9% YOY growth. However, it is important to note that the numbers were negatively impacted by currency translation, which impacted the operating profit.

Business Overview

YUM! Brands operates primarily through a franchise model, wherein it licenses its brand names and operating systems to independent business owners. This model, unlike a wholly owned business, allows YUM! to generate revenue from franchise fees and royalty payments with relatively lower capital requirements. YUM! brands core focus is on the restaurant franchising business.

Revenue Distribution

The company’s revenue is primarily segmented into two types: franchise and company revenues.

  • Franchise revenues are derived from fees charged to franchisees including upfront fees, royalty fees based on sales, and advertising fees.
  • Company revenues are from restaurants which are company owned and operated by Yum itself. Company revenues are earned directly from the sales made in stores.
  • The main revenue drivers are system sales growth, unit growth, and currency fluctuations.
A notable part of Yum’s revenue includes advertising and other fees. These are paid by the franchisees to YUM.

The global quick-service restaurant (QSR) industry is highly competitive. The industry is also showing high resilience and growth despite various macroeconomic challenges. Key trends include:

  • Digitization and technology integration: Companies are enhancing customer experience by integrating digital ordering, loyalty programs, and mobile payments. This helps to boost sales while keeping costs low.
  • Health and sustainability: Consumers are increasingly health conscious. Companies are modifying their menu options to include healthier choices and sustainable practices.
  • Emphasis on Value: Consumers are increasingly price-conscious due to macroeconomic pressures, making the value-focused offerings popular. Value-added products are very important for business growth.
  • Delivery and Online Ordering: Delivery and online orders are an area of high-growth as people want convenience in addition to fast food.
  • Globalization: Companies are focusing on emerging markets for high-growth, while also catering to local tastes and preferences.
YUM! has been increasing investment in technology (like digital menu boards and self-ordering kiosks in restaurants), supply chain and restaurant delivery to enhance customer experience and operational effectiveness. This will help drive revenue growth. The company is also increasing digital and data marketing to better target consumers. ### Competitive Landscape The QSR industry is intensely competitive with various players such as:  * **Fast-Food Chains:** McDonald's, Burger King, and Subway   *  **Fast-Casual Chains:** Chipotle, Panera Bread, and Shake Shack   * **Regional and Local Competitors:** Numerous smaller chains and individual restaurants often compete in local markets.   *  **Emerging Companies:** Companies like Domino’s, Papa Johns, and Door Dash are quickly growing their businesses, and offer alternative modes of ordering and delivery, posing a challenge for the traditional food chains.   *  The business is dependent on brands’ appeal, franchisee operations, speed of service, cost competitiveness, and ability to innovate. 

 Competitors can easily replicate the strategies in the industry. However, YUM! does have an advantage in strong global brand recognition, and an established franchise model.

Differentiation and Moat

YUM!’s business model is different from other players in the market because of:

  • Strong Global Brands: The company has a portfolio of well-recognized and established brands: KFC, Pizza Hut, and Taco Bell, with strong presence in several regions. The company has a wide global brand presence with franchisees all over the world.
    • The success of these brands provides a solid foundation for the company’s moat.
  • Franchise Model: The franchise model is a strength because of relatively lower investment in terms of operational costs. This also allows rapid expansion, as capital requirements are low and franchisees are responsible for the local operations.
  • Strong Brand Loyalty: Brand loyalty is highly relevant for YUM! brands, as the product quality, and value that each provides is well known and is trusted by consumers all over the world. Consumers often visit these chains because of familiarity and the desire for the known taste.
  • Innovation in Marketing and Menu: The company has been focusing on innovation both in terms of marketing and menu. It has been utilizing technology like mobile app ordering and delivery, while also focusing on products with new flavors and better ingredients.

However, YUM’s moat is not wide because of:

  • Replicability: Other companies can copy and implement most of the successful strategies. There is not much stopping companies from opening their own pizza, chicken, or Mexican restaurants. Therefore, the moats are not that wide and defensible.
  • Competition: Competition in the QSR industry is fierce, and companies are constantly facing pressure to increase revenue by slashing prices or creating new offerings, reducing profit margins. There are also many competitors across various geographic segments.

Moat Rating: 3 / 5

Based on the above analysis, YUM! Brands receives a moat rating of 3 out of 5. While the company has some clear advantages, including well-known brands, an established global presence, and a robust franchise model, these are counterweighted by the ability of competitors to easily replicate YUM’s strategies. The company also faces strong competition from various players across different segments and geographies. As a result, the company has a narrow moat, and must take care to protect it.

Legitimate Risks

  • Competition: Intense competition from other QSR chains and restaurants could hurt YUM’s market share and profitability. Competitors can easily replicate YUM’s strategies.
  • Changes in Consumer Preferences: Shifts in consumer behavior, regarding diet, or price points can affect YUM’s offerings and require it to make changes that can be costly.
  • Economic Downturns: Reduced consumer spending due to economic challenges can affect YUM’s overall sales. This also results in more people choosing low-cost alternatives.
  • Brand Reputation: Any negative publicity or a health scandal about the quality of the company or its products will directly affect the company, and could lead to decreased revenues and increased liabilities.
  • Supply Chain Disruptions: Any issue or disruption in the supply chain can lead to loss of inventories and revenues. Moreover, rising input costs can also affect profit margins.
  • Franchise Operations: While franchising is helpful, any problem with the operations of franchisees, can also affect YUM, such as a safety incident in a franchise location, or unethical practices followed by the franchise owner.
  • Regulatory Changes: Any regulatory change in the industry, such as menu labeling, minimum wage laws or advertising rules, can increase compliance costs and operational complexities.
  • Geopolitical Risk: Because YUM! brands operations are spread across the world, the company might be vulnerable to political instability, regulations or changes in trade agreements. The risks can be especially high for emerging economies.
  • Currency risk: If the dollar increases substantially, revenues and profit might be negatively affected when converted to U.S dollars.

Business Resilience

  • Brand Strength: While having issues with a low moat, YUM’s highly recognizable brands can make it resilient to many outside changes. Consumers are more likely to keep choosing YUM’s brands given familiarity and a history of good service and quality.
  • Franchise Model: The franchise model keeps capital expenditure low. This helps YUM to maintain healthy cashflows through its business cycles.
  • Ability to adapt: The company has shown adaptability to changing consumer preferences and technological advances. It is continuing to invest in newer technology and better menu items. YUM! has often been able to capture higher sales and keep the customer base engaged by improving brand value. This is a good indicator that the company will keep innovating and adapting, which is good for resilience.
However, as per the latest financial results, profits of the company are easily impacted by currency translation.

Financials 

YUM’s financial health is very dependent on the strength of its brand.

Income Statement Analysis

YUM! shows a consistent revenue growth trend over the last few years. It has implemented a global expansion strategy that has helped it increase both its revenues and its profitability. However, YUM!’s growth is also driven by price increases and the addition of new restaurant locations, particularly in emerging economies. * Revenues: Revenues have shown a steady positive growth over the past few years, with a YOY increase of 9% in system sales in the latest quarterly results. The revenue growth can primarily be attributed to franchised stores, which has increased revenues from $1.4 billion to $1.6 billion YOY. Company owned store revenues grew from $0.9 million to $1 million YOY. * Revenue growth is also driven by global diversification as its brands are present across different regions.

  • Cost of Revenues The company’s cost of revenues are mainly driven by the food costs, employee costs, rent and other overhead costs. These costs are impacted by economic and market conditions, such as changes in prices for raw materials, wages etc.
  • Gross Profit: While the company has had strong top-line growth, the gross profit margin is affected by inflationary pressures, and competition. It’s been around 20%, and was 20.6% in the latest quarter, showing a slight improvement * The ability of YUM! to manage and improve the margins is linked to its pricing power and scale of operations.
  • Operating Profit: Operating profit, which reflects its profitability from the core operations, is usually lower than net income because of interest expense. It has shown inconsistent results across quarters.
    • Operating profit was negatively impacted in the most recent financial results due to unfavorable currency translation.
  • Net Profit and Earnings per share: Net profits have also varied over recent periods. Net profit is impacted by several factors, like changes in expenses, interest rates, and tax liabilities. * Diluted EPS was at $1.09 in the most recent quarterly earnings, vs $0.92 in the previous year.
A big chunk of YUM’s operating costs comes from food, labor and franchising expenses. Any movement in these components can have an impact on YUM’s margins.

Balance Sheet Analysis 

*  **Assets:** YUM! Brands has a stable assets base. Their assets include both tangible and intangible items. YUM! operates more on its franchise model so the company holds less physical assets when compared to others. Some of its major assets are goodwill and other intangible assets.
*  **Liabilities:** YUM! brands has substantial liabilities, composed of long-term debt, trade payables, accrued expenses and other liabilities. It is highly leveraged, using debt as its main source of capital for acquisitions and buybacks.
*  **Equity:** The company's shareholder equity is negative. This may seem alarming, but it is fairly common among stable franchise type businesses. The negative equity is caused by YUM's strategy of paying back investors more than what it earns through buybacks, and dividend payments. For highly stable businesses, this is a viable strategy, as it allows tax advantages for the investors while showing management confidence.

Cash Flow

  • Operating Cashflows: The operating cashflow is slightly above historical averages, indicating that the company is able to produce considerable cash from operating the business.
  • Investing Cashflows: The investing cashflow remains low, indicating that most of the capital expenditures required to run the business is covered by the franchisees.
  • Financing Cashflows: Cashflows from financing are significant for YUM!, as it continues to use debt for stock buybacks, dividend payments and acquisitions. However, the company is making sure to maintain liquidity and a balance between debt and equity.

YUM!’s management claims that they are managing their debt and equity responsibly, while creating shareholder value. The company is also focused on growth and higher profitability, with their long-term strategies in place to help achieve this.

Financial Health Rating: 4/5

Although the balance sheet has a negative shareholders equity, which is not bad for a franchise based company, it is important to view the financial strength in the context of their ability to produce earnings and cashflows. Based on this, I would rate their financial health as 4 out of 5.

Understandability Rating 2/5

YUM!’s business is not very simple to understand. It operates a unique franchise model, and the business is affected by changing consumer tastes, competition, inflation, currency fluctuations and various other macroeconomic factors. It also requires significant effort to go through the financial statements, as they are quite complicated. Also to calculate correct multiples and growth rates for this company, one needs to spend time and effort on the company’s financial statements. Given all this, I would give YUM! an understandability rating of 2 out of 5.

Recent Concerns

  • As the company has a large global presence, it has been affected by the Russian-Ukraine war, and also, currency translation of the Russian business, negatively impacted its financials.
  • Supply chain disruption, caused by events like extreme weather, or political instability, can increase operational complexities and cost.
  • Inflationary pressures have been significantly impacting the company’s cost structure and is a cause of concern. Management has been proactively making efforts to mitigate this risk.
  • The company is heavily levered with debt, which increases the interest expense and is risky for a business.

Management’s View

  • YUM! is confident that it can deliver strong results because of its brand strength, business strategy, and focus on operational effectiveness.
  • The company is focused on long-term investments and will take the necessary steps to reduce operating expenses and mitigate the effect of inflation and currency exchange rates.
  • YUM! is taking a customer-centric approach, understanding their needs and preferences.
  • YUM! will continue expanding its brands and improve customer engagement through a combination of digital and real-world interactions.
  • Management is determined to achieve long-term sustainable growth, value, and high-quality results through their franchise model.
  • YUM! wants to become a more innovative and agile organization.