There's Still Investor Appetite for Yum! Brands

NEW YORK (TheStreet) -- It's been said that "a way to a man's heart is through his stomach." This is a phrase restaurant giant Yum! Brands (YUM) knows very well.

More important, the company understands the stomach also serves as a gateway to investor profits. As with the company's Pizza Hut chain, Yum! has delivered. But it hasn't come easy.

While Yum! Brands is without question a dominant force in the restaurant business where it competes with McDonald's ( MCD) and other chains, the company has had to deal with more than its share of bad publicity. That includes a China scandal involving two suppliers to the company's KFC restaurants and the safety of the chicken supply regarding the threat of avian flu, scaring off customers.

Despite these concerns, the company has persevered. The stock is still up 6% on the year and even reached as high as $72.32 on April 1, representing gains of 10%. The credit here goes to management, which has done an excellent job mitigating the damage while taking the appropriate steps to ensure consumers that the chickens (if cooked properly) were safe to eat. It's going to take more time for that message to sink in. This showed in the company's first-quarter results.

The company has made it known that China, which is the world's second-largest economy, is an increasingly important market. Yum! has made considerable investments in that region to the extent that China accounts for more than half of the company's annual sales. But preserving the company's reputation has been a struggle.

Now, with same-store sales in China falling 29% in April, the company must figure out a way to preserve its market share, especially following a 13% decline in same-store sales for March. China customers are not quite ready to forgive, which means investors must now prepare for the possibility that growth may not come back for quite some time. I believe management understands this.

For the first quarter, which ended March 23, Yum! posted 70 cents in earnings per share, which declined 8% when excluding special items. Weakness in China really took a toll here. Pperating profits plummeted 41%. This was partially offset by 19% profit increase at Yum! Restaurants International and a 5% profit increase in the U.S. division.

Same-store sales in China fell this quarter by 20%, which include a 24% decline at the KFC and 2% decline at Pizza Hut Casual Dining. But it wasn't all bad news, though. In fact, I think management deserves quite a bit of credit for a report that arrived "less bad" than expected. Plus, despite the poor Chinese environment, that worldwide system sales advanced 1% year over year, was impressive.

Besides, with all of the controversy surrounding China, I don't think enough attention is being given to the company's better-than-expected performance in other areas, including in the U.S., where same-store sales increased 2% year over year and there was a 2.4% increase in restaurant margins helped by 6% growth at Taco Bell.

More than anything, investors have to wonder what are the long-term prospects of Yum! Brands and to what extent will these public relations scandals hurt. In my view, I don't think the PR problem will have an impact. It's not as if management has tried to shield itself from scrutiny. The company has been upfront about the situation and has dealt with both the media and consumers appropriately.

The good news is the company's brand has not been severely affected outside of China. I think this speaks the level of trust Yum! has earned over the years.

I'm not trying to make light of this issues here, but there have been other companies that have rebounded from much worse situations, including Exxon Mobil ( XOM) and BP ( BP).

Bottom Line

I think it's reasonable to say that the situation involving the avian flu could have happened to any restaurant that deals with poultry and has such a wide supply chain as Yum! Again, I'm not making excuses for Yum! Brands. But I appreciate the manner in which the company has navigated this situation while showing concern for consumer safety.

From an investment perspective, it's encouraging the stock is still up year to date despite the onslaught of bad news. For that matter, I don't think there's much negativity that has not already been priced into the shares.

This is still a company that presents tremendous long-term value and I would be adding on each new low.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Richard Saintvilus is a private investor with an information technology and engineering background and the founder and producer of the investor Web site Saint's Sense. He has been investing and trading for over 15 years. He employs conservative strategies in assessing equities and appraising value while minimizing downside risk. His decisions are based in part on management, growth prospects, return on equity and price-to-earnings as well as macroeconomic factors. He is an investor who seeks opportunities whether on the long or short side and believes in changing positions as information changes.

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