Market Overlooking Yum's Long-Term Potential
Current headwinds aside, wide-moat Yum remains a compelling long-term cash flow story, says Morningstar's R.J. Hottovy.
We view
We believe that these pressures are largely macroeconomic in nature, as other consumer-facing companies in the region have also noted a sentiment-driven reduction in spending following August's equity-market volatility and yuan devaluation. However, before finalizing our comp estimates, we await management's conference call comments regarding the competitive environment and its plan to "get sales, traffic, and profits back to historic levels."
Based on a more cautionary spending environment, we now view China comp growth in the low single digits over the next 12-18 months as more realistic (versus earlier expectations in the mid single digits). This will likely result in a 5%-10% reduction in our $100 fair value estimate. However, we didn't find anything in today's results that would lead us to reconsider our wide moat rating, as the China comps overshadowed several positives from the quarter (including a 470-basis-point increase in China restaurant margins to 19.6%, positive comps across most markets for KFC, and another stand-out quarter from Taco Bell).
Certainly, investors will have to exercise patience, as China trends are unlikely to turn around overnight. However, with Yum trading at around $70 per share, we believe the market is overlooking the company's long-term free cash flow potential and possible activist-led moves like a leveraged recapitalization or spin-off of Yum China.
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