Company Reports

Wide-moat Yum Brands missed our top- and bottom-line forecasts on softer-than-expected comparable sales performance in its KFC and Pizza Hut segments, but we're encouraged by the firm's commentary regarding its ability to "bend the curve" on general and administrative costs with its technology investments and by ongoing unit growth outperformance. On balance, we expect to lower our near-term sales estimates, with our revised forecasts calling for 3% growth in sales and 4% growth in operating profit, down from 5% and 9%, respectively. That change is more than offset by a 70-basis-point uptick in long-term operating margin, to just north of 36%, driven by our assessment of the firm's efforts to leverage its global technology stack more efficiently across brands and markets and by management's commentary to that effect on the earnings call. Yum's R.E.D 360 cross-brand consumer insights platform is a proof point and positive step in this direction. The net effect is a low-single-digit percentage increase to our $139 fair value estimate, leaving shares trading at a slight discount.

As we gear up for the release of first-quarter earnings, our top picks in the restaurant industry remain wide-moat McDonald's and wide-moat Starbucks, trading at 14% and 19% discounts to our $312 and $105 fair value estimates, respectively. While industry traffic has been depressed for two years, both brands boast strong digital platforms that allow them to defend transaction frequency without indiscriminate national discounting, and both benefit from scale-driven cost advantages that should allow them to meet the needs of the increasingly value-sensitive consumer without sacrificing financial performance. These are the two most important factors, in our view, that will distinguish the best and worst performers in our industry coverage over the coming years. The industry looks fairly priced in aggregate, trading at a 3% premium to our market-cap weighted fair value estimates. The aggregate figure masks a very bimodal return distribution: Brands like narrow-moat Wingstop (up 108% annually) and wide-moat Chipotle (74%)—which boast strong unit economics and have taken material industry transaction share—have materially outperformed brands like no-moat Wendy's (down 9%) and narrow-moat Papa John's (down 17%), which have not. Those top-performing brands are fully priced, trading at material premiums to our intrinsic valuation (163% and 52%, respectively), suggestive of meaningful execution risk.

The restaurant industry has changed a lot over the past three years. We remain encouraged by the ability of the largest operators, including Yum Brands, to accelerate critical investments in e-commerce platforms, delivery integration, and technological solutions that meet the demands of the modern restaurant consumer. Recent acquisitions demonstrate the emphasis the firm has placed on digital enhancements, with 45% of systemwide sales now coming through digital channels, which we expect to remain integral to Yum's strategic playbook.

Wide-moat Yum Brands continues to drive strong growth across its global portfolio, eclipsing $60 billion in systemwide sales during 2024 as it added a striking 3,353 net stores (6.1% annual growth) despite persistent headwinds in the restaurant industry. The firm's digital capabilities provide its franchisees with a strong edge, particularly in emerging markets, and relationships with well-capitalized operators in key countries solidify the firm's competitive positioning relative to smaller category peers. This is the narrative that we believe investors should continue to adhere to coming out of a quarter that slightly missed our own (and FactSet consensus) expectations, with Yum Brands representing one of our best ideas in the industry. After digesting results, we plan to hold the line on our $139 fair value estimate, leaving shares looking slightly cheap.

As we survey the U.S. restaurant landscape looking toward 2024, the largest, chained restaurants with durable cost advantages look best positioned to outperform. We expect industry growth to remain low—just 1.3% annually in real terms through 2025, versus a long-term average of 2.5%. The sharp slowdown is predominantly attributable to slowing consumption spending, with pressured U.S. consumers already limiting restaurants’ ability to further increase prices and likely driving an uptick in industry promotional activity.

The restaurant industry has changed a lot over the past three years. We remain encouraged by the ability of the largest operators, including Yum Brands, to accelerate critical investments in e-commerce platforms, delivery integration, and technological solutions that meet the demands of the modern restaurant consumer. Recent acquisitions demonstrate the emphasis the firm has placed on digital enhancements, with 45% of systemwide sales now coming through digital channels, which we expect to remain integral to Yum's strategic playbook.

Wide-moat Yum Brands reported third-quarter earnings roughly in line with our forecasts, and we came away encouraged by the firm's positioning against a tough restaurant industry backdrop. With nothing emerging from the report that changes our long-term expectations for mid-single-digit annual growth in sales, high-single-digit annual growth in operating profit, and low-double-digit growth in diluted EPS, we expect little change to our $139 fair value estimate and continue to view shares as attractive. We’re also lowering our Uncertainty Rating to Low from Medium for the name, consistent with our quantitative methodology.

The restaurant industry has changed a lot over the past three years. We remain encouraged by the ability of the largest operators, including Yum Brands, to accelerate critical investments in e-commerce platforms, delivery integration, and technological solutions that meet the demands of the modern restaurant consumer. Recent acquisitions demonstrate the emphasis the firm has placed on digital enhancements, with 45% of systemwide sales now coming through digital channels, which we expect to remain integral to Yum's strategic playbook.

The restaurant industry looks cheap to us for the first time since fall 2022, with the recent market correction creating a buying opportunity for long-term investors. Our coverage trades at a 7% cap-weighted discount to our intrinsic valuations, with wide-moat companies like Yum Brands, Starbucks, and McDonald's looking unusually alluring, each trading at a 10%-12% discount to our respective $139, $103, and $285 fair value estimates. We recognize that slowing same-store sales pose a near-term risk, but believe that large, quick-service operators with scale-driven cost advantages and strong digital touchpoints look poised to capture market share in this dynamic environment. Restaurants are more resilient than many investors realize, with companies that outperform on the basis of "value for the money" like McDonald's and wide-moat Chipotle even posting comparable-store sales growth over the course of the 2007-09 downturn. While we expect consumer spending to slow in 2024, we continue to maintain that the U.S. will avoid an outright recession and believe that investors seeking consumer cyclical exposure would do well to consider turning toward the restaurant industry at current prices.

The restaurant industry has changed a lot over the past three years. We remain encouraged by the ability of the largest operators, including Yum, to accelerate critical investments in e-commerce platforms, delivery integration, and technological solutions that meet the demands of the modern restaurant consumer. Recent acquisitions demonstrate the emphasis the firm has placed on digital enhancements, with 45% of systemwide sales now coming through digital channels, which we expect to remain integral to Yum's strategic playbook.

Wide-moat Yum Brands posted solid second-quarter earnings per share of $1.41, surpassing our $1.24 forecast despite missing our top-line estimate, with unit development remaining strong. The firm benefited from broad-based comparable-store sales growth of 9% globally. This in tandem with disinflationary food costs helped drive momentum in restaurant-level margin, a key driver of store-level economics and, by extension, the firm's long-term unit development target of 5% annual growth. We're encouraged by a turnaround in China; Yum's largest franchisee there opened 422 gross stores, or 41% of Yum's 1,025 gross openings in the quarter. We plan to raise our $133 fair value estimate by about 4%-5% to reflect outsize unit growth and the time value of money. This will leave the shares trading in a range that we consider fairly priced.

Restaurant stocks look expensive as we take the industry's pulse, with names in our coverage trading at a market-cap-weighted 10% premium to our intrinsic valuations. While demand has held up nicely to date, we're seeing weak spots, with persistent declines in traffic and items per check suggesting price-conscious consumers and a more challenging pricing environment to come. Nominal same-store sales growth remains healthy, up around 5.7% industrywide over the past three months (RMS data), but traffic (down 1.4%) and items per check (down 3.7%) remain points of concern. We expect slowing sales momentum into the first half of 2024, resulting in a more promotional environment for the industry and a three- to four-year route to normalized restaurant-level profitability. The industry's bargain bin looks sparse, but we see modest upside in Wendy's and Starbucks shares, which trade at 6% and 2% discounts to our $23 and $104 fair value estimates, respectively.

While the coronavirus has turned the restaurant industry upside down over the past two years, we're encouraged by the ability of the largest operators, including Yum, to accelerate critical investments in e-commerce platforms, delivery integration, and technological solutions that meet the demands of the modern restaurant consumer. Recent acquisitions demonstrate the emphasis the firm has placed on digital enhancements, with 45% of systemwide sales now coming through digital channels, which we expect to remain integral to Yum's strategic playbook.

While wide-moat Yum Brands missed our $1.75 billion sales and $1.26 adjusted diluted EPS forecasts (posting $1.65 billion in sales and $1.06, respectively), we came away from the quarter cautiously optimistic and continue to view forward prospects as salient. To this effect, the firm maintained its full-year guidance for 5% or better net unit growth, high-single-digit growth in operating profits, and $1.15 billion in general and administrative costs, suggesting to us that near-term pressures were more driven by timing (and an unanticipated U.K. ransomware attack) than anything structural. In fact, we see modest upside to the long-term 7%-8% operating profit growth algorithm in 2023, driven by a strong reopening in the firm's large Chinese market. As a result, we're modestly raising our full-year operating profit growth estimate to 9% from 8%, though we've elected to modestly lower our 2024 targets for growth in sales (to 4%, from 8%) and operating income (to 5%, from 9%) due to our cautious view on near-term industry prospects. On balance, we expect to raise our $132 fair value estimate by a low-single-digit percentage, a touch behind what would be suggested by time value.

While the coronavirus has turned the restaurant industry upside down over the past two years, we're encouraged by the ability of the largest operators, including Yum, to accelerate critical investments in e-commerce platforms, delivery integration, and technological solutions that meet the demands of the modern restaurant consumer. Recent acquisitions demonstrate the emphasis the firm has placed on digital enhancements, with just north of 40% of systemwide sales now coming through digital channels, which we expect to remain integral to Yum's strategic playbook.

Wide-moat Yum Brands posted solid fourth-quarter results, with $2.02 billion in sales and $1.31 in adjusted EPS aligning closely with our $2.03 billion and $1.33 respective forecasts. If we had one gripe with performance, it would be softer restaurant margins in the Taco Bell segment (22.9%, against our 24.2% estimate), but those are inclusive of a one-time 50-basis-point drag for quarterly worker bonuses and are consistent with quarterly industry results to date. Elsewhere, there was plenty to like, with nearly 4,600 gross unit openings representing an industry record and underlying strength in the KFC and Taco Bell business units looking increasingly durable. We're finally getting on board with the Taco Bell international growth narrative, and on the back of higher medium-term unit growth estimates (to 4.4% and 390 units per year, from 4.0% and 330 prior), we expect to raise our $127 fair value estimate by a mid-single-digit percentage. We're also raising our Uncertainty Rating to Medium from Low, consistent with our quantitative methodology.

We expect sluggish sales growth to represent the key issue for the restaurant industry in 2023, following a year of investor concern regarding inflated input costs and margin compression. Though we see modest upside in wide-moat Domino's and view wide-moat Chipotle shares as fairly valued, the industry trades at a 5% market-cap weighted premium to our fair value estimates, suggesting that current entry prices are less than salient.

While the coronavirus has turned the restaurant industry upside down over the past two years, we're encouraged by the ability of the largest operators, including Yum, to accelerate critical investments in e-commerce platforms, delivery integration, and technological solutions that meet the demands of the modern restaurant consumer. Recent acquisitions demonstrate the emphasis the firm has placed on digital enhancements, with roughly 40% of systemwide sales now coming through digital channels, which we foresee remaining integral to its strategic agenda.

Wide-moat Yum Brands posted earnings a touch behind our expectations, with $1.64 billion in revenue and $1.09 in adjusted EPS missing our $1.77 billion top-line and $1.23 EPS estimates, largely attributable to stouter-than-anticipated currency headwinds that posed an 8% drag on operating profit. We're impressed by the firm's resilience against a difficult macroeconomic backdrop, with the Yum enjoying positive comparable store sales at each of its three largest units—KFC, Taco Bell, and Pizza Hut—and continuing to post impressive unit growth (3.5%, inclusive of the disaggregation of 1,112 KFC and 53 Pizza Hut units in Russia), despite declining traffic industrywide and persistent permitting and procurement issues, the latter of which should abate in the next few quarters. As we digest quarterly results, we plan to raise our $122 fair value estimate by roughly 4%, with better-than-expected international development results in the Taco Bell division driving a slightly larger increase than the roughly 2% lift from time value. Shares look fairly valued.

Our restaurant coverage has taken a beating over the past two quarters, shedding 8%-10% of its market cap (albeit modestly ahead of a 12%-13% decline in Morningstar's U.S. Large Cap Index) as inflation and a weaker consumer have driven sagging near-term prospects. With wages and food costs each up about 20% since the onset of the COVID-19 pandemic, restauranteurs have been forced to absorb substantial pressure: across our coverage, we've seen a median decline of 630 basis points of restaurant margin over the past 12 months. We don't expect a full margin recovery until fiscal 2024, particularly since consumers naturally shift spending towards the relatively cheaper grocery channel amidst periods of economic pressure, blunting restaurant operators' ability to offset inflation with price increases in the higher cost per meal channel.