YUM! Brands: Why YUM!, Why Now BY JOHNNY CHANG

What is YUM? RANKED #213 ON THE FORTUNE 500 COMPANIES LIST, YUM! WAS SPUN OFF FROM PEPSICO (PEP) IN 1997. ITS TOP BRANDS INCLUDE TACO BELL, KFC, AND PIZZA HUT, AS WELL AS RECENTLY ACQUIRED LITTLE SHEEP AND EAST DAWNING FRANCHISES WITHIN CHINA. YUM! REPRESENTS AN EXCELLENT LONG-TERM INVESTMENT WITH EXTRAORDINARY VALUE AND EXCELLENT GROWTH PROSPECTS. THIS PRESENTATION IS LARGELY BASED ON FUNDAMENTAL, QUALITATIVE ANALYSIS WITH QUANTITATIVE ANALYSIS INTERSPERSED TO ILLUSTRATE MAGNITUDE OF IMPACT.

YUM! Business •  Consumer foodservice corporation specializing in quick-

service restaurants (QSR) •  KFC, Taco Bell, Pizza Hut

•  Largest QSR chain by units (39,000 in 125+ countries/territories)

•  Achieved >10% EPS growth for past 11 years •  Consistent growth and resistance to cyclical market forces

•  18% return in past 5 years to date vs. 2% S&P •  Excellent above-market returns

Taco Bell US Pizza Hut US KFC US

Yum! Restaurants International YR China YR India

YUM! Strategies for Growth •  Reduce exposure to shrinking domestic markets

•  Lump sum + steady royalties •  Simultaneously increase exposure to high-growth

emerging markets (EMs) •  70% exposure by 2014 from 16% in 2001

•  Appeal toward growing middle class within EMs •  Lever scale and growth to attain lowest raw material

cost from suppliers in EMs •  Broaden scope into fast-casual and casual dining •  Widen economic moat through supplier relations •  Provide American food... internationally

Growth Opportunities •  YUM! actively invests in international growth •  Illustration: 58 YUM! QSR per 1M people in US

•  2 YUM! QSR per 1M people internationally •  China, YRI (YUM! Restaurants International),

and India Branches drive YUM! Brand growth •  Casual and fast-casual markets are relatively

untapped by YUM!

China: Overview •  China: the “greatest restaurant opportunity in the

21st century.” – CEO David Novak •  “Chains control just 3% of the Chinese restaurant

industry.” – PricewaterhouseCoopers 2012 •  Fragmentation is opportunity for YUM!

•  Chinese market comprised of 5,700 primarily company-owned KFCs and Pizza Huts •  Rapidly increasing company exposure to EMs

•  Wealth growing, time shrinking → growth of QSR •  4 YUM! Restaurants per 1M people vs 60:1M in US •  Twice the MCD restaurants in China

China: QSR Key Targets •  KFC is #1 QSR chain in China •  More than 1 KFC opened per day in China

•  >4000 restaurants in >800 cities •  YUM! China manager projects 20,000 stores

•  Steady growth, solid marketshare positions KFC as a cash cow in China

•  Considered one of the companies that best understands Chinese consumers

•  East Dawning creates growth opportunity

China: Short-Term Hurdles •  Chinese probe found higher-than-permitted levels

of antibiotics in chicken from 2 suppliers •  KFC sales down sharply following news •  CEO: EPS would be in mid-single digits in 2013 •  YUM! Recovery essentially guaranteed

•  EX 1: Quick recovery from Sudan Red/avian flu scare when same store sales plummeted 40%

•  EX 2:Recovered from bogus lawsuit on Taco Bell meat content

•  Timing is the unknown factor

•  Recovery strategy: aggressive marketing following historically strong sales from Chinese New Year

China: Little Sheep •  Hot pot chain acquired in 2012 to boost casual

dining branch •  Adds diversity to YUM! China portfolio •  Generated 5% of revenue base in China in

2012 •  Represents YUM! Brand’s almost monopolistic

control versus opponents in China

International: Russia •  Franchiser gained foothold; YUM! taking over •  Acquired Rostik’s-KFC and rapidly building new

company-owned units •  Relatively unpenetrated market •  Unparalleled performance: 2012 Q2 44%

system sales growth, 32% same-store sales growth.

•  Excellent growth opportunity with amazing potential

International: France/Germany, DM •  Reached sufficient scale to begin television

advertising •  Marketing campaigns lead to solid gains in

marketshare and comps •  Room to grow even in developed markets

International: India •  Controls most trusted food brands in India •  Seen as top restaurant brand that understands

unique consumer tastes •  KFC = fastest growing QSR •  Quickly developing world's #2 EM •  Taco Bell entering as 3rd international brand •  $100 mm investment

International: Africa •  Most popular YUM! restaurant brand = KFC •  Considered high-status place to eat out •  Rapidly expanding market •  Excellent comps

Domestic Strategies •  Culminates in moving company-owned stores

into the hands of franchisees •  Frees up management and capital for EM •  Decreases exposure in slow growth areas •  Increases exposure in unsaturated domestic

markets o  Pizza Hut + KFC: Follows tested DelCo Lite model o  Contemporary design fits restaurants snugly in

small spaces o  Lower investment point (Low cost to construct) o  Penetrates underserviced small towns

Debt •  D/E = 1.306 as of December 2012

•  High, but rapidly decreasing •  Dec 2011: 1.731; Dec 2010: 2.150; Dec 2009: 2.932

•  Although debt still plays a role in financing YUM, excellent stewardship moves this measurement rapidly towards a healthy point

•  This debt manifests itself in ROE v. ROA •  ROE: 80.31%; ROA: 18.02% •  Unusually large difference. Debt is a large factor in

running this company; need to be wary

Valuation •  YUM! Brands holds secure positions in not only

amazing international growth, but unprecedented domestic growth opportunities

•  Temporarily hit (-10% peak) by supplier worries •  Chinese 60 Minutes equivalent reported that 2 KFC

chicken suppliers used over the legal amount of antibiotics

•  Comps fell dramatically, but recovered quickly in the next quarter.

•  Recovery est. completed by 2014; 2013 may be a slow year

•  Short-term buying opportunity

Bulls Say •  Transient undervaluation b/c chicken scandal •  Solid international foothold for amazing growth •  Proven strategies for domestic growth •  Excellent stewardship increases exposure to high-

growth areas •  Enormous brand strength •  Reliance on debt rapidly decreasing •  = Excellent buying opportunity

Bears Say •  High level of funding by debt •  Uncertain recovery time period from KFC

chicken scandal •  Lower level of consumer confidence in KFC

within China

Conclusion EXAMINING BOTH THE BULLISH AND BEARISH REASONS FOR YUM! BRANDS, I BELIEVE THAT THE BENEFITS AND RETURN POTENTIAL YUM! PROVIDES OVERWHELMINGLY OUTWEIGH THE RISKS. THROUGH CONSISTENT RETURNS TO INVESTORS, EXCELLENT GROWTH OPPORTUNITIES, AND A SCRUMPTIOUS CURRENT VALUATION, YUM! BRANDS LOOKS UNDENIABLY DELICIOUS.