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Stock Analyst Update

Yum's Quarter Offers Investors Confidence

We're increasing our $78 fair value estimate for the narrow-moat firm.


We believe investors should walk away from  Yum's (YUM) third-quarter update with greater confidence in its longer-term growth algorithm, calling for 7% system sales and high-single-digit EBITDA/operating profit growth. Taco Bell (4% comps), KFC (3%), and Pizza Hut International (roughly 2%) each maintained or accelerated two-year comp trends, and early indications show that turnaround efforts at Pizza Hut are taking hold (most notably, advertising/operational changes to accelerate delivery). While additional refranchising transactions--Yum ended the quarter at 95% franchised and remains on track to be 98% franchised by the end of 2018--will create near-term earnings unevenness, we're becoming incrementally more optimistic about Yum's ability to drive 3%-4% system comps the next few years when factoring in the renewed delivery focus at Pizza Hut U.S., new delivery adoption at KFC and Taco Bell (helping transaction growth and average order size), and personalized marketing via mobile apps/loyalty programs. We're also expecting net unit development to accelerate to 3%-4% in 2018 as Yum benefits from development commitments attached to recent refranchising deals and greater use of alternative restaurant formats. We believe this will drive 7% system sales growth in 2018, and when factoring the operating leverage in Yum's narrow-moat business model and ongoing general and administrative cost reductions, we expect core operating profit growth to push 10% next year.

Based on increased visibility over Yum's near-term sales layers, unit development plans, and cost optimization, we still see management's 2019 EPS target of $3.75 as achievable and plan to add a few dollars to our $78 fair value estimate. While macro conditions are still a wild card, we anticipate that a more heavily franchised structure, new sales layers, and increased scale in emerging markets will keep system sales at 6%-7% and drive core operating margins to the mid-50s by 2020 (compared with 26.7% in 2016).

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R.J. Hottovy does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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