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Topic: Growth Stocks

YUM! Brands Inc. $49 – New York symbol YUM

YUM! BRANDS INC. $49 (New York symbol YUM; Aggressive Growth Portfolio, Consumer sector; WSSF Rating: Average) operates around 32,000 fast food restaurants in over 100 countries. That’s more outlets than McDonald’s (see box on page 62), although McDonald’s generates higher annual sales.

The company owns about 25% of these restaurants, and franchisees own the rest. It aims to sell more of its U.S. outlets to franchisees in the next few years, which would cut its overall risk. Yum prefers to own stores in developing countries, however, at least until local managers learn the business.

Yum gets most of its sales and profits from three main banners: KFC (chicken); Pizza Hut; and Taco Bell (Mexican food). It also operates the smaller A&W (hamburgers) and Long John Silver’s (seafood) chains.

Offering a wide variety of foods helps cut Yum’s exposure to changing tastes and preferences. It also cuts its risk to unpredictable food-safety issues, such as mad cow disease and avian flu.

Yum’s sales grew 34.5%, from $6.95 billion in 2001 to $9.35 billion in 2005. Earnings before unusual items rose 57.4%, from $1.62 a share (total $492 million) in 2001 to $2.55 a share ($762 million) in 2005.

Most of this growth comes from Yum’s aggressive overseas expansion. It now operates 1,900 KFC and 300 Pizza Hut outlets in China. Yum’s China division, which includes Hong Kong, Taiwan and Thailand, now accounts for 15% of its total sales and profits.

Surviving a 2005 safety scare

In 2005, the discovery of an illegal dye in a seasoning used in its Chinese KFC restaurants hurt Yum’s sales. It quickly fixed the problem, and sales in China still grew a healthy 11% that year. But that’s well short of Yum’s target of at least 22% growth.

Another risk for Yum’s Chinese operations is avian flu. Its chicken suppliers have stepped up testing, so it’s unlikely that any contaminated meat will ever reach consumers. In the event of an outbreak, Yum could import chickens from other parts of the world.

Yum plans to add 400 more restaurants in China this year, mostly KFC. It also plans to expand Pizza Hut’s home delivery service to more cities.

Yum has other overseas expansion targets in addition to China. It recently acquired Rostik’s, a chain of about 100 fried chicken restaurants in Russia. It’s also opening more Pizza Huts in India.

India is a particular inviting market for pizza since so much of the population is vegetarian.

In the United States, Yum aims to spur long-term growth by combining two or more of its brands in a single location. These stores, particularly KFC/Taco Bell outlets, tend to generate higher sales than standalone locations. They also make better use of real estate, and let Yum reach markets that are too small for a single-brand location.

Multibrand units fuel profits

The company now has over 3,350 multibrand stores, more than 10% of its total outlets. It plans to add 550 multibrand locations a year for the next few years.

Consequently, Yum will probably spend $2.50 a share on capital upgrades in 2006, up 14.2% from $2.19 in 2005. Capital spending could reach $2.75 a share in 2007.

Yum’s cash flow this year should reach $4.80 a share, up 8.3% from $4.43 in 2005. That gives it plenty of cash for its planned projects, as well other uses such as share buybacks. Yum just increased its quarterly dividend 30.4%, from $0.115 a share to $0.15. The new annual rate of $0.60 yields 1.2%.

Still cheap in relation to prospects

Yum has more than doubled for us since we first recommended it in our January, 2000 issue at $19 (adjusted for splits).

The stock now trades at 17.3 times the $2.83 a share it should earn in 2006. That’s cheap in light of its growth potential and well-known brands.

Yum Brands is a buy.

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