How will the coronavirus crisis in China hurt Yum China?
Miam brands (NYSE: MIAM), KFC’s parent company, Taco Bell and Pizza Hut, has divested its operations in China as Yum China (NYSE: YUMC) at the end of 2016. Prior to this split, Yum China’s growth had slowed considerably due to bird flu outbreaks and a scandal involving stale meat.
Some analysts praised the spin-off, while others said Yum was prematurely abandoning its Chinese business. But since the split, Yum China shares have jumped 75% while Yum Brands shares have risen just over 60%.
Yum China’s revenue grew thanks to strong same-store sales at KFC and Pizza Hut, and its margins gradually increased. However, that enthusiasm recently waned when the company provided a grim update on the coronavirus outbreak in its fourth quarter. conference call.
What did Yum China say about the coronavirus?
CFO Andy Yeung said the outbreaks caused “significant disruptions” in its operations due to the temporary closure of restaurants before the Chinese New Year and a “substantial drop in sales” at locations that have remained open. .
Yeung said that “over 30%” of its restaurants are still closed and the traffic in its open locations “[was] impacted by travel restrictions, suspended festivities and shortened opening hours as people avoid going out.
Yeung warned that the company still couldn’t “predict when, or how quickly, closed restaurants will reopen,” and that it could “experience operating losses” for the first quarter of 2020 and the full year if current trends continue. .
On the positive side, deliveries have remained robust as “contactless” services have increased in which couriers avoid direct contact with customers. CEO Joey Wat also noted that the coronavirus crisis is hurting Pizza Hut more than KFC, which relies more on in-store deliveries and pickups than Pizza Hut.
Despite all of these headwinds, Yum China still plans to open 800 to 850 new stores this year and increase its store count by approximately 9% to over 10,000 locations. It also expects its investments to be between $ 500 million and $ 550 million for 2020 as it opens new stores, upgrades existing stores and increases its investments in digital, IT and infrastructure.
Yeung said the company will “continue to invest” in its emerging brands and that its acquisition of casual restaurant chain Huang Ji Huang is still on track for closing at the start of 2020. In short, Yum China is still considering the coronavirus crisis as a one-off event that will not slow down its long-term growth.
But is Yum China too optimistic?
When the coronavirus outbreak began, many analysts compared the outbreak to the SARS outbreak, which lasted around eight months and killed nearly 800 people in 2002 and 2003.
However, the COVID-19 coronavirus appears to be significantly more dangerous than SARS. It has already claimed more than 2,000 lives and infected more than 75,000 people since the virus was identified last December.
The lack of media transparency in China, along with widespread mistrust of official government figures, also makes it difficult to assess the true impact of the virus on the Chinese economy. China’s recent actions – including financial stimulus packages, city-wide closures and the hasty construction of a massive hospital – also indicate that the situation could get worse.
If the situation worsens, Yum China could publish at least several quarters of double-digit revenue decline and slumped margins. Meanwhile, stricter closures and quarantines could prevent the company from meeting its goal of exceeding 10,000 stores by the end of 2020.
Wall Street currently expects Yum China’s revenue and profits to fall 8% and 52% respectively this year. These forecasts mainly reflect the economic downturn and gains from its investment in the delivery platform Meituan Dianping (OTC: MPNGF) instead of the recent coronavirus outbreak.
Yum China’s futures P / E of 23, which is based on these outdated forecasts, is already high for a company facing declining revenues and profits this year. If these forecasts are lowered, its valuation will rise even more, indicating that the stock is currently overvalued.
The bottom line
We cannot say how the coronavirus crisis will hurt Yum China again, but there just isn’t enough fear in the course of action. Investors should avoid this stock until management offers a clearer view of the situation and demonstrates that it can weather the storm.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.