It’s said that investing in stocks is basically a bet.
After all, plunking down thousands of dollars for equity in a company is making a bet that they’ll be able to grow over time and grow your investment as well.
However, I like to hedge that bet by making sure that I invest in companies that pay growing dividends.
That’s because I’m receiving a little bit of my investment back with every dividend payment. That reduces the size of my “bet” over time, and the amount of capital I can possibly lose.
[ad#Google Adsense 336×280-IA]But another way to hedge is to invest in companies that produce products and/or services that people almost cannot live without.
Take food for instance.
It’s a good bet that people aren’t going to stop buying takeout pizza, right?
Would it be too much of a stretch to say that consumers will still be buying fried chicken 10 years from now? What about Mexican food like burritos and tacos?
A company that provides these types of products has likely been around for a while and will also likely remain so.
That’s why an investment in a company like Yum Brands, Inc. (YUM) seems like a good idea here.
Yum is the less well-known name for a company that houses some of the world’s most popular quick service restaurants. That includes KFC, Taco Bell, and Pizza Hut. Combined, the company operates more than 40,000 units across more than 125 countries.
This company has a huge opportunity on its hands. Sure, young consumers here in the US are perhaps increasingly likely to purchase food from higher-cost restaurants that serve what’s perceived to be higher-quality food. However, YUM is spread out across the world with a lot of exposure to fast-growing markets in India and China. There are huge tailwinds on their side here as you have an increasing number of consumers joining the ranks of the global middle class, and these consumers will be hungry and in a hurry.
YUM has grown especially quickly in China, where its KFC brand has been incredibly popular. KFC now operates more than 4,600 outlets in China, which makes them by far the country’s largest quick service restaurant chain. As Chinese consumers have prospered, so has KFC. Though that means the market becomes more competitive and consumers’ choices become greater, this growth has helped fuel YUM’s global brand.
So let’s take a look and see what a massive collection of global, high-quality quick service restaurant chains can deliver in terms of profit and growth.
Revenue was $9.011 billion in fiscal year 2004. That grew to $13.084 billion in FY 2013, which is a compound annual growth rate of 4.23%. Not too shabby, but one would perhaps hope for a better top-line performance.
Earnings per share increased from $1.21 to $2.36 during this 10-year stretch. That’s a CAGR of 7.71%. More impressive, though fiscal year 2013 was negatively impacted by some meat supplier issues in China. This rate of growth, that’s well in excess of revenue, was assisted by a rather aggressive share buyback plan. During this period, YUM reduced its share count by approximately 25%. So that’s about 3/4 the shares with which to split net income between, which makes a huge difference for the remaining owners.
S&P Capital IQ is predicting that EPS will grow at a compound annual rate of 12% over the next three years, citing greater growth in China after some aforementioned issues with food suppliers.
But there’s more than just growth. After all, if a company isn’t sharing a piece of the profit pie with its shareholders, then all of your money is on the line. So when the stock goes up or down, so does your wealth. Dividends meanwhile flow directly from the company to your pockets and reduces the amount of capital you have riding on the stock. Dividends also count for a significant portion of investors’ total returns over long periods of time.
YUM has definitely been sharing the good fortune with its shareholders – they’ve increased their dividend for the past 11 consecutive years.
And the raises have been impressive, leading to a five-year dividend growth rate of 14.3%.
The stock only yields 2.27% here, but you can see how the combined yield and growth rate can lead to outstanding total returns. Indeed, the stock is up more than 200% over the last decade alone.
Looking at the payout ratio, we can see that YUM is paying out 51.3% of earnings in the form of a dividend.
That’s not only a moderate payout ratio, but it’s also temporarily elevated since FY 2013 earnings are lower than normal. The dividend is definitely well-covered here.
Shareholders should be reassured with this dividend policy. I see no reason why the dividend won’t continue growing at a very attractive rate. A solid yield and a high growth rate should continue to produce great total returns, as the sum of the yield and the dividend growth rate is a proxy for total returns over the long term.
One aspect of the company’s fundamentals that I’d like to perhaps see improved is the balance sheet. A conservatively run balance sheet allows a company a ton of financial flexibility, so lower debt is usually a good thing. However, low interest rates has led to a lot companies taking advantage and piling on low-interest debt to retire shares and increase returns. Not a bad idea as long as it’s done responsibly.
YUM’s long-term debt/equity ratio is 1.35, while the interest coverage ratio is 6.74. These numbers aren’t worrisome, but they could probably be improved.
Profitability appears to be robust. Looking at net margin, it’s averaged 10.12% over the last five years, while return on equity averaged 112.98%. The ROE seems inflated from low common equity.
Some people like to make investing complicated. But it needn’t be so. This is a business that’s really easy to understand. Fried chicken and coleslaw. Tacos and burritos. Pizza and bread sticks. It’s obviously not difficult to understand how this company stays in demand and makes money. Consumers are just plain highly likely to continue consuming these types of products for years to come.
YUM isn’t a risk-free investment, however. Competition in the global restaurant industry is fierce. In addition, consumers’ tastes change over time. And being a global firm, the company is highly exposed to fluctuating currencies, which can act as either headwinds or tailwinds. Finally, input costs can vary, which can affect margin and profit.
This stock has typically been priced at a premium relative to the market, and the same is true today. At a P/E ratio of 22.62, this is well in excess of the S&P 500 index. However, this is in line with YUM’s five-year average.
I valued shares using a dividend discount model analysis with a 10% discount rate and a 7.5% long-term growth rate. That’s in line with the 10-year growth in earnings per share, but this also factors in the fact that EPS growth was recently hampered. So I believe there’s a margin of safety here. The DDM analysis gives me a fair value on shares of $70.52.
Bottom line: Yum Brands, Inc. (YUM) is a global juggernaut in the quick service restaurant industry. They have dominant and established brands across multiple concepts, with especially solid placement in China. They’re well-positioned to continue serving good food fast to people across the world and profiting from it, while shareholders will likely continue collecting a portion of those rising profits. Shares appear roughly fairly valued right now, which could be an opportunity to buy into this fast food giant here.
— Jason Fieber, Dividend Mantra
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