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Ahead of Sohn, A Look At Loeb’s Yum! Thesis

In all likelihood, Keith Meister of Corvex will be talking Yum! Brands at the Sohn conference. Dan Loeb is also long Yum! after revealing the news via its 1Q letter. Here’s the condensed version of its Yum! position.

The key thesis is Yum!’s troubles in China are over, which should change public perception over the next year or so. The company took it on the chin in 2012 and 2014 due to safety concerns. 2012 marked the news of excessive antibiotic use in its poultry and then in 2014 there was the use of expired meat.

Now, It has a massive franchise in China, operating 3x as many restaurants there as McDonald’s. The key is that it owns 80% of its stores there and it generate over a third of profits from there.

However, the concept (KFC in China) is still resonating with customers there. There’s room to get current customers coming back to its stores. Its average China KFC brings in $1.3mm today with a 15% operating margin, versus the $1.7mm and 20% margins they had before the 2012 safety concern.

Long-term focuses:

  1. China: Yum! sees the potential for 20,000 KFC and Pizza Hut stores in China, versus the current 7,000.

  2. Outside of China: Boost the mix of high cash flow generative franchised units from 91% to 95% by 2017.

Brand specific fixes:

  1. KFC needs to improve its menu and offerings. KFC generates $1.2mm/unit with a 13% restaurant-level operating margin. Plenty of room for improvement, where Popeyes generates $1.6mm/unit at 19% margins, Bojangles does $1.8mm/unit at 18% margins and Chick-fil-A does $3mm/unit. The fix includes adding more chicken sandwiches (look at Chick-fil-A’s success) and enter the late night and breakfast categories.

  2. Pizza Hut needs to find its relevance. Trying to be casual dining concept with delivery doesn’t work, especially with Domino’s killing it in delivery. Pizza Hut is pulling in $0.8mm/unit with 8% restaurant-level operating margins. Domino’s is doing the same revenue per unit, with much smaller stores and margins of 23%. Digital and small box delivery models should be Pizza Hut’s focus.

Look for management to leverage value-enhancing actions like:

  1. More re-franchising

  2. More leverage

  3. Or an alternative ownership structure