Hot Stocks: Fast Food Restaurateur Yum! Brands Making China Its Main Course

By Mike Caggeso
Associate Editor
Money Morning

Yum! Brands Inc. (YUM) expects another year of double-digit profit growth.

For nearly everyone else, 2009 won’t be just “another year.” Nearly every economist expects the first half of the New Year to bring more of the same, a deepening global financial crisis that’ll throw an even bigger, wetter blanket on economic growth than it did this year.

Indeed, even more than in 2008, next year will be a real-life case study of the survival of the fittest. And Yum’s certainly fit for the fight.

“Our industry is better-positioned in times like this,” Yum Chief Executive Officer David C. Novak told The Wall Street Journal. “We’re better-positioned than most other categories and industries.”

Already, we’re seeing companies slash work forces, trim (or abolish) dividends, and lock the safe that stores their spending money, sell off holdings or even shut down completely.

Yum’s not immune from the downturn. It, too, is cutting $60 million in operating costs from its U.S. business. It’s also putting a hold on buying back shares next year to preserve cash.

But unlike most, Yum hasn’t red-lighted its 2009 expansion plans – it’s still planning to build as many as 1,400 restaurants in international markets. About 500 of those new stores will be in China. That’s part of the reason the overall company is projecting at least 10% profit growth in 2009.

More broadly, Yum is expanding in the world’s fastest-growing economies and is making its menu part and parcel of every foreign country in which it operates. Two factors have imbued the company with a corporate killer instinct that’s enabling it to survive and thrive in the face of the current harsh economic environment: The innate strength of its own brands and a proven ability to adapt to any market it decides to pursue.

For marketing muscle, the Louisville, Ky.-based Yum has an army of brands – Pizza Hut, Kentucky Fried Chicken, Long John Silvers and A&W – plus its own line of Yum Restaurants that it operates outside the United States.

And its overseas franchises – especially Pizza Hut and KFC – are especially adept at making themselves the people’s favorite local flavor, instead of just their favorite American flavor.

Here’s a look at some of the items on Pizza Hut’s China menu: tuna fish pizza, roasted squid, zesty shrimp soup, a variety of rice-and-meat dishes (kimchi pork, curry beef and Hungarian beef rice), green tea, and chocolate mousse cake.

The bottom line: Yum’s stronghold and growth potential in China is shaping up as one of the most promising investment stories of 2009.

China Stronghold

As far as Yum Chief Financial Officer Richard T. Curucci is concerned, the company’s target for 10% profit growth should be easy to hit.

“We can get these numbers without heroic sales performance” at existing restaurants in China, Carucci said on a Webcast from the company’s analyst meeting, Reuters reported.

While Carucci says that Yum is “still not sure how China’s going to respond to a slowing economy,” he is certain of the company’s master plan which makes the Red Dragon the centerpiece of its growth strategy.

As of now, the United States accounts for 41% of Yum’s operating profits. China accounts for 28% and the rest of the company’s operations around the world account for the remaining 31%.

By 2013, China will account for 40% of Yum’s operating profit, while the United States and the rest of the world will each account for a 30% share, according to company projections.

As this plays out, Yum should outdistance some of its rivals, especially McDonald’s Corp. (MCD). That’s because Yum has done a better job penetrating the China market.

From 2002 to 2007, Yum opened 1,678 new stores in China, for a total of 2,558. In that same span, McDonald’s added 330 stores, giving the Golden Arches’ owner a total of 876 stores in China.

Yum has even stolen McDonald’s thunder in the mascot department. Its KFC mascot, a chicken character (naturally) named “Chicky,” roams stores and interacts with children. And the company’s Chicky program includes in-store birthday parties, kids’ fun camp and school tours of its stores. No wonder that Novak, the Yum CEO, boasted to Business Week two years ago that Chicky had already become “the Ronald McDonald of China.”

“We’re on the ground floor of a booming market, just like when Colonel Sanders started KFC and Ray Kroc started McDonald’s,” Novak told Business Week, noting that he one day wants to have as many restaurants in China as he does here in the United States.

Stateside Strategy

Novak said last week that the United States market was the lone problem the company has had in 2008.

Not only does Yum face a wider number and variety of competitors, but also fighting the headwinds of recession.

In addition to cutting $60 million from operational costs and suspending the company’s share buyback, Yum will offset the planned opening of 200 new U.S. restaurants by closing about the same number.

Other strategies will appear on the menu.

At Pizza Hut, the company is adding lasagna to its new Tuscani pasta line.

At KFC, it’s rolling out a grilled chicken option, a menu item Novak called a “transformational product” at an investor conference last week, The Associated Press reported.

The chicken chain will also create and promote a value menu, featuring items costing from $0.99 to $1.99.

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