Should You Invest in Yum! Brands?

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Source: Thinkstock

Source: Thinkstock

Since being spun off by PepsiCo (NYSE:PEP), Yum! Brands (NYSE:YUM) has been an incredible performer — up 900 percent in 15 years. But recently, the company has faced some challenges. While investors were used to seeing double digit earnings growth like clockwork, the company saw its earnings decline and its margins compress. This was largely the result of a public relations snafu in 2012 when Chinese consumers found out that Kentucky Fried Chicken was giving antibiotics to its chickens. Sales in the company’s fastest growing market suddenly turned negative, and this took its toll on the company’s sales, profits, and margins.

Nevertheless, the company plans to “makeover” its Kentucky Fried Chicken brand in China, according to Reuters, and it is confidently projecting 20 percent earnings per share growth despite last year’s setback.

As a result, investor confidence has returned. In fact, the analysts seem to be more confident than the company itself, which is unusual. With the company projecting at least 20 percent earnings per share growth, this brings its 2014 earnings to about $2.85/share. Analysts are projecting $3.63/share. This means that analysts see the stock trading at just 20.6 times 2014 earnings. This makes the stock inexpensive considering the explosive growth projections that we are seeing.

However, if the company’s low end projection is correct, then the shares trade at 26.5 times earnings. This is a major difference; if the company is growing 2014 earnings 20 percent, then 26.5 is not a very appealing multiple to pay for the company’s earnings, especially since it is unlikely that the company will be able to maintain such a robust level of growth. After all, the growth projections from 2014 versus 2013 are only so high because management and investors are expecting a recovery off of a low point. If we average out the growth over a few years, the company’s earnings per share growth is in the low double digits even if 2014 growth comes in at 25 percent. This is certainly impressive considering how cutthroat the restaurant industry is, and considering the economic landscape, but it is not worth 26-times earnings.

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