Yum China Stock: Correction Presents Good Opportunity

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(C) Reuters. Yum China Stock: Correction Presents Good Opportunity

Yum China (YUMC) stock surged to its 52-week high of $69.67 on June 2. The stock has subsequently witnessed some correction.

A recent announcement that the company’s adjusted operating profit is likely to be 50% to 60% lower in Q3 2021 accelerated the downside. A renewed COVID-19 outbreak in China has been the catalyst for the downward revision in growth estimates.

However, I am bullish on Yum China stock. The headwind is temporary and the company has aggressive long-term growth plans. (See YUMC stock charts on TipRanks)

Aggressive Store Expansion

The pandemic is likely to impact the company’s expansion in Q3 2021. Yum China however, has ambitious long-term plans.

To put things into perspective, the company opened 404 new stores in Q2 2021. Further, in the last 12 months, the number of stores has increased by 1,069.

Yum China has also entered 100 new cities in the last 12 months. With ample scope for penetration, coupled with an attractive payback period, there is potential for sustained expansion.

The store openings have translated into healthy revenue growth for the company. For the first half of 2021, Yum China reported revenue growth of 37% on a year-over-year basis.

Recently, Yum China and Lavazza announced plans to accelerate growth in China. The partnership has plans to open 1,000 stores through 2025.

Besides aggressive store openings, the following two factors are likely to boost growth and key margins.

First, the company has been focused on omnichannel growth. Delivery, as a percentage of total sales was 29% for KFC, and 35% for Pizza Hut. The company’s same-store sales growth was 8% for the first half of 2021. It’s likely that same-store sales growth will remain strong.

Further, Yum China has been focused on product innovation across brands. As an example, the company had changed 40% of the menu items for Pizza Hut in March 2021, on a year-over-year basis.

Similarly, for the KFC brand, the company has been focused on catering to local taste buds. These initiatives have already delivered results in the form of higher same-store comparable sales.

Strong Financial Profile

As of Q2 2021, Yum China reported $4.3 billion in cash and equivalents. Further, for the first two quarters of the year, the company reported operating cash flows of $470 million.

Therefore, there is ample financial flexibility to pursue aggressive expansion and increase shareholder returns. It’s worth noting that Yum China resumed cash dividends in Q4 2020. There is a strong possibility of sustained dividend growth considering the expansion plans.

Additionally, Yum China has been active on the merger and acquisition front. Last year, the company acquired Huang Ji Huang.

Wall Street’s Take

According to TipRanks’ analyst rating consensus, YUMC stock comes in as a Moderate Buy, with four Buys and one Sell assigned in the past three months.

The average YUMC price target is $70 per share, implying 18.7% upside potential from current levels.

Bottom Line

Yum China’s growth is likely to witness a temporary pause due to the pandemic headwind. However, the long-term outlook remains robust. For 2021, the company has a target of opening 1,300 new stores.

Multiple sales channels, and increased store penetration is likely to boost top-line, and earnings, growth. Further, a dynamic menu is likely to boost the average ticket size, and same-store sales growth. Over the next few years, the operating margin is therefore likely to trend higher.

Yum China stock therefore looks attractive after its recent correction.

Disclosure: At the time of publication, Faisal Humayun did not have a position in any of the securities mentioned in this article.

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