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Is Yum! Brands (YUM) A Short?

Added on by Gordon Gekko .

Be sure to check out our detailed stock analysis (click here). With all the uncertainty around China, should Yum! Brands (NYSE: YUMbe a short candidate? Perhaps not enough downside risks have been built in for Yum!'s exposure to China, where over 50% of revenues are generated. 

The recent news driving Yum! down was the fact that KFC China’s suppliers overloaded its chicken with chemicals to expedite growth (see why Yum! is trying to fix China). Yum! remains unsure about how long it will take to recover sales at KFC in China, with management expecting weakness in China to deliver an expected drop of 25% in same store sales for the first quarter of 2013.

This recent event might be unveiling a bigger issue, brand erosion in China. Not only this, there are other regulatory issues related to operating in China. The slowing Chinese economy will also put pressure on the company, all of which have compelled management to offer guidance of low to mid-single digit earnings per share decline in 2013, opposed to its long-term target of at least 10% earnings growth.

While shorting any stock is risky, given there's limited upside and unlimited downside, I would rather avoid Yum! and invest in one of the other top performing fast food chains. Question is; which one?

Fast food frenzy

Jack in the Box Inc. (NASDAQ: JACK)posted EPS of $0.54 last quarter, versus $0.25 for the same quarter last year, on the back of 2.1% higher same store sales. Now the company expects next quarter same store sales to be flat, with specific same store sales down 2% at Qdoba. Jack in the Box still appears to be in restructuring mode, with plans to transform ownership of its higher-margin Qdoba units, from franchised to the company level and will likely see margin compression as a result. The Wendy's Company (NASDAQ: WEN) is seeing significant amount of capital expenditures as it tries to implement its turnaround. CapEx is expected to come in at upward to $500 million this year for overhaul and new store openings. 

Burger King Worldwide Inc (NYSE: BKW)reentered the public markets in 2012 after being acquired by 3G Capital in 2010, which helped the company reduce expenses and navigate a decline in consumer spending. 3G's changes included introduction of a value menu and a franchising effort that includes making 97% of Burger King’s restaurants franchised, versus 90% at the end of 2011. The move has helped the company to increase its bottom line, and reduce operating costs by 40%. Other key moves for taking market share from McDonald's and Wendy's includes renovation of 600 restaurants in US and Canada in 2012 and more expected to come (read about Burger King's venture into coffee).

Chipotle Mexican Grill, Inc. (NYSE: CMG) managed to continue growing throughout the economic downturn, and opened 155 to 165 new stores in 2012. For 2013, the company looks to open some 165 to 180 restaurants (see why Whitney Tilson is short Chipotle). The other positive for the company is its international expansion plan. The company plans to open ten international stores this year; four in Canada, five in London and one in Paris. The company also sees more opportunities in Europe, namely the UK, Germany and France. Chipotle's business model also offers robust high operating margins when compared to competitors.

Although the company has avoided the uncertainty and decline in China, the company has opened an Asian themed restaurant called ShopHouse Southeast Asian Kitchen in Washington, D.C. in 2011. The concept has performed well, and Chipotle plans to open yet another ShopHouse in D.C. and one in L.A. during 2013 (see more about the Taco Bell-Chipotle battle). It appears that Chipotle might be one of the best positioned fast food stocks, and this includes the fact that it has the best expected earnings growth:

Earnings growth (5-year expected)

  • Yum! 12%
  • Jack in the Box 13%
  • Wendy's 16%
  • Burger King 18%
  • Chipotle 20%

Another reason I like Chipotle is its superior balance sheet...

Debt to equity 

  • Yum! 137%
  • Jack in the Box 93%
  • Wendy's 74%
  • Burger King 260%
  • Chipotle 0%

Don't be fooled

Although Burger King has solid expected earnings potential, its balance sheet is a reason for concern. Since Burger King came back to the public markets in 2012 (after its short stint as a private company) the company has not had enough time to work down its debt. Thus, I think the company with the best expected growth, Chipotle, might be the better bet given its no-debt balance sheet. What's more is that Chipotle is looking to expand beyond internationally, and not to China, for now.