Business Context and Reporting Period
Yum! Brands, Inc. filed this Form 10-K for the fiscal year ended December 31, 2019, which included a 53rd week for U.S. and certain international operations. The company franchises and operates KFC, Pizza Hut and Taco Bell across 152 countries and territories. At year-end, it had 50,170 restaurants; 98% were franchised. Results reflect an asset-light model and the continuing shift of company-operated restaurants to franchisees.
Financial Results and Key Metrics
| Metric | 2019 | 2018 | Change / context |
|---|---|---|---|
| Total revenue | $5.597 billion | $5.688 billion | Down 2%; franchise advertising contributions and related expense are reported gross, limiting comparisons with periods before 2018 adoption of the revenue standard. |
| Operating profit | $1.930 billion | $2.296 billion | Down 16%, principally reflecting much smaller refranchising gains. |
| Net income | $1.294 billion | $1.542 billion | Down 16%. |
| Diluted EPS | $4.14 | $4.69 | Down 12%; diluted EPS excluding Special Items rose 12% to $3.55. |
| Operating cash flow | $1.315 billion | $1.176 billion | Up; capital spending was $196 million. |
| Cash and cash equivalents | $605 million | $292 million | Year-end cash increased, including following an $800 million note issuance. |
| Total debt | $10.6 billion | $10.1 billion | Includes short-term borrowings and long-term debt; net interest expense was $486 million. |
| System sales | $52.584 billion | $49.237 billion | Reported growth 7%; growth excluding FX and the extra week was 8%. |
Same-store sales increased 3% worldwide; net new units grew 4%, with 2,040 net openings. By division, same-store sales were KFC +4%, Taco Bell +5% and Pizza Hut flat. Core operating profit grew 12%, or 11% excluding the extra week. The extra week contributed an estimated $24 million to operating profit, $17 million to net income and $0.05 to diluted EPS.
Company restaurant margin was 20.1%, compared with 18.3% in 2018; the filing attributes the improvement partly to sales growth and refranchising. The GAAP effective tax rate was 5.7%, versus 16.2%; excluding Special Items, it was 19.8% versus 20.4%. A one-time $226 million deferred tax benefit related to intellectual-property transfers materially affected the reported tax rate.
Material Changes Versus the Prior Period
- Refranchising gains fell to $37 million from $540 million in 2018 and $1.083 billion in 2017; 25 restaurants were refranchised in 2019. Company sales declined to $1.546 billion from $2.000 billion, principally due to refranchising.
- Franchise and property revenue rose to $2.660 billion from $2.482 billion, supported by unit growth and franchise sales. Reported franchise advertising contributions and related expense were $1.391 billion and $1.368 billion, respectively.
- Yum repurchased 7.8 million shares for approximately $810 million and paid $511 million in dividends. The declared annual dividend was $1.68 per share.
- The Grubhub investment generated a $77 million pretax fair-value loss in 2019, compared with a $14 million gain in 2018.
Liquidity, Outlook, Risks and Unusual Items
Management said cash, operating cash flow and an undrawn $1 billion revolving facility were expected to fund operations, planned capital spending and debt obligations for the next 12 months. The company targets leverage of approximately 5.0x EBITDA; approximately 92% of year-end debt was effectively fixed-rate, at an effective overall rate of about 4.7%. The balance sheet had a $14 million current-liability excess over current assets and a shareholders’ deficit of $8.016 billion. Management characterized working-capital deficits as typical for the business.
- Coronavirus: As of the filing, Yum China had widespread restaurant closures, reduced hours and significant sales declines; nearby markets were also affected. Yum China royalties represented about 20% of KFC and 16% of Pizza Hut division operating profit in 2019. Management expected significant impact in the quarter ending March 31, 2020, with possible continuing effects, but could not reliably quantify them.
- Pizza Hut U.S. franchisee stress: Pizza Hut recorded $22 million of bad-debt expense, primarily tied to financially challenged U.S. franchisees. Management cited pressured unit economics, wage increases, sales declines and high franchisee debt, and warned of potential further bad debt, lease-guarantee payments, advertising reductions and closures.
- India enforcement matter: An order issued January 29, 2020 imposed a penalty of approximately $156 million on a subsidiary and former directors. The company disputes liability, intends to appeal and did not record a reserve, judging a significant loss not probable; a deposit may be required during appeals.
- Other risks: Dependence on franchisees and Yum China; food safety and supply disruptions; labor, commodity, competition, currency, cyber and regulatory risks; substantial debt and refinancing exposure; and litigation and tax uncertainties.
- Acquisition: In January 2020, Yum announced an agreement to acquire The Habit Restaurants for approximately $375 million, plus potential funding of amounts under Habit’s tax receivable agreement and transaction costs. The proposed deal was expected to close by the end of Q1 2020 and was to be funded with cash and revolving-facility capacity.
Most Important Facts for Investors to Verify
- Track coronavirus-related closures, system sales and royalty receipts, especially from Yum China, and assess effects beyond Q1 2020.
- Monitor Pizza Hut U.S. franchisee solvency, bad debts, unit closures, advertising contributions and Yum’s contingent lease exposure.
- Assess debt maturities, covenant compliance, interest costs and the company’s ability to maintain its leverage and capital-return plans.
- Review the India penalty appeal and any required deposit, as well as material tax positions and the assumptions underlying the intellectual-property tax benefit.
- Separate recurring operating performance from the 53rd-week contribution, refranchising gains, Grubhub fair-value changes and tax-related Special Items.