The shares of Yum China Holdings (YUMC) are a bargain, according to Quo Vadis President John Zolidis.
They trade for just 10x EV/EBITDA on projected Fiscal Year 2023 earnings. “Imagine an equivalent business in the U.S. with 20%+ RLM and mid-teens EBITDA margins growing at this rate,” he says. “It would be trading where? 18x 20x? Certainly, not 10x.”
I’m neutral on YUMC’s shares. (See Insiders’ Hot Stocks on TipRanks)
Lackluster Performance
Zolidis’ comments came after the American-based restaurant operator in China reported lukewarm Q3 financial results last week due to the negative impact of COVID-19 outbreaks in some of the provinces in which it operates.
That’s something the company has already warned investors of a couple of months ago, and it is expected to impact fourth-quarter results as well.
“Our third quarter results are in line with expectations that we indicated in the September business update. We took immediate action to manage costs and leverage technology to drive productivity,” said Andy Yeung, CFO of Yum China. “Looking ahead, we expect the near-term environment to be challenging. We expect that COVID-19, especially the Delta variant outbreaks, will continue to affect consumer behavior and impact our same-store sales recovery.
“Keep in mind that fourth quarter is the seasonally lowest quarter for sales and profit margins, so small changes in sales and operations will considerably impact profitability.”
Investing in China is Out of Favor
COVID-19 outbreaks aren’t YUMC’s only problem. In recent months, investing in China-related business has been out of favor as the Chinese government has harshly criticized private enterprises, and tightened business regulations.
Wall Street has noticed. YUMC’s shares have been flat year-to-date compared to a 25% gain of the S&P 500. The three Wall Street analysts following the company’s shares in the last three months see a limited upside potential over the next 12 months. The average Yum China price target is $64.97, with a high forecast of $72, and a low forecast of $52.90. The average price target represents a 15.6% change from the last price of $56.21.
Nonetheless, Zolidis is bullish on the company, citing a solid balance sheet with $4 billion in cash and no corporate debt, other than the money owed for leases.
“If you can put aside ‘it’s China’ as a negative filter, the company is super interesting right now,” he says. “YUMC is the fastest growing restaurant company (in terms of units) in the world.”
Meanwhile, Zolidis points to the company squeezing costs out of the box.
“The math is clear,” he adds. “Assuming revs and margins hold, a lower investment equals more cash flow for the total company and higher ROIC. Normally, these should correlate with valuation expansion.”
Hopefully, he’s right, provided that the COVID-19 situation improves, the Chinese government eases its criticism of private businesses, and U.S.-China relations do not turn for the worse.
Disclosure: At the time of publication, Panos Mourdoukoutas owned shares of YUMC.
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