Trading at 25x earnings and with an array of challenges ahead, shares of Yum! Brands (YUM) look fully valued right now.
Don’t get me wrong. I have no shame in confessing that I’m a big fan of the Taco Bell breakfast, the nacho fries, and maybe even the occasional Baja Blast here and there.
Still, at current prices, the overall upside seems limited in the short term, and I would wait for a pullback to consider looking at Yum! Brands a Buy. I am neutral on the stock.
Valuation
While YUM is a well-run business that has delivered good returns to shareholders for many years, the valuation seems stretched right now at 25x earnings and 26x forward earnings.
We are in a market environment where many high-multiple companies are enduring multiple compression. I don’t necessarily think YUM’s multiple will contract meaningfully, but it is hard to see it expanding from here against this market backdrop. A P/E ratio approaching 30x would historically be reserved for a company exhibiting phenomenal growth and innovation.
For comparison’s sake, a company like Alphabet (GOOG) is trading at 27x earnings. Historically, YUM has traded at an average of 24x earnings. So, compared to this benchmark, it seems fully valued.
YUM pays out a dividend, but at 1.5%, it is a fairly low yield at current prices, and this will become even less meaningful as rates increase.
YUM is priced for perfection right now, and unfortunately, as I will explain next, this does not seem like the perfect operating environment for the company.
Wage and Commodity Inflation Challenge Top and Bottom Line
Most of us have probably heard about the ‘Great Resignation’ and how companies are having trouble attracting employees to come back to work, especially at the lower ends of the wage scale. This is a challenge for fast food restaurants like those in Yum’s portfolio, and you can see this coming into fruition by the fact that some locations are operating with reduced hours.
Anecdotally, I have seen a Taco Bell near me reduce its operating hours from noon to 9:00 PM. This cuts out the breakfast part entirely and the late-night window, which Taco Bell has become synonymous with over the years.
This will, unfortunately, hurt companies like this on both the top and bottom lines – increasing wages to attract employees and achieve adequate staffing eats into the bottom line, while operating with reduced hours and missing entire things like breakfast reduces top-line growth.
Not only does YUM have to contend with rising wages and getting its locations fully staffed again, but franchises are also dealing with inflation in terms of food costs. In addition to rising input prices, supply chain challenges can mean that some items are missing entirely for several days at a time.
Wall Street’s Take
Turning to Wall Street, YUM stock earns a Moderate Buy consensus rating based on seven Buys and seven Holds assigned in the past three months.
The average Yum! Brands price target is $144.08, implying 11.3% upside potential.
Takeaway
I don’t think shares of YUM are going to tank, and I would not go as far as to short the stock or go full-on bearish here, but valuation seems like a stretch against a challenging backdrop, and I feel that upside is limited in the short-term at these levels.
There are a lot of other companies trading at similar or lower multiples that seem like they have more upside. I would wait for a significant pullback in shares of YUM before re-evaluating it as a buying opportunity.
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