Yum Brands: Be Bold, Buy on Weakness

Source: Thinkstock

Source: Thinkstock

Shortly after Yum! Brands (NYSE:YUM) released its earnings figures, I suggested that the company was rebounding, and that the company stood out as one of the better fast food bests among its peers. However, I also suggested that the stock looked a little pricey, and that investors who appreciated the thesis should consider waiting for a pullback.

Since then the stock is down about $3 to just under $75/share. Is now the time to buy, or is there more downside before it becomes attractive?

Before discussing this let us look at the investment thesis. Yum! Brands is attractive because it is growing faster than its peers. While this growth subsided for a couple of years it appears to be back, as evidenced by the company’s most recent earnings report. Sales, profits, and margins grew, and whereas investors had been concerned that the company had lost its competitive advantage in China due to health concerns, this seems to be in the past. Furthermore the company largely avoided the margin compression we saw from other companies as a result of a stronger dollar versus foreign currencies and rising agricultural commodity prices. Given the company’s growth rate it offers good value at $75/share, as it trades at just 21 times 2014 earnings and 18 times 2015 earnings.

Despite this I think that we can see the stock pull back further, and rather than getting the stock at a good valuation, I think investors might be able to get it at a great valuation. There are a few reasons for this.

First, there is a debate going on regarding the minimum wage in the United States. As this debate continues I think that companies that employ several workers as cashiers, clerks, and as fast food chefs are vulnerable to the downside even if they, as individual companies, won’t be affected to a large extent. If this debate makes the headlines, and especially if a minimum wage hike bill moves forward expect to see stocks such as Yum! Brands trade down. But as the market reacts keep in mind that Yum! Brands gets most of its business overseas, and that it would be largely unaffected.