John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
Craving some finger-lickin' good dividend growth? Yum Brands might just hit the spot.
The operator of KFC, Taco Bell and Pizza Hut is the largest fast-food purveyor in the world by number of restaurants, with nearly 38,000 locations in more than 120 countries. Although it trails market leader McDonald's in total revenue, Yum dominates in China and is expanding aggressively in India and other emerging markets, opening roughly four new restaurants outside the United States every day.
Fresh from posting third-quarter results that topped expectations, Yum is poised for its 11th consecutive year of earnings growth in excess of 13 per cent.
"Yum is a diversified, franchised cash machine," Mitchell Speiser, an analyst with Buckingham Research Group, said in a note in which he reiterated his "buy" rating on the shares.
To the delight of dividend investors, more of that cash is finding its way into their pockets.
Since initiating a dividend in 2004, Yum has raised its payment at double-digit rates for eight consecutive years. That includes an 18-per-cent increase in September, which lifted the dividend to 33.5 cents (U.S.) a share quarterly, or $1.34 annually. The company has also shown a healthy appetite for buying back its own shares.
"Despite growing at a rapid pace in overseas markets, the chain still generates significant cash and has increasingly committed to returning cash to shareholders," Edward Jones analyst Jack Russo said in a note to clients.
Helping to boost Yum's cash flow is a strategic decision to focus on franchising, which requires less capital than opening corporate stores.
Although Yum primarily operates company-owned stores in China because of that country's restrictive franchising laws, the vast majority of its other international restaurants are franchised. Yum is also freeing up cash by converting U.S. corporate restaurants into franchises, a move that often boosts sales and profits because the franchisee has his or her own money at stake and is familiar with the local market, Mr. Russo said.
Given Yum's healthy cash flow and payout ratio of just 36 per cent of estimated 2012 earnings, there's plenty of room for the dividend to grow. Mr. Russo estimates conservatively that over the next five years the dividend will climb about 9 per cent annually – slightly below Yum's projected earnings growth rate.
Is Yum a sure thing? No. For one thing, the company is heavily reliant on China, which accounted for 56 per cent of its revenue in the third quarter, most of it from KFC. Yum chief executive David Novak said Yum's competitive position in China is "stronger than ever," with 6-per-cent same-store sales growth in the quarter, total system sales growth of 22 per cent and plans to add 750 restaurants this year. But China's economy is slowing, and it remains to be seen if this will hurt Yum's growth there.
Another concern is Yum's valuation. The stock trades at 19 times estimated 2013 earnings, compared with 15.7 times for McDonald's. Also, Yum's dividend yield is 1.9 per cent, significantly below McDonald's, at 3.3 per cent. Although Yum's dividend is growing faster, the lower current yield may not appeal to investors who are looking for income now.
Given its growth potential, though, most analysts think Yum deserves to trade at a premium.
Of the 25 analysts who follow the company, 17 rate the shares a "buy", with eight "holds" and no "sells", according to Bloomberg. The average 12-month target price is $78.05 – 10 per cent higher than Tuesday close of $70.95.
"With Yum Brands continuing its expansion into the world's high-growth, high-return (typically emerging) economies, we believe the stock merits a premium valuation versus its history and the market, and that the multiple should steadily re-rate higher as growth accelerates," said Sanford Bernstein analyst Sara Senatore, whose $85 price target is the highest on the Street.
Bottom line: Yum's relatively high price-to-earnings ratio means the stock could be vulnerable if growth disappoints. But long-term investors who can accept that risk will almost certainly be rewarded with earnings and dividend growth for years to come.
John Heinzl