Yum China Becomes World's Largest Publicly Traded Franchisee

Yum! Brands, Inc., the parent company of Taco Bell, KFC and Pizza Hut, is now trading as two separate entities.

The first, Yum! Brands, Inc. YUM consists of the company's global operation except for China, and the second business, Yum China Holdings Inc YUMC, is a licensee of Yum! Brands in mainland China.

"As a ‘pure play' franchisor, the transformed Yum! Brands will become more efficient and capital light with an optimized capital structure, improved cash flow and laser-like focus on our key strategies to drive same-store sales and new unit growth worldwide," Yum Brands' CEO Greg Creed said in October when he made the case for the business separation to investors.

John Glass of Morgan Stanley initiated coverage of Yum China on Tuesday with an Overweight rating and $32 price target.

Glass noted that Yum China is the largest publicly traded franchisee in the world and also boasts the largest network of chain restaurants within China. Given the company's already established and recognizable brands and coupled with a deep and experienced management team, Yum China provides investors with an opportunity to profit.

Glass continued that the market appears to be pricing Yum China's stock as more of a sub-scale, local Hong-Kong listed quick service restaurant (QSR) rather than what the company really is: a "share leading, cash generative global QSR." The analyst did however acknowledge that the business is facing several challenges including a nascent recovery in sales following multiple supplier issues in 2012 and 2014.

"With new unit returns still strong, this is a bet on recovering sales," Glass continued. "Our confidence is based on new management and new initiatives (focusing more on core menu, renovating stores, embracing the growing digital channel with a strategic investment from AliPay)."

Glass further noted that his estimates may even be conservative as it implies no margin expansion in 2017, 3 percent same-store sales growth and no buybacks.

Bottom line, the analyst believes the entire Chinese restaurant market stands at $500 billion and Yum China's penetration is still low, at less than 20 units per million people versus the approximate 600 units per million people in the United States.

Image Credit: By Davestraub@yahoo.com (Own work) [CC BY-SA 3.0 or GFDL], via Wikimedia Commons