3 Reasons Why Yum Brands Is Not So Craveable

 | Oct 03, 2016 | 10:00 AM EDT
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It has been a pretty fascinating year for Yum Brands (YUM) .

Shares of the owner of KFC, Taco Bell and Pizza Hut have tacked on about 27% year to date as investors have positioned themselves ahead of the company's late-October split into two publicly traded companies.

The bullishness around the trade has been fairly simple to comprehend: struggling Yum China gets spun off, parent company Yum raises a ton of money to be used toward buying back stock and paying richer dividends. Moreover, Yum Brands will get a steady stream of cash from Yum China via a licensing deal for the KFC, Pizza Hut and Taco Bell brands. Management has sold the benefits of the deal very well to analysts and investors, and it's reasonable to expect the strong sales job to continue when the team visits New York City later this month.

But the time to look at Yum Brands as a restaurant company instead of some kind of investment vehicle is fast approaching. And on that score, it's probably going to be hard to stay long the name too far beyond the spinoff of China this month. Yum Brands' earnings this week will likely explain what I am talking about here.

For starters, the fast-food industry by all measures continued to struggle in the third quarter as consumers chose to eat at home amid falling food prices. The lines I am seeing in the evenings at Walmart (WMT) are fierce (and so are the number of items in the basket).

The bottom line is that consumers are seeing more value right now planning out their meals than pulling up to a McDonald's (MCD) or Taco Bell. As a result, one really saw an intensification of fast-food discounting in the quarter. Just take a look at burger chain Sonic (SONC) , which pre-announced a tepid quarter last week and saw its stock subsequently get destroyed.

Second, the sales slowdown at Taco Bell of late has been a story not many are discussing (except yours truly), but stands as a short-term headwind.

Known for remarkable sales strength due to its often "craveable" and affordable Mexican fare, sales at Taco Bell's more than 6,400 U.S. restaurants fell 1% in the second quarter. A year ago, sales at the late-night fast-food stop rose a healthy 6%. It marked the second consecutive quarterly sales slowdown for Taco Bell, and followed a meager 1% gain in the first quarter.

For Taco Bell, the stretch of sluggish sales likely reflects the broad industry slowdown, heightened price competition from burger players, and the continued popularity of McDonald's all-day breakfast. McDonald's continued to up its game in breakfast during the quarter, expanding its all-day breakfast menu. Meanwhile, the Golden Arches continues to launch decent-sized tests of more localized food offerings, which is a strategy that seems to be working in its favor.

While Yum Brands noted in July that Taco Bell's sales were up to start the third quarter, it's a strong possibility they softened for yet another quarter.

Sprinkle in pizza players Papa John's (PZZA) and Domino's (DPZ) raising their discounting game in the quarter, possibly hurting Pizza Hut, and it's hard to get excited about the short-term fundamental outlook for Yum Brands. The market may continue to choose to stay long into the spinoff, but once it's completed investors could return to a likely mixed third-quarter report as reasons for cutting bait.

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