Fitch Ratings has affirmed and withdrawn the following ratings for
YUM!Brand's (NYSE: YUM):
--Long-term IDR at 'BBB';
--Senior unsecured notes at 'BBB';
--Short-term IDR at 'F2'.
Fitch is discontinuing the ratings, which are uncompensated.
The Rating Outlook is Stable. At the quarter ended Sept. 7, 2013, Yum
had approximately $3 billion of total debt.
KEY RATING DRIVERS
Significant Cash Flow, Diversification
YUM's cash flow from operations (CFO) has grown at a five-year compound
annual growth rate of 8% to $2.3 billion in 2012 and FCF (defined as CFO
less capital expenditures and dividends) has averaged over $500 million
annually since 2007. For 2013, Fitch expects CFO to decline at a
high-single digit rate, but remain over $2 billion, and FCF to decline
over 40%, but exceed $350 million, due to the challenges in China
discussed below.
During 2012, China represented 51% of YUM's revenue and 42% of its
operating income before corporate expenses. YUM Restaurants
International (YRI) represented 24% and 30% of revenue and operating
income, respectively, and the U.S. represented 25% and 28%. Ratings
incorporate the opportunities and risks of YUM's considerable and
growing exposure to China in addition to the diversification provided by
its KFC, Pizza Hut, and Taco Bell brands.
China Sales, Profits
Consumer reaction to excessive antibiotic use by two KFC China poultry
suppliers in December 2012 and fears about a bird flu outbreak in April
2013, the latter which has since subsided, have continued to negatively
affect same-store sales (SSS) in China. YUM owned 79% of its units in
China during 2012; therefore, SSS declines have translated into markedly
lower divisional operating income and margins. Year-to-date (YTD)
through Sept. 7, 2013, SSS declined 16% in China and operating income
was down 31% to $557 million from $812 million.
In October 2013, YUM reduced its 2013 earnings guidance due to September
SSS for China being worse than the company expected, its updated view
that China SSS may not be positive by the fourth quarter of 2013, and a
higher tax rate. Nonetheless, YUM continues to expect 2014 to be a
bounce back year with China generating at least $1 billion in operating
profits, a 40% increase versus the firm's profit expectations in 2013.
YUM has launched a quality assurance program for suppliers, consolidated
its supplier base, and implemented extensive marketing programs,
including its I Commit campaign coming this November, to reassure
customers about the safety of properly cooked chicken.
Fitch's ratings affirmation and Stable Outlook assumes a partial
recovery for China in 2014. Fitch anticipates that SSS will gradually
recover but believes the December 2012 poultry supply incident could
have more of a lasting impact on consumer perceptions given the
prevalence of social media and increased competition. The effects of
past food safety concerns, including SARS in 2003 and Sudan Red and AI
in 2005, in China only lasted for a few months.
Ratings consider YUM's financial flexibility should China continue to
perform below expectations and the fact that a significant portion of
YUM's rent expense in China is contingent on sales. Absent a
reacceleration of SSS declines in China, Fitch believes YUM can maintain
credit metrics appropriate for its 'BBB/F2' ratings.
However, a second year of SSS and operating income declines in China
without a significant reduction in new unit development would further
pressure the firm's CFO and FCF, and likely result in downside risk to
credit ratings. Fitch currently projects that rent-adjusted leverage
will approximate 3.0x, CFO will exceed $2 billion, and FCF will be more
than $300 million in 2014.
YRI and U.S. Performance
YUM's cash flow is supported by nearly $2 billion of annual royalties
and franchise fees from YRI and the U.S. At Sept. 7, 2013, 79% of YUM's
39,564 restaurants worldwide were franchised, licensed, or operated by
unconsolidated affiliates but 91% of both YRI's 14,878 units and the
U.S. division's 18,038 units were franchised or licensed.
YUM's ongoing earnings model is 15%, 10% and 5% operating profit growth
for China, YRI and the U.S., respectively. Profit growth at YRI and the
U.S. has generally been in line with targets partially mitigating
declines in China. YTD through Sept. 7, 2013, SSS and operating income
for YRI were up 1% and 7% to $525 million, respectively. SSS and
operating income for the U.S. were up 1% and 3% to $502 million,
respectively. YTD operating income growth factors in the negative impact
of cost related to YUM's biannual 2013 YRI franchisee convention and the
impact of U.S. refranchising.
Credit Statistics, Financial Strategy
For the latest 12 months (LTM) ended Sept. 7, 2013, rent-adjusted
leverage (defined as total debt plus 8x gross rents-to-operating EBITDA
plus rents), excluding charges related to Little Sheep, was roughly
3.2x. CFO and FCF approximated $2.0 billion and $307 million,
respectively.
YUM's cash flow priorities are to invest for growth and return all
remaining cash to shareholders via dividends and share repurchases. For
2013, YUM plans to spend over $1 billion of its operating cash flow on
capital expenditures as it opens over 1,800 new international units,
with at least 700 new units in China, 1000 in YRI markets, and 150 in
India. YUM's long-term dividend payout target is 35% - 40%. Management's
financial strategy includes managing its balance sheet in order to
maintain its investment grade rating.
Liquidity, Maturities, and Financial Covenants
YUM's liquidity at Sept. 7, 2013 consisted of $753 million of cash and
availability under its undrawn $1.3 billion revolving credit facility
which expires March 22, 2017. Material upcoming maturities of long-term
debt include $250 million of 4.25% notes due Sept. 15, 2015 and $300
million of 6.25% notes due April 15, 2016.
Financial maintenance covenants in YUM's bank agreements include a
maximum leverage ratio (defined as consolidated net debt including
securitizations-to-EBITDA adjusted for acquisitions and divestitures) of
2.75x. The company is also subject to a minimum fixed-charge coverage
ratio (defined as EBITDAR less capital expenditures-to-interest plus
rent) of 1.4x.
Fitch estimates that YUM has substantial room under these covenants as
net debt-to-EBITDA at Sept. 7, 2013 was less than 1.0x. YUM's unsecured
notes do not contain financial covenants but most tranches contain a
Change of Control Triggering Event clause.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria and Related Research:
--'Fitch Affirms YUM!Brand's IDRs at 'BBB/F2'; Outlook Stable (July 15,
2013);
--'Corporate Rating Criteria' (Aug. 8, 2012);
--'Short-Term Ratings Criteria for Non-Financial Corporates' (April 2,
2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Effective from 8 August 2012 - 5 August
2013
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460
Short-Term Ratings Criteria for Non-Financial Corporates
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=714415
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=804947
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