Fitch Affirms YUM! Brand's IDRs at 'BBB/F2'; Outlook Stable
Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) and issue level ratings of YUM! Brands, Inc. (NYSE: YUM) as follows:
--Long-term IDR at 'BBB';
--Senior unsecured notes at 'BBB';
--Bank credit facility at 'BBB';
--Short-term IDR at 'F2'.
The Rating Outlook is Stable. At June 16, 2012, Yum had approximately $3.3 billion of total debt.
YUM's ratings reflect its strong operating cash flow, significant free cash flow (FCF), extensive exposure to faster growing emerging markets, and scale with nearly 38,000 system-wide units. On a worldwide basis, approximately 80% of YUM's core Kentucky Fried Chicken (KFC), Pizza Hut, and Taco Bell restaurants are managed by franchisees or affiliates while 20% are company-owned and operated.
Cash flow from operations has grown by a compound annual growth rate of 9% to approximately $2.2 billion for the year ended Dec. 31, 2011 and FCF has averaged over $500 million annually since 2007. During 2011, 70% of YUM's revenue and 73% of its operating income (before corporate expenses) was derived from international markets, up from 41% and 48%, respectively, in 2006. More than 50% of 2011 operating income was from emerging markets.
China is YUM's largest geographic market representing 44% of sales and 42% of operating profit during the latest fiscal year. YUM had nearly 4,500 units in China at Dec. 31, 2011, of which over 80% are company-operated. International expansion remains the primary growth engine for YUM. In 2012 the company plans to open a record 1,700 new units outside of the U.S., with 700 opening in China and the rest across YUM Restaurants International (YRI) and India. Key growth markets other than China include Africa, France, Germany, and Russia.
Fitch remains concerned about YUM's significant exposure to China, due to slowing economic growth. However, concerns have been partially mitigated by the fact that new unit growth is being funded with internally generated cash. YUM has also demonstrated its ability to operate effectively and profitably in China. The China division has reported 10 consecutive quarters of positive same-store sales (SSS) growth and a restaurant margin averaging more than 20% since 2001. Fitch rates China 'A+' with a Stable Outlook on a foreign currency long-term IDR basis and 'AA-' with a Negative Outlook on a local currency IDR basis and is forecasting GDP growth of 8% in 2012, down from 9.2% in 2011.
For the latest 12 months (LTM) ended June 16, 2012, rent-adjusted leverage (defined as total debt plus eight times gross rents-to-operating EBITDA plus rents) was approximately 2.8x, operating EBITDAR-to-gross interest expense plus rent was about 3.5x, funds from operation (FFO) fixed-charge coverage was an estimated 3.1x, and FCF was $646 million. Fitch expects rent-adjusted leverage to approximate current levels and annual FCF of around $500 million in 2012 and 2013.
Liquidity, Maturities, and Financial Covenants:
YUM's liquidity at June 16, 2012 consisted of $984 million of cash and $1.2 billion of availability under its undrawn revolving credit facility, net of $88 million of letters of credit. YUM's $1.3 billion revolving facility expires due March 22, 2017. Following the repayment of $263 million of 7.7% notes due July 1, 2012, YUM does not have any material maturities until Sept. 15, 2015 when $250 million of 4.25% notes come due.
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. Based on Fitch's estimates, YUM had substantial room under these covenants at June 16, 2012. The company's unsecured notes do not contain financial covenants but most tranches contain a Change of Control Triggering Event clause.
For the quarter ended June 16, 2012, consolidated revenue grew 12% to $3.2 billion. SSS increased 10% in China, 4% at YRI, and 7% on a blended basis in the U.S. Brand-level SSS growth in the U.S. was 13% at Taco Bell, 4% at Pizza Hut, and 1% at KFC. Worldwide operating profit, excluding gains and losses from refranchising, and other special items, increased 8% to $459 million. Currency provided a 1% benefit to operating profit.
YUM's worldwide company-operated restaurant margin declined 0.6% to 15.2% during the latest quarter as a 5.8 percentage point increase in the U.S. was offset by a 4.1 percentage point decline in China and a 1.1 percentage point decline in YRI. The restaurant margin in the U.S., China and YRI was 17.5%, 15.6%, and 11.8%, respectively. Margin improvement in the U.S. was due to improved sales and continued efforts around efficiency while the decline at YRI was due to higher costs in Thailand and SSS declines at KFC in France.
China's restaurant profitability was negatively affected by 13% labor, 6% commodity cost inflation, and higher start-up costs from an increased pace of new unit development. Additionally, due to YUM's focus on delivering value to the consumer, the company implemented a more phased-in targeted approach to pricing. The full benefit of these price increases will take effect later in 2012.
Fitch views YUM's expectation of mid-single-digit SSS growth and improved restaurant margins for China during the second half of 2012 as achievable. Despite a slowing Chinese economy, transactions increased 6% in China during the most recent quarter and management should have good visibility on food cost for the rest of the year. KFC China's focus on breakfast, delivery service and 24-hour service along with Pizza Hut Casual Dining's strategy of offering variety and every-day value continues to produce results.
Fitch also believes YUM's multi-year transformation plan for its U.S. business has gained traction. YUM expects restaurant margins to improve to the mid-teens level from 12.1% last year due mainly to Taco Bell and Pizza Hut and believes its KFC business has stabilized. The company also continues to make progress with refranchising closing in on its goal of less than 10% company-operated units. Over the past couple of years, YUM's U.S. business has also launched a number of well-received new menu items including its Doritos Locos Taco, KFC Grilled Chicken, and Tuscani Pasta and Wings at Pizza Hut.
What Could Trigger A Rating Action
Future developments that may, individually or collectively, lead to a positive rating action include:
--Materially reduced rent-adjusted leverage due to a combination of good SSS performance, cash flow growth and/or debt reduction;
--Continued generation of meaningful discretionary FCF and the ability to self-fund new unit development.
Future developments that may, individually or collectively, lead to a negative rating action include:
--A sustained increase in rent-adjusted leverage due to SSS weakness and declining operating cash flow growth, particularly due to significantly reduced profitability in China;
--Material increases in debt due to a more aggressive financial strategy related to dividends or share repurchases or the inability to fund new unit growth with internally generated cash flow.
Additional information is available at 'www.fitchratings.com'. The ratings above were unsolicited and have been provided by Fitch as a service to investors.
Applicable Criteria and Related Research:
--'Corporate Rating Criteria' (Aug. 12, 2011).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Carla Norfleet Taylor, CFA
70 W. Madison Street
Chicago, IL 60602
Judi M. Rossetti, CFA/CPA
Wesley E. Moultrie, II, CPA
Brian Bertsch, +1-212-908-0549 (New York)
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