The Ratings Game: Yum Brands downgraded as Pizza Hut weakness weighs more than coronavirus

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Yum Brands Inc. was downgraded to neutral from buy at BTIG on Friday on concerns that the weakness at the company’s Pizza Hut chain will outlast challenges posed by the coronavirus outbreak.

“While we expect Yum’s core operating profit to be below the long-term target this year due to the transitory coronavirus issue, we expect the challenges at Pizza Hut U.S. to persist and the outlook seemed to step down this quarter,” analysts led by Peter Saleh wrote in a note to clients.

Chris Turner, Yum’s chief financial officer, said on the company’s earnings call that 2%-to-3% same-store sales growth in the long-term is still in the plan. However, there are hurdles. There’s a $24 million headwind as the company laps an extra week. And there’s the coronavirus outbreak in China that’s impacting a number of businesses outside of Yum Brands YUM, -1.92%,  which also owns Taco Bell and KFC.

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But there is also a Yum-specific problem.

“There is potential for choppiness in near-term results at Pizza Hut U.S., primarily related to our largest franchisee,” Turner said, according to a FactSet transcript. “Given the fluid nature of these issues, specific forecasts for impacts are challenging at the moment.”

BTIG said the franchisee in question is NPC International, which says on its website that it’s the largest Pizza Hut and Wendy’s Co. WEN, +0.07% franchisee in the U.S. NPC has 1,225 Pizza Hut locations and 385 Wendy’s restaurants, the website says.

“The struggles at NPC will likely lead to more unit closures near-term and a longer time frame for planned asset upgrades and relocations to improve the overall system,” BTIG said.

Both Yum Brands and Yum China Holdings Inc. YUMC, -2.63% reported quarterly earnings this week.

Yum China is a licensee of Yum Brands in that region, with the exclusive rights to all three Yum Brands chains. It also owns a number of others, including Little Sheep and Joy.

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Yum China said its operations were “significantly impacted” by the coronavirus outbreak, and it will likely have a “materially adverse impact” on both the operating and financial results for the first quarter and full year 2020.

RBC Capital Markets analyst Christopher Carrill agreed that Pizza Hut is a weak spot this year.

“[T]he impact related to coronavirus is not company or brand-specific, and thus we would expect a recovery to profits/earnings over time,” Carrill wrote. “And while Pizza Hut U.S. is less than 10% of profits, questions around its potential impact to Yum Brand’s earnings model linger, though management did note it remains committed to remaining asset-light.”

Pizza Hut in the midst of a transition that includes restaurant closures and a move to a fast-casual delivery format from dine-in.

RBC rates Yum Brands stock sector perform with a $107 price target.

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UBS analysts said the concern about Pizza Hut is overblown.

“We expect weakness continues in 2020, but we believe new leadership, technology and turnaround plans are good steps toward improving trends over time,” analysts led by Dennis Geiger wrote in a note.

UBS rates Yum Brands stock buy with a $120 price target.

Yum Brands stock is down 4% for the week, but up 7.4% for the past year. The S&P 500 index SPX, -0.47% has gained 23.2% over the last 12 months.

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