Yum Brands a Buy Thanks to China Food Scandal

Valuation, sentiment and growth promise upside once the latest scare has passed

Yum Brands (YUM) has long been a way to play the rise of China, but sometimes that dependence on the Middle Kingdom can slam results. Case in point: Yum’s third-quarter earnings released Wednesday.

The latest food scandal in China is still hurting Yum Brands’ results despite the company having little exposure to the supplier that was selling bad meat. Consumers either don’t know that or don’t care.

Either way, it has made Yum Brands offerings — KFC, Taco Bell and Pizza Hut — much less palatable in company’s largest market, and that derailed the company’s bottom line and full-year forecast. Even worse, Yum said it’s still “too early know how quickly sales will rebound in China.” More than an earnings miss, the market hates uncertainty.

For the most recent quarter, Yum Brands earnings on a net basis rose to $404 million, or 89 cents per share, from from $152 million, or 33 cents a share, a year ago. On an adjusted basis — which is what analysts look for — earnings came to 87 cents, or a penny shy of Wall Street’s estimate.

The disappointing quarter was the result of slumping revenue and same-store sales in China. Chinese same-store sales — a key measure of a retailer’s health — plunged 14% in the most recent quarter. Meanwhile, Yum Brands’ total revenue fell slipped 3.2% to $3.35 billion. Analysts surveyed by Thomson Reuters forecast revenue to come in at $3.45 billion.

Although better results in other markets — notably the U.S. and India — helped offset some of the blow from China, the damage to earnings forced Yum Brands to take a hatchet to its growth forecast.

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Yum Brands now expects full-year EPS growing 6% to 10%. Before the food scandal, Yum was targeting growth of 20%.

Yum Brands Turned Upside Down on China Woes

Yum stock was actually having a pretty good year before China messed everything up. As of the middle of July, Yum stock was up 10% in 2014. Since then, shares have lost more than 15% to leave them down nearly 8% on the year so far.

If there’s a bright side to that selloff, it’s made Yum stock worth considering for new money. At some point the company will get past the food scare in China and sales will rebound. No, Yum stock hasn’t been beaten down to the point where’s it’s a screaming bargain-basement buy, but the valuation is much more favorable.

Yum stock fetches 18 times forward earnings, which is reasonable considering it has a growth rate of more than 14% per year. Yum stock also trades in line with its own five-year averages, according to Thomson Reuters Stock Reports. No, by those measures it’s not cheap, but neither is it expensive either. It’s also significant that Yum stock trades at a discount to the restaurants and bar subsector.

If anything, it’s a credit to Yum Brands that shares haven’t been beaten down more than they have. A bigger shellacking would be better, but Yum stock looks pretty good at current levels. The valuation and growth are there. It just needs this latest food scandal to pass.

By Dan Burrows, InvestorPlace Feature Writer  |  Oct 8, 2014, 2:11 pm EDT

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securitie