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Fast food giant Yum! Brands (YUM ) announced a 12% dividend increase when the company reported quarterly earnings on Tuesday, October 6. Yum! Brands operates the Taco Bell, Pizza Hut, and KFC restaurant chains. The company is struggling this year due to declining sales growth in China and the strengthening U.S. dollar. These headwinds are combining forces to significantly weigh on Yum’s growth.
However, the company is still highly profitable and generates a lot of cash flow. This is what allows it to continue increasing dividends at double-digit rates each year. As a result, while growth investors may not view Yum! as a promising investment opportunity, dividend investors should view Yum attractively.
In Yum’s fiscal third quarter it’s adjusted earnings came in at $1.07 per share on $3.42 billion of revenue. Revenue failed to meet expectations as analysts expected $3.68 billion of revenue according to data compiled by Thomson Reuters. Yum’s revenue miss was due largely to poor performance in China. To that end, Yum’s same-restaurant sales, which measures sales at locations open at least one year, grew just 2% last quarter in China. Analysts had expected 9% same-restaurant sales growth in that country.
This is problematic for Yum because China is a crucially important growth market for the company. With a population of approximately 1 billion, and an emerging consumer class, Yum has invested heavily in building its business in China. The company opened 108 units last quarter in China alone. As a result, weakening growth in the nation is a significant concern for Yum since China is the company’s biggest geographic market. China itself accounts for 57% of Yum’s total revenue.
More broadly, the emerging markets in general are weak. Yum opened 376 new restaurants in the international markets last quarter, 72% of which were located in the emerging markets. However, a separate key emerging market, India, is presenting another problem. Same-restaurant sales in India declined by a staggering 18% last quarter, year over year, and Yum fell to an $8 million operating loss there, more than twice the operating loss in the same quarter last year.
Yum does not foresee the problems in China improving in the current fiscal year. Management now expects same-restaurant sales to decline in the low single-digits for the full fiscal year. Nevertheless, Yum still generates healthy cash flow, which is the most important metric for its dividend policy.
Fortunately, the good news for investors is that Yum continues to generate enough free cash flow not only to sustain its current dividend, but also to raise its dividend at high rates each year. Along with its fiscal third-quarter earnings, Yum raised its dividend by 12% to $1.84 per share annualized. This is the eleventh year in a row that Yum has increased its dividend by double-digits on a percentage basis. In addition, Yum returns even more cash to shareholders through stock buybacks. Year-to-date through October 5, Yum has repurchased 4.5 million of its own shares totaling $370 million.
Yum’s aggressive cash returns are due to its high free cash flow. The company generated $1.175 billion over the first three fiscal quarters, representing 22% growth from the same period last year. Yum’s free cash flow more than covered its cash returns. In the first three fiscal quarters, Yum spent $370 million on share repurchases, and $532 million on dividends. Yum’s dividend payout ratio, as a percentage of free cash flow, is just 45% over the first three fiscal quarters. A free cash flow payout ratio under 50% signals a comfortable free cash flow position, which is why management is confident enough to raise its dividend by 12%, even though revenue growth has disappointed thus far in 2015.
At its current $67 stock price, Yum yields 2.7%. That is roughly 70 basis points greater than the S&P 500 Index, which yields approximately 2%. While Yum does not appear to be an attractive stock for growth investors, given its slowing sales in the emerging markets, the stock still looks like a good pick for dividend investors. That is because Yum offers both a high dividend yield that beats the average stock yield and also high dividend growth.