By Annie Gasparro
Yum Brands Inc. (>> Yum! Brands, Inc.), the parent company of KFC, Pizza Hut and Taco Bell, is selling hundreds of its U.S. restaurants to franchisees in an effort to further distance itself from the volatility of the owner-operated restaurant business.
The Louisville, Ky.-based company, which now earns the majority of its profits internationally, plans to reinvest the money from sales of its domestic restaurants in building new ones in countries such as China and India, where economic growth is stronger.
The so-called refranchising of its U.S. restaurants will help the company boost its profit margin at home. But there are risks to relinquishing corporate control of a brand's image, and it's tough to find restaurant operators who are willing to expand in the current economic environment.
In the U.S., Yum plans to reduce its ownership of Taco Bell restaurants to 16% from 22%, and its Pizza Hut and KFC stakes to 5% from 7% and 9%, respectively.
"We tend to reduce our ownership of highly-penetrated, low-growth or lower-performing businesses, and we increase our ownership in lower-developed, higher-growth businesses, where we think we can get better returns," Chief Financial Officer Rick Carucci said during a recent investor presentation. Yum says its returns on invested capital, reaching more than 22%, are some of the highest in the industry.
Five years ago, less than one-third of Yum's company-owned stores were in emerging markets. Because of refranchising in developed countries, and increased equity stakes in China and elsewhere, now about 60% of company-owned stores are in emerging markets, and Yum expects that figure to reach 70% by 2014.
Refranchising is fairly common among mature restaurant chains because it insulates the parent company from the impact of external factors like unemployment and commodity costs. It also relieves them of many capital expenses associated with keeping stores' kitchens, technology and decor updated, says John Gordon, a principal at Pacific Management Consulting Group, an advisory firm for chain restaurants.
McDonald's Corp. (MCD), which often serves as a best-practice model for the fast-food industry, maintains about 10% ownership of its restaurants in the U.S.
"Older brands refranchise because return on invested capital becomes so important, and so mathematically, it makes sense for them to do so in mature markets and develop in places like China," Gordon said.
With the latest refranchising, Yum says it has achieved about one percentage point of margin expansion in the U.S., most recently reporting a profit margin of 14.4%.
"If franchisees have access to capital and are good operators, then sure, go for it," Gordon said. "But at the same time, you can't just ignore the U.S.; it's still largest economy in world."
Yum is in the midst of attempting to turn around its U.S. business, after seeing sales at established locations slip last year. Gordon says stepping further away from the ground floor of restaurant operations can make a revamp like that all the more difficult.
"But restaurant companies divesting of their locations doesn't mean they're abandoning brand; it just means they don't think they're good operators," says Adam Hanft, a brand strategist and CEO of Hanft Projects. "Yum has been aggressive in refranchising, so it's clear strategically that they don't want to operate in the U.S."
Still, the struggling U.S. economy is limiting the number of franchise operators who have the money and desire, to expand--especially in brands that aren't doing so hot.
Adding to the hurdles, the U.S. market is heavily saturated with fast-food competition and banks are especially tight on loans. Franchisees don't always have the access to cash that the parent company would for fixing up older units or investing in new products and marketing, necessary to orchestrate a resurgence of a chain.
Yum remains optimistic about its recent progress in the U.S. and the potential for its brands under a more franchised model. "We realize there is much work to be done," said Chief Executive David Novak. "And we expect more consistent performance going forward."
-By Annie Gasparro, Dow Jones Newswires; 212-416-2244; email@example.com