Pizza Hut dishing disappointment

by Monica Watrous
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Pizza Hut's performance in the U.S. is Yum! Brands' primary challenge.

LOUISVILLE, KY. — A comprehensive menu revamp at Pizza Hut has not delivered the desired results for parent company Yum! Brands, Inc., which reported a decline in profit during the first quarter. While lingering effects of a supplier scandal in China weighed on sales, the pizza chain’s performance in the United States remains Yum!’s primary challenge.

“You can never be pleased when you report an e.p.s. decline for the quarter, but the story behind the numbers gives me even more confidence that we can and will deliver at least 10% e.p.s. growth in 2015,” said Greg Creed, chief executive officer, during an April 22 earnings call with financial analysts. “I would summarize our performance as our KFC and Taco Bell divisions are firing on all cylinders, China is clearly improving, and there is still much work to be done at Pizza Hut.”

For the first quarter ended March 21, Yum! had net income of $362 million, or 83c per share on the common stock, down 9% from $399 million, or 89c per share, in the prior-year period. Total revenues declined 4% to $2,622 million from $2,724 million in the comparable quarter.

Worldwide system sales grew 4%, with the development of 294 new international units, and worldwide operating profit decreased 8%. Foreign currency translation negatively affected operating profit by $20 million.

In the past six months, Pizza Hut has pulled out all the stops, with the launches of a gluten-free crust, 10 new crust flavors, 6 sauces and 11 new recipes, and the roll-out of a “world-class digital ordering experience.” The chain even introduced a new logo on pizza boxes and uniforms.

So far, it has not been enough.

Pizza Hut Division system sales rose 2% during the quarter, reflecting 2% unit growth and flat same-store sales. Operating profit decreased 2% to $81 million.

“As you know, we recently launched a new pizza platform in the U.S., where over half of the division’s profits are generated,” Mr. Creed said. “This new platform has given our customers unparalleled variety with exciting new toppings, crusts and flavors. Unfortunately, we haven’t been as effective as we would like with our marketing and need to balance its appeal to millennials with mainstream pizza customers.”

To shape up Pizza Hut’s performance in the United States, Yum! in February acquired Collider, an insights-driven marketing company that has helped improve the Taco Bell business. Jeff Fox, former president of Collider, was named chief concept and brand officer of the Pizza Hut Division.

“We’re also making the needed investments in digital for all of Pizza Hut,” Mr. Creed said. “We have a firm grasp on what needs to improve and are taking the necessary actions globally to drive better performance.”

Digital sales at Pizza Hut account for more than 40% of delivery and carry-out sales in the United States, up from 30% a year ago, and executives expect the percentage to grow over time.

“This is important because digital orders provide customers with a superior ordering experience, drive higher levels of loyalty, and generate higher average spend,” said Pat Grismer, chief financial officer.

KFC Division system sales increased 8%, driven by 2% unit growth and 5% same-store sales growth. Operating profit increased 11% to $169 million. The division opened 72 new international restaurants in 36 countries during the quarter, with nearly 80% in emerging markets.

“Simply put, KFC is a franchise-led global powerhouse with a significant lead in many emerging markets and tremendous growth ahead,” Mr. Creed said. “With its always original positioning, I believe KFC is poised to deliver consistently strong results going forward. One of the significant competitive advantages KFC has is its partnership with strong international franchisees.”

Taco Bell Division system sales advanced 9%, led by 3% unit growth and 6% same-store sales growth. Operating profit surged 37% to $26.6 million.

“I have never been more confident in Taco Bell’s ability to reach its goal of becoming a $14 billion business with 8,000 restaurants,” Mr. Creed said. “By all measures, Taco Bell continues to go from strength to strength, and I am thrilled to see the team take the brand to a whole new level. Breakfast is doing well, owning a 6% mix, and restaurant margins approached 20%.”

China Division system sales fell 6%, reflecting 8% unit growth offset by a 12% same-store sales decline, due to the lingering effects of adverse publicity in July 2014 surrounding improper food handling by a former supplier. Operating profit tumbled 31% to $190 million.

“The fact is that the business is clearly improving,” Mr. Creed said. “Same-store sales and customer metrics continue to move in the right direction. In addition, the team has done an impressive job managing costs and delivered restaurant margins of nearly 19% in the quarter.”

India Division system sales climbed 1%, reflecting 18% unit growth largely offset by an 11% decline in same-store sales. Operating loss was $4 million, which compared with an operating loss of $3 million in the prior year.

For 2015, management expects to deliver at least 10% earnings per share growth. The company is on pace to set a new record in international development this year with the opening of 2,100 new restaurants. Despite headwinds from foreign currency translation, the company expects overall operating results will yield double-digit earnings per share growth in 2015 and beyond.

Near term, however, several factors lead executives to expect a steeper decline in second-quarter earnings per share compared with prior-year performance.

“First, this is largely due to the fact that we are expecting a higher year-over-year quarterly tax rate compared to Q1,” Mr. Grismer said. “Second, we will be lapping China’s strongest quarter from 2014, which you may remember included same-store sales growth of 15% and operating profit growth of nearly 200%. And third, while we are expecting Taco Bell to deliver another quarter of double-digit profit growth, it won’t be 37% as it was in Q1.

“So, for the second quarter, we’re estimating e.p.s will lag prior year by about 20%, but we continue to believe that we have the overall business momentum that sets us up for a strong second half to achieve at least 10% e.p.s. growth of the full year.”
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