Thursday, February 20, 2020

We pivot back to coronavirus today because things are a lot more serious now than when we first explored coronavirus disclosures last month. Since then, scads of companies have published some sort of warning about potential disruption, and even the Securities and Exchange Commission issued a statement about firms’ disclosure obligations here.

A good example comes from Yum Brands ($YUM), owner of Taco Bell, Pizza Hut, and KFC, among other chains. Yum has extensive operations in China, both at the retail and the supply chain levels. So when Yum filed its Form 10-K on Feb. 20, we gave it a read.

Coronavirus first appears in Item 1A, Risk Disclosures. Nothing specific, and nothing good either:

Many of our restaurants located within mainland China have been temporarily closed, have shortened operating hours and/or have otherwise been adversely affected by the impact of the coronavirus, and these developments have also impacted the ability of Yum China’s suppliers to provide food and other needed supplies at our Concepts’ restaurants in mainland China…
While it is premature to accurately predict the ultimate impact of these developments, we expect our results for the quarter ending March 31, 2020 to be significantly impacted with potential continuing, adverse impacts beyond March 31, 2020.

Further into the filing, however, Yum does elaborate about how coronavirus disclosures might impede financial performance. Yum operates in China through a master franchisee, a spin-off firm known as Yum China ($YUMC) — and Yum China did offer a more fulsome glimpse into the coronavirus in its own earnings release from Feb. 5.

For example, Yum China has closed 30 percent of its 9,200 stores in China. For the remaining stores that were still open, same-store sales fell 40 to 50 percent compared to the year-ago period. Yum China executives weren’t sure when the stores would re-open, or when customer traffic would return to normal levels.

Again, nothing good there. But how might all of this translate into financial impact?

Yum Brands does offer us one other big clue: Yum China pays Yum Brands 3 percent of sales that Yum China reaps in Mainland China.

Moreover, “These continuing fees represented approximately 20 percent of the KFC Division and 16 percent of the PH Division operating profits in the year ended December 31, 2019.”

So if we know what those segment operating profits are, we can start to get a sense of the financial impact to Yum Brands if coronavirus wipes those fees away for a quarter or two.

Thankfully, Yum does disclose operating profits of its major brands. See Figure 1, below, which shows the revenue and operating profits for KFC, Pizza Hut, and Taco Bell.



So if Yum China accounted for 20 percent of Yum Brands’ $1.052 billion in operating profit for KFC last year, that was $210 million. At 16 percent of Pizza Hut profits, that was $59.04 million.

That’s a total of $269 million in operating profit that came from Yum China last year, or 14 percent of Yum Brands’ total operating profit.

Now, the big question: how much could coronavirus reduce an amount of financial activity roughly that size?

Nobody knows. But $269 million is roughly $67.25 million per quarter. Will coronavirus eradicate all of that profit for Q1? Probably. It’s quite reasonable to assume Yum China will operate at a loss for this quarter and further into 2020, and inevitably that will also occupy more of Yum Brands’ time as it tries to help its largest, most important franchisee.

To be clear, this is speculation on our part, but it’s not far-fetched to assume all of that $269 million in Yum China operating profit goes away for Yum Brands in 2020.

That is a guess, but it’s an informed guess. The numbers are there in the disclosures to help reach that conclusion — and Yum Brands is only one of many, many companies starting to confront the implications of coronavirus.

Now we’re off to study the disclosures of pharmaceutical firms, because the sooner somebody finds a vaccine for this thing, the better.


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