Yum Brands Incorporated - Research Paper Example

Financial Analysis – A case of Yum! Brands Inc. The analysis of the financial ments of Yum! Brands, Inc. involves several areas such as profitability, capital structure/ leverage/gearing, activity/efficiency and liquidity. These ratios provide important relevant information to the users of the financial statements. They make their decisions based on these ratios. This paper seeks to determine the leverage position, liquidity, profitability and efficiency of Yum! Brands, Inc. Financial Analysis – A Case of Yum! Brands Inc. Analysis of financial statements of an entity give a clear insight of the nature of entity, its performance, sustainability and its future performance. It provides awareness to the investors in that guide them in making important investment decisions. The analysis of the firm will reveal its financial background, operating efficiency, liquidity position, and profitability, going concern, and capital structure and gearing position. Industry analysis facilitates the understanding of the operating environment, identification of external threats and opportunities for investment, analysis of trends within the industry and the general performance of the industry. The Yum! Brands Inc. is a fast food restaurant incorporated in 1927. The company establishes, operates, franchises and licenses a global system of restaurants, which make, pack and sell a menu of priced food commodities. The company has three powerful brands, TACO Bell, KFC and Pizza Hut, which has continuously sustained its profitability over the years. Over the years, the company has reported increase in turnover, profits and returns to shareholders. The earnings per share of the company has an upwards trend for the past eight years with the exception of 2013 when the earnings dropped significantly (Morningstar Inc., 2014). The company’s growth is driven by its powerful brands, superior marketing strategies, breakthrough innovations and competing values, and venturing into new markets (Yum! Brands Inc., 2014). The restaurant business in the U.S is highly competitive with major multinational companies such as Yum! Brands, Starbucks, McDonald’s, Wendy’s, and Chipotle. Personal income, demographics and consumer tastes and preferences drive demand in this industry. Individual entities in the industry have varied profitability levels. Whereas the quick-service restaurants rely on high-volume turnover and efficient operations, the full-service restaurants rely on effective marketing and high-margin items. This industry is experiencing an upward growth trend in sales, profitability and shareholders returns over the years (Epstein, 2014). Short term liquidity of Yum! Brands Inc. Short-term liquidity is measured using liquidity ratios such as current ratio, acid test ratio, cash ratio and the Altman Z-score test. These liquidity ratios measure the extent to which the enterprise will be able to meet its short-term obligations from the available resources when they fall due. The current ratio indicates the ability of the company to meet its current obligations from its current assets. It is obtained as Current assets/current liabilities. From the financial data available, Yum! Brands, Inc. cannot meet its short term obligations from its current assets. The company’s current ratio has a downward sloping trend from 0.94 in 2010 to 0.75 in 2013 with values less than the recommended ration of 2:1 as shown in Figure 1 in the appendix. The quick ratio is determined as (Current Assets – Inventory)/Current liabilities. The company results portray values below the recommended level of 1:1. This indicates that the company will not be in a position to meet its current liabilities from its most liquid resources. Based on these financial data, the trend of the quick ratio is falling from 0.87 in 2010 to 0.62 in 2013. The company’s cash ratio also shows a deteriorating trend with very low values indicating that it cannot meet its short-term obligations from cash and cash equivalents. The trend falls from a high of 0.58 in 2010 to 0.25 in 2013 (Yum! Brands Inc., 2012 & 2014). The areio is calculated as Cash and Cash equivalents/Current laibilities. In general, the liquidity ratios show that the company has a weak liquidity position which continuously worsens over the years. The Altman Z-scrore test can also be used to predict the bankruptcy or the ability of a business to meet its obligations when they fall due. It incorporates several variable and the results are measured against set standards to predict the possibility of the entity going into bankruptcy within two years. However, other non-financial factors such as contingencies after the date of the financial statements, which might cause equitable doubt in the minds of the investors about the entity’s going concern, are considered before concluding on whether the company is facing financial distress of not. Values higher than 2.99 are regarded to be in the safe zone and therefore the company would not go into bankruptcy. Values between 1.81 and 2.99 are regarded to be in the grey zone and may or may not go into bankruptcy. Values below 1.81 are treated to to in the distress zone and such companies may suffer financial distress. Yum! Brands, Inc. has Z-scores ranging from 1.37 to 1.52 indicating that it is facing financial distress. Operating Efficiency The operating efficiency of the company is estimated using the efficiency/activity ratios that measure the efficiency with which the company utilizes its resources to generate revenues. These ratios include, day’s sales outstanding and payable period, stock holding period, inventory turnover, asset turnover, receivables turnover, cash conversion cycle and fixed asset turnover. Stock turnover shows the number of times inventory was converted into sales. It is determined as Cost of sales/Average stock. Yum! Brands’ stock turnover is decreasing over the years with the highest record of 88.47times in 2005 to 31.83times in 2013. Its stock holding period also increases rapidly from 4.13days in 2005 to 11.47days in 2013 (Morningstar Inc., 2014). This indicates that company’s efficiency is weakening with time. The debtors’ turnover is fairly stable with a high of 49.92times in 2004 and a low of 42.21 in 2013. The debtors’ collection period show an equally stable trend ranging between 7.31 in 2004 and 8.65 in 2013. This shows that the number of times sales are made are stable throughout the periods. The operating efficiency is therefore maintained. The creditors’ payment period was unstable ranging between 42.33 and 70.74 (Morningstar Inc., 2014). This shows that the entity’s ability to realize enough sales to pay its obligations is weak. The level of activity therefore continuously deteriorates. The fixed asset turnover of Yum has an increasing trend with the lowest of 2.68 in 2004 and highest of 3.29 in 2012. This indicates how effectively the fixed assets are utilized to realize sales. The efficiency of the use of the fixed assets is therefore rising with time. The total asset turnover has a fairly stable trend ranging between 1.47 and 1.64times (Morningstar Inc., 2014). This indicated that the assets are well utilized to realize sales for the company. Lastly, the cash conversion cycle of the company 29.85 and 54.22 days (Morningstar Inc., 2014). This shows the duration between the acquisition of resources, their conversion to sellable products, ultimate sale and collection of cash. The few days for the conversion indicate that the operating cycle of the company is very efficient. Capital Structure of Yum! Brands, Inc. Capital structure is the combination of long-term finances of a company. Decisions regarding the financial mix by an entity is based on the ultimate goal of maximizing the shareholders’ value. The capital structure designs used by a company should attain the maximum shareholders’ wealth and best approximate the optimal structure. Various theories have been designed to suggest the most optimal capital structure of a firm such as Modigliani and Miller (MM Theories). However, a simple approach will be used in our analysis. The analysis involves the review of the debt equity ratio. The debt to equity ratio measures the extent to which the assets of the entity have been financed using external internal and external finances. It shows the owners’ claim in the business and the outsiders’ claim in the business. Yum Inc. was financed with both equity and debt. The debt equity ratio is given by Total Long term Debt/Equity. The analysis of Yum shows that the ratio was increasing at a decreasing rate between 2004 and 2009 before it stated falling at an increasing rate between 2009 and 2013. The results also indicate that the company was highly geared with most assets being financed from debt capital. This therefore increased the cost of capital due to the interest charge that was paid annually. The debt/equity trend is as shown in figure 2 in the appendix. Profitability analysis of Yum Profitability analysis is very significant for long term planning in the organization. Several ratios are used in the analysis of the profitability of an entity, such as net margin, return on investments, return on equity, interest cover, and return on total assets. The company’s net margin fell in 2013 from 11.71% in 2012 to 8.34%. This was as a result of the fall in revenues from $13,633 million in 2012 to $13,084 million in 2014. The return on equity dropped significantly between 2012 and 2013 from 80.31% to 50.51% respectively. This can also be attributed to the increase in tax rate from 25.04% in 2012 to 31.4% in 2013 and the fall in revenues between these two years. Interest cover for the company reduced drastically from a high of 15.40 times in 2012 to a low of 6.74 times in 2013. This can be as a result of the fall in revenues, increase in cost of sales and overall costs and increase in the interest expense from in 2012 to $270 million in 2013. The return on total assets also dropped significantly from 17.90% to 12.3%. This indicates that the assets were not properly utilized to realize sales revenue. The earnings per share of the company dropped significantly in 2013 from 2012. However, the trend is increasing as shown in figure 3 in the appendix. In conclusion, the management should consider diversifying their brands to increase their market share in the restaurant industry. Addition of more products besides the three main brands is also essential for the growth of the firm. This will lead to increase in revenues and consequently increase in the earnings per share of the company. The management should also analyze the effects of government activities on their operations, such as the effects of taxation. The 2013 tax rate for instance was very high leading to a fall in the company’s margin, earnings per share, dividends and retained earnings. Cheaper financing sources should also be sought such as ploughing back the company’s profits rather than issue of long term bonds as it this has a direct impact on the company’s profits. The cost of capital will subsequently reduce. Appendix: List of Figures References Epstein, L. (2014). Financial decision making. An introduction to financial reports. . Morningstar Inc. (2014, December 12). Growth, Profitability and Financial Ratios for Yum Brands. Retrieved from Financials Morning star: http://financials.morningstar.com/ratios/r.html?t=YUM Yum! Brands Inc. (2014). 2013 Yum Annual Report. 1441 Gardiner Lane, Louisville, Kentucky: Yum! Brands Inc. Yum! Brands, Inc. (2012). 2011 Yum Annual Report. 1441 Gardiner Lane, Louisville, Kentucky: Yum! Brands, Inc. Read More