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Author: TMFTardior Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 711  
Subject: Re: Buffett buying YUM?? Date: 2/11/2000 8:00 PM
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Hey johnsonkirk (both very Minnesotan names),

Sorry it took me so long to get back to you; at some times our 'Replies to your posts' area works better than at others...

I'll take your points in order:

Number of stores: Yes, as I understand it they will be opening 1300 stores next year, but it was not clear to me whether these were system stores or company stores, so I left 'em out. They stated definitively that they were shooting for 20% system ownership next year, so either the net change will be -1000, or perhaps it will be 20% of the current amount plus 1300, in which case you'd want to add 260 to their number of stores.

And you make it seem almost specious that they are growing earnings by paying down debt...I think it's a pretty important concept...Decreasing sales isn't always a bad thing, particularly if they're dumping unprofitable (or less profitable) stores in favor of paying off debt.

I agree with you 100% on this point. I think that it was essential for YUM to reduce its debilitating debt. Taking that quarterly interest expense off of their income statement is a big step toward financial health. My point merely was that the earnings growth was funded by outlet sales. Lower interest expenses are good, but they are only going to bring "growth" to earnings in one quarter/year.

The free cash flow benefit, on the other hand, will be ongoing, so it's very good. Your 'lower sales are not necessarily bad' point is absolutely on target. Jack Byrne demonstrated this concept very well at GEICO. After he took over the bleeding-red company in 1976, he reduced the number of policies written from 2.7 million to 1.5 and returned them to profitability in a year.

I see debt reduction as very positive. Still, the company was touting its earnings, and that is the point I meant to address. More about this later.

I do disagree that divestiture was the only way to prevent "insolvency" (at least in the way you use it). I assume we're talking ability to meet obligations insolvency, as opposed to the net worth test (under which I am soooo amazingly insolvent it is ridiculous due to law school loans).

Good point. The company probably could have remained solvent for a long time to come. It would have been better to have said 'return to positive book value' or 'give shareholders any hope of equity' or something, rather than 'prevent insolvency'. It is not a minor point, and you are correct.

I'll add, too, that it seems clear that YUM is keeping the better stores and selling the worse (though they sold more Pizza Hut than anything last year). Earnings for the company stores total about 1/3 of total system earnings, even though the company owns less than 1/4 of the stores. They're doing something right on that score.

I agree that YUM has made great strides. Their situation now is much better than it was two years ago. Still, I have a very hard time with the 'what's sexier to own' argument. I've seen it too many times, with too many companies that are failing. The market doesn't diss a stock just because it's not sexy. It disses a stock because its future appears uncertain. You're talking about a company in an industry where margins and profits are thin enough as it is; add in large debt, a shrinking source of revenue, and slow-growing same store sales, and you've got potential trouble. The market doesn't like trouble.

YUM's management is handling the situation pretty well, I think. I'm not sure, however, that its attempt to pass itself off as a growth company in its earnings report was well-advised. This is an industry for the extremely patient and contrarian. The market, generally, is neither.

Maybe WEB will get involved after all...

Now it is I who have begun to ramble. I'll wrap up with a rah-rah-rah for Sky-U-Mah!

Fool on!
BrianZ
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