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Yum Brands Expanding in the Wrong Country

Yum Brands (YUM), the parent company of KFC, Pizza Hut and Taco Bell, is on the offensive: Its Taco Bell chain will be adding 2,000 new domestic locations in the next 10 years.

To put that in perspective, there are currently about 6,000 Taco Bell restaurants scattered across America. This means that the chain will be increasing its presence by fully one-third in a country that already has no shortage of fast-food taco joints.

Most of these new units will be franchises (as opposed to company-owned), and Yum Brands is specifically targeting women and minority franchisees in an effort to attract “new blood.”

I’ve been known to frequent Taco Bell a little more often than my doctor might like; it seems I have a weakness for tacos that sell for less than a dollar. But my own (admittedly awful) dining preferences aside, Yum’s massive domestic expansion raises a few questions.

I’m a big fan of the franchise restaurant model as opposed to the company-owned restaurant model. It turns a gritty, hypercompetitive and low-margin business into a higher-margin brand-management company.

But strong brands don’t need to go out looking for franchisees; they normally have would-be franchisees knocking on their doors. Yum brands’ aggressive recruiting efforts may be creating major headaches for YUM stock down the line if some of these inexperienced new franchisees find themselves in over their heads.

But more fundamentally, why the sudden domestic push? Yum Brands jumped into emerging markets with both feet decades ago, primarily through expansion of KFC, and emerging markets have long been the company’s primary engine of growth. In fact, I would go so far as to say that Yum is first and foremost an emerging-market company. YUM stock gets 60% of its revenues from emerging markets and has more than 13,000 emerging market locations — nearly double that of McDonald’s (MCD).

The sudden emphasis on the American market raises questions about management focus. Sure, China’s growth is slowing, and 2013 has been a rough year for emerging markets in general. But refocusing on the American market seems like a major distraction in what has otherwise been a remarkably successful expansion strategy.

Furthermore, its Taco Bell restaurants have major competition from Chipotle Mexican Grill (CMG) and its imitators, and that’s a battle the company will have a hard time winning. Chipotle is wildly popular among younger and more health-conscious Americans for its use of organic ingredients.

Taco Bell has responded by taking its menu upmarket and in a healthier direction. For example, its Fresco Menu and Cantina Bell Menu are both massive steps up from its traditional low-budget options.

It’s tempting to dismiss this as putting lipstick on a pig, but the quality of Taco Bell’s food really has improved in recent years. Whether it has improved enough to realistically compete with Chipotle is another story, however.

So, what about YUM stock? Is it a short?

No — or at least, not yet. YUM stock trades at 21 times expected 2014 earnings, which is a little on the expensive side. But at 2.6 times sales, the company is considerably cheaper than MCD stock (3.43 times sales), CMG stock (5.27 times sales) or Burger King stock (BKW) (5.82 times sales).

And as I mentioned before, Yum Brands’ strong presence in China and other emerging markets is a major plus.

So, I’m not shorting YUM stock any time soon. But I’m not buying it either — not until I see management refocus its efforts where they are likely to bear the most fruit.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Click here to receive his FREE weekly e-letter covering market insights, global trends, and the best stocks and ETFs to profit from today’s exciting megatrends.

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Want Emerging Markets Exposure? Go for Global Beer

From the news, you would think that Brazilians had stopped drinking beer.  Ambev (ABV), the Brazilian brewing giant, is expected to see mildly negative volume growth this year, as slower economic growth and rising inflation appear to have dampened the party spirits.

Ambev—which trades as a separate ADR despite being controlled by global brewer Anheuser-Busch InBev (BUD)—has followed the Brazilian market lower this year.  In dollar terms, Ambev is down about 17% from its February high vs. a loss of 15% on the popular iShares MSCI Brazil ETF (EWZ).

So, after its recent spill, is Ambev a buy?

At current prices, Ambev is not a compelling buy.  True enough, the brewer is one of the purest plays on the rise of Latin American living standards.  This is a durable macro trend and, in my view, one of the most  attractive investment themes of the next decade.  But trading at 23 times expected 2013 earnings and yielding only 2.3% in dividends, it can’t be considered a screaming bargain.

What about its behemoth international partner, Anheuser-Busch InBev?

BUD is the largest brewer in the world and one of the most diversified.  It counts over 200 beers in its product portfolio, claims 6 of the 10 most valuable beer brands in the world, and it sells over half of its beer by volume in emerging markets.

BUD isn’t “cheap” trading at 20 times earnings, but for a high-quality, defensive dividend grower with unparalleled international reach, I wouldn’t consider it expensive.

Earlier this week, I wrote about my favorite way to invest in emerging markets: Western-domiciled multinationals with an oversized presence in the developing world, or what I like to call “Emerging Markets Lite.”  Anheuser-Busch InBev would certainly make the cut here.

But as attractive as BUD is, it’s not my favorite.  That distinction belongs to Dutch-based megabrewer Heineken (HEINY).

Heineken depends on Western Europe for a larger chunk of its revenues than Anheuser-Busch InBev, which has muted investor enthusiasm.  But Heineken gets about half of its revenues and more than 60% of its sales by volume from emerging-market countries, and it has excellent positioning in Africa, the last real investing frontier of any size.

Africa already accounts for 22% of Heineken’s sales by volume, and this percentage will only increase with time as African consumer trade-up from home brews to branded beer.

Heineken trades for a reasonable 17 times earnings and pays a modest 1.8% dividend.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he was long HEINY. Click here to learn about his top 5 global investing trends and get your copy of “The Top 5 Million Dollar Trends of 2013.”  This article first appeared on InvestorPlace.

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The Best Way to Invest in Emerging Markets

There are three ways to get exposure to emerging markets, according to Barron’s Shuli Ren:

  1. Buy an emerging market index
  2. Buy a global materials index
  3. Buy a basket of multinationals with heavy emerging markets exposure

I’ve written about the first option recently, giving my recommendation on choosing the right emerging market ETF.  The most direct route I have found is via the EG Shares Emerging Market Consumer ETF (ECON).  The underlying holdings of ECON get about 90% of their revenues from selling within their home markets and other emerging markets, which is a stark contrast to most mainstream emerging market ETFs.

For example, the iShares MSCI Emerging Markets ETF (EEM) is comprised of companies that, while domiciled in the emerging world, get a large chunk of their revenues from exporting to the West.  Think Samsung (SSNLF) and Taiwan Semiconductor (TSM).  (Whether or not South Korea and Taiwan are “emerging markets” or “developed markets” is another debate for another day, but both countries are well represented in EEM.)

What about the Ren’s second option, buying a global materials index?

I’m not the biggest fan of commodities as an asset class.  There were numerous studies in the early-to-mid 2000s that showed a basket of commodities offering “equity like” returns (such as this one) and recommending commodities.

But things have changed over the past decade; correlations between commodities has increased.  As commodity mutual funds and ETFs such as the PIMCO Commodity Real Return Fund (PCRDX) and iShares S&P GSCI Commodity-Indexed Trust (GSG) have become popular, commodities that once traded largely independently of each other now get lumped together and bought and sold as a group. Furthermore, the financialization of commodities has caused their correlation to stocks to rise as well.  So, the touted diversification benefits are now mostly moot.

Furthermore, most investors have little understanding of how commodities investing works.  Outside of a few ETFs that hold the physical commodity, such as the SPDR Gold Trust (GLD), most funds and ETFs use commodities futures.  And the price of the underlying spot commodity is only one return driver.  You also have to take into consideration the roll yield (or the return you from buying a futures contract and having its price converge to the spot price) and the return from the collateral (which is usually Treasury securities).

Well, the collateral returns—which were significant in decades past—have been close to zero in the age of quantitative easing.  And due in no small part to excessive interest from new retail investors, many commodities futures have been trading in contango (i.e. have a negative roll yield).  This means that futures investors actually lose money every month relative to the price of the underlying commodity.

Why does this matter?  Gorton and Rouwenhorst wrote a paper that compared spot commodity returns to futures returns to see how commodities stack up as an asset class.  Their “investable” futures portfolio had annual returns of 10.31% from 1959 to 2004.  Yet the spot return was only 3.47%…which was actually lower than the 4.15% in inflation over the period.

This means that two thirds of “commodities” returns were actually from the roll yield and the collateral…neither of which is a source of return in today’s market.

This brings us to multinationals.  This is my preferred way to invest in emerging markets for most clients because, if done right, it is the best of all possible worlds.  You can get emerging market growth from companies with Western management and subject to higher standards of governance and regulation.  I call the strategy “Emerging Markets Lite” or “Emerging Markets though the Back Door.”  But whatever you want to call it, it’s a great way to invest the growth portion of your portfolio.

By and large, you’re going to get a better selection of Emerging Markets Lite stocks in Europe.  Want a few examples?  How about consumer products and food giants Unilever (UL) and Nestle (NSRGY).  Both are stable performers with long histories of paying and raising their dividends.  And both have monster presences in emerging markets.  Unilever gets nearly 60% of its revenues from emerging markets, and while that has hurt the company this past quarter, it ensures that it has a bright future.  Nestle gets more than 40% of its revenues from emerging markets.

Exposure to emerging markets is a double-edged sword. You benefit from the growth, but you also get whacked by the occasional currency crisis and by the occasional bout of political instability.  Just consider it a cost of doing business.  The rise of the emerging market consumer is a durable investment theme, and any macro shocks that cause Emerging Market Lite stocks to take a short-term tumble should be viewed as a buying opportunity.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he was long ECON, UL and NSRGY. Click here to learn about his top 5 global investing trends and get your copy of “The Top 5 Million Dollar Trends of 2013.”  This article first appeared on InvestorPlace.

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Vodafone the Victor in Verizon Wireless Buyout

British telecom giant Vodafone (VOD) agreed to sell its stake in Verizon Wireless to Verizon Communications (VZ) in one of the biggest deals in history.  That’s the headline.  But the question no one seems to be asking is Why was Verizon that eager to spend $130 billion on a capital-intensive business in a saturated market with cutthroat competition from cheaper upstarts?

Seriously.  Mobile phone penetration is the United States was 102% as of the end of last year, and this is a conservative number using the entire population of the United States and its territories as the denominator.  Removing small children, the elderly and infirm and the prison population, the number would be significantly higher.  Not only does every American already have a cell phone, but many of us have two or three.

Sure, everyone already has a phone, but there is still growth in the smartphone market, right?

Not nearly as much as you might think.  Already, more than 61% of all American mobile phones are smartphones. Even among Americans aged 55 and older the rate of ownership is 42%.

Will the Baby Boomers adopt iPhones and Androids in larger numbers going forward?  Probably.  But the low-hanging fruit was picked a long time ago.  And to the extent that the over 55 demographic adopts smartphones, they are likely to buy entry-level data plans that are highly competitive on cost.

It’s hard to see a lot of room for margin expansion in a saturated market where the “stickiness” of consumer loyalty is being steadily eroded by falling switching costs to the consumer.  Add to this the body blow that T-Mobile (TMUS) dealt to the industry with its adoption of transparent pricing and the elimination of the carrier phone subsidy, and it’s hard to find much to like here.

Don’t underestimate the effect of that last point.  Carriers have offered “free” or highly discounted phones for a long time as a way of enticing you to pay up for a Cadillac voice and data plan.  It was a terrible deal for the consumer, but the pricing was opaque enough that most had no idea just how bad of a deal it was.  T-Mobile’s transparent pricing has been something of a wake-up call.

All of this is a long way of saying that Vodafone got the better end of this deal.  They rid themselves of a profitable but soon-to-be no-growth business, have the means to pay off all company debts nearly three times over, and have the financial firepower to expand their emerging markets presence, which is already one of the largest among Western carriers.

As far back as 2011, Vodafone’s CEO had publically stated that Vodafone was an “emerging markets company” and not a European company.  Emerging markets accounted for 29% of Vodafone’s service revenue last year and virtually all of its expected future growth.  The company operates in 30 countries and partners with other carriers in 40 more.

So, what will Vodafone do with all of its cash?  That’s a fine question, and the company hasn’t given a lot of specifics just yet.  Some combination of debt retirement, share repurchase, and a special dividend would seem likely.

Should you buy Vodafone now, after the Verizon Wireless divesture?  Perhaps. Vodafone likely will release a large special dividend, but it’s harder to say whether its current generous 6% dividend will stay intact. Also, Vodafone is a great way to get “back door” access to the emerging middle class in India and parts of Africa.

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he had no position in any stock mentioned. Click here to learn about his top 5 global investing trends and get your copy of “The Top 5 Million Dollar Trends of 2013.”

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