Back in 1930, Harland Sanders started selling chicken out of a gas station. That famous “secret recipe” chicken became the foundation for Kentucky Fried Chicken. Now owned by Yum! Brands, Inc. (NYSE:YUM), KFC is ditching the founder who died in 1980 in an attempt to enter the fast casual business.
KFC dumps the colonel
A new fast casual brand named “KFC Eleven” will open in August in Louisville, Kentucky. The new concept is named after the 11 herbs and spices that make up the Colonel’s secret recipe. The first location will be in a stand-alone setting, with several strip mall stores planned. The stores will also be the first KFC locations to not feature the famous Colonel Sanders on the exterior of the building.
This is a great move by Yum! Brands, Inc. (NYSE:YUM), the company behind Taco Bell, Pizza Hut, and KFC. By taking KFC into a fast casual setting, the company can expand its presence in strip malls and more upscale settings. The new brand could also boost operating margins and improve same-store sales in the United States.
Yum! Brands, Inc. (NYSE:YUM) has been hurting due to poor Chinese-region sales. In the second quarter, same-store sales in China fell 20%. This came after a 29% drop in April, 19% drop in May, and 10% drop in June. Worldwide sales increased 1% on the strength of the United States and international regions. Same-store sales at Yum! Brands three restaurants increased 1% in the United States.
Operating margins dropped 2.7% to 12.5%. In comparison to rivals, KFC Eleven should have stronger operating margins with its upscale feel and higher price points. Down the road, this could provide a boost to United States region where operating margins increased to 18.3%. In the United States, KFC saw same-store sales increase 3%. This was the largest of the three brands, as Taco Bell increased 2% and Pizza Hut dropped 2%.
Competitors KFC could hurt
The fast casual expansion by Yum! Brands, Inc. (NYSE:YUM) could put pressure on two competing chains. Chipotle Mexican Grill, Inc. (NYSE:CMG) has dominated the fast casual market with its upscale healthy restaurant locations. The chain caters to a different type of customer who wants fresh natural products. KFC Eleven will offer similar products to Chipotle and could be a direct competitor.
In the recent second quarter, Chipotle Mexican Grill, Inc. (NYSE:CMG) saw same-store sales increase 5.5%. This is a nice increase, but also shows the level that competition has dented into Chipotle’s normal double-digit gains. For the first six months of the year, same-store sales are up only 3.4%, despite strong traffic increases. In the second quarter, Chipotle opened 44 new restaurants. For the fiscal year, Chipotle expects to open 165 to 180 new restaurants. The company ended the quarter with a total of 1,502 restaurants. Operating margins for Chipotle are 27.6%.
KFC Eleven will not immediately impact Chipotle Mexican Grill, Inc. (NYSE:CMG), but it could spell trouble down the long road. Chipotle is still growing its restaurant base with strong numbers. The popular chain has seen its margins drop and same-store sales growth slow down. Competition from chains like KFC Eleven could send shares of Chipotle down as valuations drop.
Panera Bread Co (NASDAQ:PNRA) is another fast casual company that could see pressure from a successful KFC Eleven national brand. In the recent second quarter, Panera saw same-store sales increase 3.5% at company-owned stores and 4.3% at franchised locations. The majority of that growth (4.3%) came from check growth with rising prices rather than transactions, however.
In the fiscal year, Panera Bread Co (NASDAQ:PNRA) is planning on opening 115 to 125 restaurants. As of June 25, the company had 1,708 stores open. The chain is pretty evenly split between company-owned stores (835) and franchised locations (873). Panera has smaller margins than rivals Yum! Brands, Inc. (NYSE:YUM)and Chipotle Mexican Grill, Inc. (NYSE:CMG), with a 14.2% operating margin. Panera recently reported poor earnings and shares could be in for a nice rebound. Down the road, Panera could see KFC Eleven enter similar territory and put further pressure on operating profits and same-store sales.
Conclusion
Shares of Yum! Brands, Inc. (NYSE:YUM) trade with a higher valuation compared to earnings. Other fast casual chains also trade with high valuations, as investors price in the growth and expansion of the companies. As Chinese worries are in the spotlight, Yum! Brands can use a positive lift from this new brand. KFC Eleven should see a strong open with a well-known and loved brand. The brand could eventually balloon into 1,000 or more locations around the nation.
Chris Katje has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill and Panera Bread.
The article Kentucky Fried Chicken Fires Colonel Sanders to Take on New Rivals originally appeared on Fool.com.
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