Tricon profits rise despite sales dip

Nation's Restaurant News, May 8, 2000 by Richard L. Papiernik

KFC sandwich line erodes core product

LOUISVILLE, KY. -- When KFC restaurants launched their own chicken sandwich brand last September, the new menu item became an instant hit at the register, ringing up dramatic sales gains.

KFC since found that there might be such a thing as being too good.

"When we launched the chicken sandwiches, we figured we'd get about $100,000 in sales per restaurant from them," said David Novak, chief executive of parent Tricon Global Restaurants, which operates or franchises some 30,000 restaurants. "What we got were sales of $130,000."

With Tricon's first-quarter profits up 13 percent from the same period a year earlier, ongoing international operating profits up 33 percent and sales of a new product climbing 30 percent above expectations, it would be difficult, at first glance, to see any real problems.

But there were problems, according to the company and to industry analysts, and one problem started with those chicken sandwich sales.

Instead of adding to unit revenues, the popular chicken sandwiches gobbled up so much business at the typical unit that they started eating away at the core sales of "chicken-on-the-bone" at the KFC chain.

"The problem was that the sandwiches just moved the mix around, so we did not have incremental sales," Novak said. "Now we are going into a more balanced marketing program and a more balanced calendar at KFC."

Other problems also popped up at KFC and the two other brands that fly under the Tricon flag in the fiscal 2000 first quarter that ended March 20.

Same-store sales at KFC were down 3 percent. At Pizza Hut same-store sales dropped 2 percent from the same quarter a year earlier. And same-store sales at Taco Bell tipped only slightly to the positive side. Though that was a significant turn, it was not enough to bring the "blended" comp numbers up to the positive level for the quarter. The blended, or combined, same-store sales were down more than 1.5 percent.

Novak, in a conference with industry analysts following release of the first-quarter report, noted that falling same-store sales at Pizza Hut ran up against a banner 14-percent increase in the same quarter a year earlier.

The 2-percent decline at Pizza Hut "was better than expected," and there were good prospects for improvement at KFC and Taco Bell, he said.

"Based on the progress Tricon is making," Novak said, "we are pleased to reaffirm our full-year commitment of 2 percent to 3 percent U.S. blended same-store sales growth and ongoing operating EPS growth of 23 percent to 27 percent."

Total system sales for the quarter grew 2 percent, to $4.93 billion, and revenues, because of the unit divestment program, were down 12 percent, to $1.6 billion.

The outlook for growth in ongoing operating earnings excludes a possible impact by the bankruptcy of its major supplier, AmeriServe Food Distribution Inc. It also excludes charges for unusual and extraordinary expenses and accounting changes.

"Long-term, I'm confident of strong EPS growth," Novak said, "and post-2000, of growing EPS at midteen rates on a sustainable basis."

But Joe Buckley of Bear Stearns in New York, along with several other restaurant industry analysts, said they have yet to be convinced that Tricon is turning around.

"We have remained skeptical on the Tricon story," Buckley said. "Their earnings have been better than their operating performance. Their operating trends are poor."

Buckley said he was concerned particularly with what the company calls its "facility actions," the program under which Tricon is selling off its units to franchisees.

"When you sell as many restaurants to franchisees as Tricon, you run the risk of losing your quality and consistency."

Novak insists that eager "franchise partners," such as the ones who acquired 183 restaurants during the first quarter, are "growth-ready franchisees" who add strength to the company.

And the divestment does help prop up the bottom line.

But investors and observers contend that the lack of The Street's confidence in margins and operational stability have brought Tricon stock prices down from nearly $75 a share about this time a year ago to its current trading in the high 20s and low 30s per share.

Merrill Lynch analyst Peter Oakes, who has a "buy" recommendation on the stock, said, "Trading at just 10 times our 2000 operating BPS estimate, well below its depressed peer group, investors either have little confidence in the earnings estimates or else are holding back until the results come through."

Oakes views the depressed Tricon stock as a buying opportunity "in advance of improving signals over the next few months."

Earlier this year New York based analyst Damon Brundage told the Wall Street Transcript he believes that Tricon is doing a number of things that are having "a positive effect on earnings." They include: such strategies as continuing its sales to franchisees, using the proceeds to pay down debt, thus lowering their interest expense, and "getting a bit better handle" on general and administrative expenses as well as buying back its own stock under a $350 million share-repurchase program.