This Global Fast Food Chain is Expanding Like Crazy in China

The past weekend’s news that China will allow its currency, the yuan, to appreciate against the dollar sent positive waves through the market for much of Monday’s trading session. Aluminum and steel stocks were up, as were domestic consumer plays in mainland China. But, as StreetAuthority’s David Sterman mentioned, it may take years before the benefits are realized.

That’s why it’s important to take a step back. Rather than using the weekend’s news as the sole reason to buy a particular stock, investors should use it as one more reason to buy shares of companies that will capitalize on catalysts that are already at work — and will be for years to come.

The biggest and yet one of the least talked-about stories related to China is its emerging middle class. Chinese officials worry about having to rely on American and European consumers to grow their economy — rightly so, considering recent economic crises. It’s in China’s long-term interest to have a stronger currency, rising wages and at least a partial social safety net so its citizens will be encouraged to save less and spend more.

Fact: China already has a middle class of about 300 million people. That number is expected to exceed 500 million in 10 years.

Some more interesting facts: Nearly one new Kentucky Fried Chicken fast food restaurant opens in China every day. There are almost 4,000 KFC locations in China, compared to only about 1,100 McDonald’s locations. Soon, there will be more KFCs in China than in the United States.

And that’s not all that KFC parent Yum Brands (NYSE: YUM) has been up to. . .

The company opened more than 1,400 new restaurants around the world in 2009 — 509 of those were in China. Yum operates and franchises the KFC, Pizza Hut and Taco Bell brands, among others, and now has nearly 35,000 locations worldwide.

Yum isn’t just a global play with a partial China angle — it has a major footprint in the country. And there’s good reason behind the aggressive expansion in China — 34% of Yum’s 2009 revenue came from its Chinese locations, despite having just over 10% of its total locations in the country.

The average Yum fast food location in China carries margins of more than 20%, according to its most recent annual report, and can achieve “cash payback” within two to three years.

The global recession caused Yum’s same store sales to be flat, except in China, where sales grew +10%. Profits from Chinese operations were up +29% in 2009 after growing +28% in 2008.

The entire company carries an operating margin of 14% — not bad for the restaurant business. The global slowdown didn’t hurt Yum too bad either. In fact, earnings per share grew by +13% in 2009.

Yum believes its brands, particularly KFC, can be as prevalent in China as McDonald’s (NYSE: MCD) is in the United States. The company has been generous to shareholders, having paid $8 billion in dividends and share repurchases since it spun off from PepsiCo (NYSE: PEP) in 1997. And speaking of McDonald’s, Yum’s stock has outrun its golden-arched rival during the past 10 years with a gain of +640% compared to +160%.

Action to Take –> Yum has ambitious goals for China. Given its success so far, there’s no reason to doubt that’s possible. At less than 19 times earnings, the stock is reasonably valued on both a historical basis and compared to its peers, considering its long-term potential for global growth.

The stock’s 2% yield may not seem appealing at first, but consider that this is still a company that is expected to grow +12% annually during the next five years. The dividend has grown about +33% during the past five years, yet the company still pays out about 35% of earnings. Don’t be surprised to see a steadily rising dividend, especially once management feels it has reached its potential for expansion.