Yum! Brands, Inc. (NYSE: YUM) shares currently trade at 12.2x its trailing EBITDA which is higher than the Consumer Discretionary sector median of 10.3x. While this makes YUM look like a stock to avoid or sell if you own it, equity investors might change their mind after taking a closer look at the assumptions behind the EV / EBITDA ratio. In this article, I define how to calculate an EBITDA Multiple and what to keep an eye out for when applying it in a comparable companies analysis.
YUM Comparable Companies Analysis
A comparable companies analysis, also known as a multiples valuation, determines the value of a subject company by benchmarking its financial performance against similar public companies or peers. We can conclude if a company looks undervalued or overvalued relative to its peers by comparing metrics like growth, profit margin, and valuation ratios.
Enterprise Value-to-EBITDA Multiple, also known as the EV / EBITDA ratio or an EBITDA Multiple, measures the dollars in Enterprise Value for each dollar of EBITDA. To determine if a company is expensive, it’s far more useful to compare EV / EBITDA multiples than the absolute stock price. The general formula behind an EBITDA Multiples valuation model is the following:
Enterprise Value = EBITDA x Selected Multiple
The EV / EBITDA ratio by itself is not very helpful at all. It is only useful when comparing it to other companies that are considered similar to the subject company. The basic idea is that companies with similar characteristics should trade at similar multiples, all other things being equal. Therefore, we can come to a conclusion about the stock if the ratios are different. In the chart below, I compare YUM’s EV / EBITDA ratio to its peer group that includes Chipotle Mexican Grill, Inc. (NYSE: CMG), McDonald’s Corporation (NYSE: MCD), Domino’s Pizza Inc(NYSE: DPZ) and Restaurant Brands International Inc. (NYSE: QSR).
Since YUM’s EBITDA multiple of 12.2x is lower than the median of its peers (18.9x), it means that investors are paying less than they should for each dollar of YUM’s EBITDA. As such, our analysis shows that YUM represents an undervalued stock. In fact, finbox.io’s EBITDA Multiples Model calculates a fair value of $100.18 per share which implies 16.1% upside.
I selected a fair multiple of 13.8x in my analysis by averaging YUM’s current EV / EBITDA ratio with its peer group and sector.
Are Comps Really Comparable?
Before concluding that YUM should be added to your portfolio, it is important to understand that our conclusion rests on two important assumptions.
(1) the selected peer group actually contains companies that truly are similar to YUM, and
(2) the selected peer group stocks are being fairly valued by the market.
If the first assumption is not accurate, the difference in EBITDA multiples could be due to a variety of factors. For example, if you accidentally compare YUM with higher growth companies, then its EBITDA multiple would naturally be lower than its peers since investors reward high growth stocks with a higher price.
source: EBITDA multiples model
Now if the second assumption does not hold true, YUM’s lower multiple may be because firms in our peer group are being overvalued by the market.
How This Impacts Shareholders
As a shareholder, you may have already conducted fundamental analysis on the stock so its current undervaluation could signal a potential buying opportunity to increase your position in YUM. However, keep in mind the limitations of an EBITDA multiples valuation when making an investment decision. There are a variety of other fundamental factors that I have not taken into consideration in this article. If you have not done so already, I highly recommend that you complete your research on YUM by taking a look at the following:
Valuation Metrics: what is YUM’s short ratio and how does it compare to its publicly traded peers? It represents the percentage of total shares outstanding that is being shorted. View the short ratio here.
Risk Metrics: how much interest coverage does YUM have? This is a ratio used to assess a firm’s ability to pay interest expenses based on operating profits (EBIT). View the company’s interest coverage here.
Efficiency Metrics: fixed asset turnover is calculated by dividing revenue by average fixed assets. View YUM’s fixed asset turnover here.
Author: Andy Pai
Expertise: financial modeling, mergers & acquisitions
Andy is also a founder at finbox.io, where he’s focused on building tools that make it faster and easier for investors to do investment research. Andy’s background is in investment banking where he led the analysis on over 50 board advisory engagements involving mergers and acquisitions, fairness opinions and solvency opinions. Some of his board advisory highlights:
- Sears Holdings Corp.’s $620 mm spin-off via rights offering of Sears Outlet, Hometown Stores and Sears Hardware Stores.
- Cerberus Capital Management’s $3.3 bn acquisition of SUPERVALU Inc.’s New Albertsons, Inc. assets.
Andy can be reached at email@example.com.
As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.