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Tricon serving up healthy net earnings of 41%, but Wall Street investors have little appetite

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Since its 1997 spinoff from snack-and-soda giant PepsiCo Inc., Tricon Global Restaurants Inc. has been serving up a profitable menu of chicken, tacos and pizzas.

So why does Tricon give Wall Street heartburn?

The world's largest restaurant company - operator of the Taco Bell, KFC and Pizza Hut chains - has seen its stock price nearly sliced in half from its year-ago high. Monday on Wall Street, Tricon, which trades under the ticker symbol YUM, closed at $29.88 a share - around where it was trading at the time of the spinoff.

Yet last year, net earnings at the Louisville, Ky.-based fast-food company rose 41 percent. In the first quarter of 2000, net profit increased 13 percent to $120 million, or 80 cents a share, on revenue of $1.6 billion. As for second-quarter earnings, analysts polled by First Call/Thomson Financial see profit jumping 20 percent.

"Their track record since going public is pretty terrific, as far as earnings," said Chuck Hill, First Call's director of research.

But Peter Oakes, an analyst at Merrill Lynch, is one of many cautious Wall Streeters.

"In our opinion, YUM remains a complicated turnaround story," he wrote in a recent report.

Analysts say too much of Tricon's rosy performance comes from profits generated from selling restaurants to franchisees, not from selling fast food to customers.

At its largest unit, Dallas-based Pizza Hut, 30 percent of the restaurants have been sold since the spinoff. The proceeds were used to pare down Tricon's huge inherited debt of $4.71 billion. Long-term debt now stands at $2.58 billion, according to a recent securities filing.

"A lot of the gains are one-time in nature from the sales of the restaurants," said Howard W. Penney, an analyst with Morgan Stanley Dean Witter, who has a neutral recommendation on Tricon. "I would prefer to see ... [Tricon's] restaurants performing better."

Indeed, Pizza Hut saw sales at outlets open for at least one year - a key measure of performance in the restaurant industry - fall 2 percent in the first quarter. That quarter, though, was compared to a particularly bullish 1999 first quarter, when so-called same-store sales increased 14 percent.

At KFC, same-store sales in the quarter were down 3 percent, and at Taco Bell, they were nearly flat.

Wall Street's skepticism has helped fuel a 44 percent slide in Tricon's stock over the last year. By comparison, the Standard & Poor's restaurant index has fallen about 18 percent since a year ago.

The S&P restaurant index, which includes Tricon, is heavily weighted by the fortunes of McDonald's Corp.

Tricon explains the tumble as an "old economy" vs. "new economy" story. Old economy stocks, including the household names of the consumerist economy, have underperformed in recent years, while new economy stocks, such as Cisco Systems Inc. and Intel Corp., have been Wall Street darlings.

Tricon executives also point out that there are positive aspects to their story.

Going global

For instance, there are the company's go-go global profits, particularly in China and Mexico. "International is really going to be a growth engine going forward," says David Deno, Tricon's chief financial officer.

Of its 30,000 company-owned, franchised and licensed restaurants, nearly a third are overseas and run by Dallas-based Tricon Global International. In fact, the top-selling Pizza Hut restaurant is in Paris, rather than the United States.

In the first quarter, international operating profits were up 33 percent, and that's on top of 34 percent growth in the comparable 1999 quarter.

Moreover, when Tricon's performance is measured purely on operations - that is, without the proceeds from restaurant sales - it still shows steady growth.

Operating earnings were $1.83 a share in 1998 and $2.58 in 1999. And operating profits are expected to continue growing - to $3.18 a share this year and $3.62 in 2001, according to analysts polled by First Call. Tricon can also boast a low price-to-earnings multiple of 11 - barely half that of its peers.

As a general rule, the lower a stock's P/E ratio, the better a bargain that stock may be for investors.

Making noise

Whatever its fortunes on Wall Street, Tricon is continuing to fight for supremacy in the crowded restaurant field with the usual weapons: new products and clever marketing. Particularly clever marketing.

"It's like electricity," explains Randy Gier, Pizza Hut's marketing chief. "The more news you have, the more noise in the marketplace, the more people eat it up."

Tricon brought the world what's become an advertising icon: the "Yo quiero Taco Bell" Chihuahua. Though the Chihuahua was criticized by a few Latino activists as demeaning to the Spanish-speaking, others inside and outside the Latino community applauded the humor.

Late last year, though, an industry magazine weighed in with a cheeky story implying that the Chihuahua sold lots of, well, Chihuahuas - but few chalupas. Some even thought that retirement was near for the Chihuahua, whose campaign was created by the Los Angeles office of TBWA/Chiat/Day.

"There were some rumors that we were getting him out of our life," says Peter Waller, Taco Bell's president and CEO. "[But] the Chihuahua is very much part of our life."

Last month, the 8-pound spokesdog played a splashy role in a rollout of freshly fried nacho chips. Figuring that an easy way to get attention was to spoof the mania for dot.com stock offerings, the non-silicon chips were teased via a Web site called www.newchip.com.

Then the Chihuahua was trotted out at the New York Stock Exchange to ring the opening bell.

Publicity was extensive, with the Chihuahua making its bark on national morning television.

"You can always take life too seriously," explained Mr. Waller, who predicts the chips will be a big success.

Interactive advertising

At the KFC unit, promoters are turning advertising over to the consumer. This month, KFC said it will offer a $10,000 grand prize and a home theater system for the person who can come up with the best "sandwich superstar" advertisement.

Novices must cater their pitch around one of the KFC chicken sandwiches, which were launched last year with less-than-appetizing results. The winner will also get an all-expenses paid trip to New York City to attend a recording session with actor Randy Quaid, the voice of the revamped animated KFC Colonel.

Such hoopla is essential, says University of Dallas marketing professor Dale Fodness. "We're an incredibly affluent society, and we're bored," he said. "Food can't be just food anymore, it has to be entertainment."

At Pizza Hut, the biggest player in the $25 billion pizza industry, promotions come fast and furious. Most recently, it's been hype over the comeback of The Edge, a pizza covered with toppings from edge to edge. Earlier, film director Spike Lee and actress Fran Drescher helped push the rollout of the 16-inch Big New Yorker pizza. A few months back, it was a make-your-own CD with a name-your-own-toppings pizza. Music choices included such new-pop stars as Britney Spears and Christina Aguilera.

In fact, promotions spin out with such regularity that Mr. Gier, Pizza Hut's marketing chief, returned from vacation to discover his marketing minions had hatched a new promotional gimmick: a presidential poll in which consumers link the candidates to the most likely pizza ingredients. And when Pizza Hut launched its new logo a year ago, it emblazoned it on the side of a rocket and launched it into space, arguing that its food formula is "rocket science."

Pizza Hut takes its promotions so seriously its lawyers spent a good portion of their time last year in court accusing rival Papa John's of false advertising when it boasted of "better ingredients" and "better pizza." Pizza Hut won the bulk of the case.

Fresh ideas

While marketing rolls ahead, Tricon's units have also tried to keep their restaurants stocked with new products like the Big New Yorker - or at least "reintroduced" versions of limited-time offerings like The Edge. Soon, Pizza Hut hopes to unroll a bake-it-at-home pizza that can be stored in the refrigerator until mealtime. Taco Bell's new "freshly fried, cantina-style" tortilla chips were two years in the making, and the chain recently rolled out a line of chalupas.

Tricon officials hope the combination of marketing and culinary innovation will help them capitalize on the growing U.S. economy - and the penchant for dining out that goes with it.

"I think it's a terrific time to be in the restaurant industry," Mr. Deno said. "All the demographic trends favor eating away from home." Tricon's trendy advertising campaigns feature familiar images such as Taco Bell's ubiquitous Chihuahua, Pizza Hut's Big New Yorker and KFC's animated Colonel.
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