Yum! Brands Doubles Down on China

In the middle of a firestorm of negative media and cratering sales for its KFC locations in China right now, Yum! Brands (NYSE: YUM  ) is charging full speed ahead with its expansion plans in the country.

Sales have been hit hard by adverse publicity from what the company calls its "poultry supply situation." That problem started when a Chinese regulatory investigation found a few local farmers that were using excessive levels of antibiotics in raising their chickens. Despite the company's quality assurance and testing practices, some of that product made its way into Yum!'s supply chain. And the news of that lapse set off "intense and negative" media attention toward the KFC brand.

What followed has been a sharp decline in sales since the report aired on Chinese media on Dec. 18. It's too early to tell just what effect it will have on Yum!'s business. Yet the results over the last seven weeks have been bad enough to convince management that 2013 will end the company's 11-year run of annual earnings growth.

Still, Yum! hasn't scaled back its expansion plans one bit. After opening 900 new restaurants in China last year, it still expects to boost its footprint by 700 stores in 2013. The company sees China as a huge avenue for growth, and it has made no secret about its plans to replicate McDonald's successful model in the states. Just like Mickey D's did in the U.S., Yum! aims to aggressively snatch up all the premium retail spots in China, leaving competitors to fight over second-best locations.

But that kind of aggressive growth means Yum! will have to balance the huge market potential it sees against ongoing weakness in sales this year. Just to begin 2013, Yum! expects China same-store sales declines of 25% over the January and February months. If that drop persists into the spring, it's hard to see how the company could justify an ongoing investment in aggressive unit growth, no matter how big the potential is.

Yum! has pledged to update investors monthly until KFC is back on track in China. Investors should carefully follow those reports for signs of progress rebuilding the brand, or for hints that the company may have to scale back its expansion plans.

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