Yum! Brands' (YUM 1.22%) investors seem a little worried about the company's outlook after the fast food giant reported a steeper than anticipated decline in same store sales in China. This American restaurant chain has struggled in its main market for a long time. Yum! posted a 13% drop in comparable store sales in China for the month of July.
Concern over antibiotic levels in chicken and the impact of the bird flu outbreak have been stressing sales growth in the Chinese mainland. Let's take a closer look at the situation and find out if investors really need to worry about their money.
What happened and why?
Yum!'s KFC restaurants in China have faced sales struggles since last December, when the Chinese food regulatory agency identified unacceptable levels of antibiotics in the chain's chicken supply. China is Yum!'s biggest market and accounted for over 50% of its revenue in 2012. McDonald's (MCD -0.05%) faced similar accusations. Both fast food behemoths immediately cut ties with the suppliers concerned to ensure food quality and consumer safety. However, the Westerners weren't spared so easily. Yum!'s KFC sales experienced a severe decline, and they still aren't back to normal levels.
Just when the situation was improving, the avian flu outbreak in March shattered investors' hopes. Investor appetite for Yum! has fallen because of the uncertainties in the Chinese market. Same store sales had been falling by a smaller amount month after month, which was good news for the investors. April comparable store sales plunged 29%, May was better with a 19% drop, and June even better with a 10% fall. The trend had been expected to continue in July as well. On the contrary, July comparable store sales fell 13% as KFC experienced a steep 16% sales drop, while Pizza Hut sales only grew 3%.
Fellow players went a step ahead
Several market watchers also felt that the July results wouldn't have been as bad had the Louisville company focused on drinks and ice cream for the summer. This was an area where KFC did not really offer anything special to consumers, particularly as the mainland temperature in China hit record highs. KFC executives should have experimented with a new category of food for the summer. Hot and fiery chicken would not appeal as much as something cool in such sweltering conditions.
Fellow players McDonald's and Starbucks (SBUX 1.00%) were a step ahead.
Shaun Rein, the Managing Director of China Market Research Group, told Reuters that "McDonald's, Starbucks Corp, and Häagen-Dazs have been grabbing more share of the late afternoon and evening dining" because they offered cold drinks and ice creams that were better suited for the scorching heat.
McDonald's website heavily promoted iced drinks and McFlurry ice cream to beat the heat. This helped the fast food giant lure customers away from Yum! and gain market share. In contrast, KFC promoted hot food. Clearly the biggest Western fast food restaurant operator in China faces increased competition from its arch rival McDonald's.
Starbucks also saw solid 30% sales growth in the Asia Pacific region, which mainly came from its outstanding performance in China. The Seattle-based coffee giant offered its main foods and beverages in China while adding local options, a strategy it also uses in Western markets. The American coffee giant has appealed to the Chinese population despite the fact that the region has a tea drinking culture. Solid sales were also driven by the company's expansion program of opening 500 new stores last year in the mainland. Starbucks plans to continue its expansion in the country for further growth.
Competition might have become a little tough for Yum!, but the company is well positioned overall. Yum! has growth prospects in all its divisions, including the US, China, India and Yum! Restaurants International (YRI). Yum! gets around 25% of its revenue from its YRI division, and the company is expanding its operations in the rest of the world. About 205 units were opened in the last quarter, of which 87% were franchises. Franchise openings indicate demand in the region.
The bottom line
Investors seem cautious and doubtful, after seeing the slow growth pace of the Chinese economy. However, Yum! is trying to diversify its market instead of confining itself to China. The company is not sitting idle and waiting for the Chinese economy to recover and post strong numbers. Yum! is working hard to strengthen its markets in other parts of the world, including the UK and Ireland, to reduce its reliance on a single market.
The Chinese population considers Western outlets, such as KFC, to be benchmarks for class and quality. A problem like high levels of antibiotics in the chicken can hurt brand perception and hit consumer confidence very badly.
What needs to be noted is that the company did not change its current year outlook in China. It is optimistic about the recovery and forecasts that results should turn positive in the fourth quarter of the year. I believe Yum! is a perfect stock for long term investors. The stock may appear a bit difficult at the moment, but patient investors could gain from considering a low-cost position. This is not the first time Yum! has witnessed a road bump in China, and it has successfully handled similar crises before. The stock has strong growth potential, and its current setbacks are temporary.
