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While the fast-food industry is no stranger to scandals, usually concerning the quality of its meat, Yum! Brands (NYSE: YUM ) seems to be experiencing more than its fair share. The owner of KFC, Pizza Hut and Taco Bell is being slammed by one controversial story after another. While this in and of itself is bad enough, the bad news is starting to translate to the company's bottom line. Yum!'s most recent earnings report was a severe disappointment to investors as weakness in China sales weighed on operating results.
As Yum!'s history of scandals is fairly extensive, I will focus on some of the most recent ones. While KFC has been catching most of the flack lately in China, Taco Bell may have a more sordid history in the US. Back in 2000, the Mexican fast-food chain was embroiled in a Kraft Foods recall of taco shells which were made with contaminated genetically modified corn. Several years later, in 2006, the company was implicated in a number of E. coli outbreaks which sickened hundreds of people .
While food safety and hygiene may be an issue in the US, the situation is presumably even more dire in China where lax legislation gives fast-food operators a little more slack. In 2012, a very large scandal erupted in China after state television aired a report stating that KFC chicken contained excessively large amounts of antibiotics and growth hormones . Spectacularly, CEO David Novak's reaction to the scandal at Yum!'s analyst day was as follows: "No worries. It will blow over ... It always has ".
The icing on the cake was perhaps an even more recent scandal surrounding the quality of the meat in Chinese hotpot chains, which turned out to contain all manner of animal meat other than the lamb it was advertised as. However, other US fast-food chains have run into trouble as well. McDonald's (NYSE: MCD ) was implicated in the very same poultry case as KFC in China. The iconic American brand has been the target of many campaigns. Among other things, it was targeted over its non-vegetarian French fries and its practice of buying meat from factory farms .
McDonald's key rival Burger King (NYSE: BKW ) has not managed to escape scrutiny either. It was very recently revealed that one of BK's main suppliers in Ireland and the UK, Silvercrest Foods, made patties with traces of horsemeat. While BK management was quick to assert that there was no reason to believe its products were affected, the burger maker dropped the supplier immediately . No doubt, the story has done little to bolster BK's image in the area.
Hurting the bottom line
Weak results recently released by Yum! Brands suggest that the recent scandals in China have hit the company's earnings. The company gets more than half of its revenue from China. Any slowdown in the area is sure to be significant. The third quarter report missed earnings per share expectations by around 8%. Moreover, quarterly earnings were down around 15% from the year-earlier period. Weakness in China was a prime culprit.
Comp store sales in China were down 11%. This was led by a 14% drop in KFC comps largely attributed to the recent poultry scandals. Pizza Hut was a bit of a bright spot with a 5% increase in comps. Adding to the problems was a recent avian flu scare which no doubt reduced traffic across the region . As such, the company has adjusted its outlook for China. Yum! now expects a high-single to low-double-digit full-year EPS decline . While the company's CEO seems unperturbed, it is clear that the company's dubious record in terms of food safety is starting to be felt in its purse.
The bottom line
Yum Brands! has caught a lot of flak recently because of a number of food quality and safety scandals, especially in China. This has hit the company hard because it relies on China for the majority of its revenue. With earnings on the decline and a lowered outlook, Yum! doesn't look particularly appetizing as an investment at the moment, nor does it seem attractive as a fast-food option. Perhaps this earnings weakness will convince management to raise its food quality standards.
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