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China’s Fascination With Fast-Food Restaurants

China's rising middle class and robust economy are encouraging the Chinese to adopt spending habits commonly found in the U.S. and other Western countries. Eating at fast-food restaurants has gained popularity among China's young people, who see the establishments as a trendy place to meet and eat.

In Hong Kong, McDonald's (NYSE: MCD  ) restaurants are even hosting wedding parties at various locations. Referred to as 'McWeddings,' the parties are very similar to a typical wedding party, where a newly married couple gathers with friends and family to celebrate. Customers can choose from several "wedding packages" that come in a variety of price ranges. These restaurants offer a cheaper alternative to a traditional (and expensive) Chinese wedding.

It would seem that even as the country goes through an economic slowdown that has affected the fast-food sector, the Chinese have developed a taste for fast food.

KFC suffers setback in China
China's consumer market is a major draw for foreign investment, especially from the fast-food industry. Yum! Brands' (NYSE: YUM  ) KFC restaurants are the leader in the number of restaurants operating in China, with more than 4,000 units in operation.

The China division's 11% drop in third-quarter operating profit to $335 million was attributed mostly to last year's avian flu scare and news about excessive antibiotic levels found in chickens sold by one of KFC's suppliers. In addition, Yum!'s same-store sales for its overall international division grew 1%, and the U.S. segment's sales were flat in the third quarter.

While it has taken much longer than the company expected for sales in China to recover, Yum! Brands still believes in China's rapid growth and is on track to open 700 new restaurants this year. In the company's third quarter press release, Yum! revised its full-year outlook and "estimates a high-single to low-double digit full year [earnings per share] decline versus [the] prior year." The company's other restaurants, Taco Bell and Pizza Hut, had better results and showed growth during the quarter.

McDonald's challenged by market conditions
McDonald's sales were also down 0.5% in its Asia/Pacific, Middle East, and Africa segment during August. The company had negative results in Japan, China, and Australia, which were partly offset by positive sales in other markets in the region. Its goal in this segment is to improve the connection with consumers by promoting products that are relevant to each local market and stressing affordability and convenience.

The company's second quarter (ended June 30) had similar results for the APMEA segment, with a comparable sales decline of 0.3%, due to weak results in China, Australia, and Japan. Other operating segments had similar results. McDonald's CEO Don Thompson stated that overall conditions for the rest of the year remained challenging.

China's not running on Dunkin' yet
Dunkin' Brands Group's  (NASDAQ: DNKN  ) presence in China is limited compared to Yum! Brands and McDonald's, which is on pace to open 2,000 restaurants by the end of 2013. Dunkin' Brands is looking toward China with a slower expansion plan than that of its competitors.

When Dunkin' first expanded overseas, it looked for smaller markets with greater ties to American culture, such as South Korea, the Philippines, Indonesia, and Japan. Chief executive officer Nigel Travis appears to take a cautious approach to investing in a larger market like China, where he favors a "disciplined expansion." The company seems to want to learn more about the Chinese market before opening restaurants all over the country.

Dunkin's methodical approach to doing business may help it weather the current challenges present in the fast-food sector. Issues such as rising commodity prices for wheat and coffee can take a bite out of profits and lead to higher prices passed onto the consumer. Unlike KFC, Dunkin' Brands generates almost three-fourths of its revenue in the U.S.

Earlier this year, the company announced plans to increase its presence in the Western part of the U.S. in places like California and Colorado. So, it may take time before China runs on Dunkin'. Compared to its competitors, Dunkin' had U.S. comparable-store sales growth of 4% and 151 new restaurant openings during the second quarter. Adjusted operating income rose 15.5%, and adjusted EPS increased by 24% to $0.41. 

My Foolish conclusion
Despite the recent slowdown in China's economy and other challenges affecting the fast-food sector, the Chinese consumer is one worth coveting. And evidence shows that the Chinese have rather easily adopted fast-food meals into their lifestyle, which has become increasingly fast paced as household incomes have risen. If the current trends continue, these fast-food restaurants should benefit over the long term from their operations in China, where the fast-food sector is expected to grow annually by about 7% into 2017.

And Dunkin' Brands may be one to watch closely. The brand's slower approach to growth may help the company avoid the costly mistakes of over-expansion while gaining more in-depth knowledge about China's consumer market and how best to serve it.

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9/26/2016 4:00 PM
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