Yum! Faces Uphill Battle in China

2014 was supposed to be a return to growth for the fast food company's biggest market, but early data doesn't show it. Should investors remain cautious?

Jan 16, 2014 at 4:16PM

For years, Yum! Brands (NYSE:YUM) had the fast food industry's darling -- unparalleled exposure to the endlessly giving market that is China. To this day, the company is the largest U.S. fast food provider in the world's most populous country; yet, its fortunes have turned the other way for more than a year now.

KFC, the flagship property overseas, isn't drawing in the droves of Chinese chicken seekers that it once was. For a while, this could have been attributed to the fact that the past years' growth was simply not repeatable in perpetuity (a fair claim), or that the global economic slowdown kept consumers from eating out as often. (Abroad, KFC doesn't have the same cheap and dirty stigma that it does in the U.S.) The reason may be a shift in consumer taste preference, as well as a string of incidents that eroded the Chinese lust for fried chicken. What evidence is there that 2014 will be any different for Yum! in China?

Playing chicken
Starting a year ago last November, Yum! ran into some quality control issues and, thus, a PR problem that hasn't abated much. At the time, a report came out alleging that KFC was using growth hormones and antibiotics in its chicken -- a claim that went viral (pun intended), and prompted a bigger discussion about food safety. Sales dropped off shortly following.

Last spring, avian flu broke out in the region, casting further doubt in the minds of fowl-eating Chinese.

Yum! has more than 6,000 stores in China; it's not a region that can languish for long with the rest of the company's operations propping it up. Another Yum! property saw tremendous success throughout 2013 -- Taco Bell -- due to gimmicky menu items and spot-on marketing. Whether that will continue into 2014 is yet to be determined. Without it, Yum!'s weakness in its greatest market will shine much, much brighter.

Change ahead
Last year, management did its best to assuage investor and analyst fears regarding KFC's China Syndrome.  However, recently released December figures kept the doubt flowing, as the numbers did not signify a legitimate turnaround.

Same-store sales rose 2% -- the first positive number since before November 2012's snafu. While any positive number is favorable, it still came in well under analyst estimates of 6% growth. Outside of KFC, the company saw weakness in another brand with high hopes in China -- Pizza Hut -- which saw its same-store sales drop 3% year over year.

Management had guided for double-digit same-store sales growth in the coming year for China, but these numbers tell a potentially different story. Investors should remain wary in the short term of Yum!'s misfortune in its most crucial market.

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