Will China Continue to Drag Down Yum! Brands' Earnings?

Last year was a difficult year for Yum! Brands (NYSE: YUM  ) , with sales in China plummeting due to an avian flu scare and investigations into a chicken supplier. There was some improvement in November, with flat same-store sales for KFC China, and in December KFC China returned to same-store sales growth.

Yum! is set to report its fourth-quarter earnings on Feb. 3, and with McDonald's (NYSE: MCD  ) already reporting lackluster sales in the United States, both the domestic and Chinese markets will be in focus. Here's what to expect when Yum! reports earnings.

What analysts are expecting
Yum!'s December results actually came in below analyst expectations, with an average estimate of 6% for same-store sales growth in China. While KFC China grew same-store sales by 5% in the month, a 3% decline at Pizza Hut China brought down the total. With Yum! missing this mark, it's safe to assume that analyst estimates for the quarter might be on the high side.

Analysts are expecting approximately $4.3 billion in revenue for the quarter, a 2.7% year-over-year increase. Earnings are expected to decline to $0.80 per share, down from $0.83 per share in the same quarter last year. Full-year earnings per share are expected to fall by 10.5% compared to 2012, but analysts expect a strong recovery in 2014.

More problems in China
Though it seems that KFC China has finally recovered from the problems of 2013, a new batch of issues is emerging for Yum! in China. It's been reported that the H7N9 avian influenza virus has infected 96 people in China so far this year, killing 19, causing Shanghai to halt live poultry sales for three months.

With KFC a big part of Yum!'s strategy in China, consumer distrust of poultry has the potential to hit Yum!'s China results hard. This couldn't have come at a worse time for Yum!, with the Chinese New Year holiday, typically a busy period for KFC, beginning on Jan. 31.

2014 may end up being a repeat of 2013 for KFC China, where the chain saw same-store sales decline in the double digits for much of the year. This would destroy the big recovery that analysts are expecting in 2014, and it puts Yum!'s long-term earnings growth goal in jeopardy. Without a stable, safe poultry supply in China, it's hard to imagine KFC China being successful in the long run.

Yum! has yet to comment on the new China problems, so be sure to listen in on the conference call to see what management says about the issue.

Taco Bell is a bright spot
In the United States, Taco Bell has proven to be a bright spot for Yum!. Last quarter, Taco Bell grew same-store sales by 2%, marking the seventh consecutive quarter of same-store sales growth. This has partially been driven by the success of the Doritos Locos line of tacos, which have remained popular since their initial release.

The company announced last year that it would be expanding Taco Bell in the United States, with plans for 2,000 additional restaurants to be built over the next 10 years. This would increase the current restaurant count by one-third.

Along with this expansion, Taco Bell has some serious menu innovations planned for 2014. After testing a new breakfast menu last year, Taco Bell' plans to roll it out nationally later this year. This puts Taco Bell in direct competition with McDonald's, which relies on breakfast for a significant portion of its sales.

Along with the new breakfast menu, Taco Bell is increasingly focusing on beverages. The company plans to roll out six new beverages in an attempt to lure people to the stores for more than just food. All beverages will be cold, with half carbonated and half non-carbonated, marking a distinct difference between the beverage strategy of McDonald's. McDonald's has been focusing on high-end coffee drinks, and the company recently reiterated that coffee was one of its top priorities.

This has caused problems for McDonald's, since adding all of these complicated coffee drinks slows down service and makes the restaurant less efficient. Taco Bell is going a different route, not sacrificing the food business for the beverage business, and it's likely to be more successful.

The bottom line
Yum!'s problems in China may not be over, with new avian flu fears sweeping the nation. While these problems may not show up in Yum!'s fourth quarter, management will have a tough time convincing investors that 2014 will be different than 2013. In the domestic market, Taco Bell has been a bright spot, and further same-store sales growth would show that Yum! is doing a lot of things right with the brand. The China problems may overshadow these successes, though, and Yum!'s big bet on China is at risk of failing.

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  • Report this Comment On February 02, 2014, at 12:30 PM, egrandbuy001 wrote:

    My homies in China say KFC is so dead and quiet. Nobody wants to catch any bird flu for Chinese New Year. Also people around the world are finally realizing how shady and dirty KFC is with their steroid chicken and unsanitary practice. My bet is that it's over for KFC and a new Fast Food King will be crowned to replace it. Business is all about momentum. This negative momentum KFC has been getting the last few years will be super deviated for KFC in the long run.

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