For Yum! Brands, Inc., China Is No Longer a Problem

Yum! Brands and McDonald's are fighting for fast food supremacy in China.

Yum! Brands' China Division saw solid gains in same-store sales and operating income last quarter. Photo credit: Yum! Brands, 

I hope you're hungry, fast-food investors, because Yum! Brands  (NYSE: YUM  ) is officially back on track. Well, at least in China, that is. 

Interestingly, as of yesterday's mixed first-quarter results that were released after the bell, KFC is now reporting in five distinct divisions: a China division, an India division, and one division each for KFC, Pizza Hut, and Taco Bell locations outside of China and India. Yum! is still breaking down some numbers in the latter three divisions between international and U.S. locations, but it's apparent that the China division is leading the charge.

China system sales, for example, increased 17% thanks to a combination of 7% unit growth and 9% same-store sales growth. That includes an 11% same-store sales increase in the quarter for KFC, and 8% at Pizza Hut. Better yet, China restaurant margin rose 6.8 percentage points, to 23.4%, which drove an 80% increase in operating profit for the region. 

For perspective, on a worldwide basis, Yum! enjoyed system sales growth of just 4%, restaurant margin growth of 3.3 percentage points to 19.2%, and a 22% increase in operating profit. Yum!'s overall revenue also increased 7% year over year, to $2.724 billion, which translated to earnings of $0.87 per share. Analysts, on average, were looking for lower earnings of $0.85 per share on higher revenue of $2.8 billion.

But this raises the question: How did Yum! so furiously turn the corner in the Middle Kingdom?

Part of it is simply due to the fact that Yum! had to step over a lower bar this quarter. Remember, around this time last year, Yum! was blaming a 16% plunge in China same-store sales on both supply chain quality issues and consumer misconceptions surrounding an avian flu outbreak in the region. As long as Yum! continued to actively educate diners that properly cooked chicken is perfectly safe to eat, same-store sales just had to turn positive eventually.

And Yum!'s not completely alone in its outperformance, either; yesterday, McDonald's (NYSE: MCD  ) also said its own China comparable sales increased 6.6%. Sure enough, McDonald's management pointed to the "residual effects of consumer sensitivity related to last year's supply chain issue in the chicken industry." But because Chinese consumers didn't overwhelmingly correlate McDonald's brand with chicken, the Golden Arches simply weren't hit as hard as Yum!'s KFC brand.

In any case, this represents a solid continuation of Yum!'s progress in China last quarter -- which similarly featured its own earnings beat and top-line miss, by the way -- during which China division same-store sales fell around 4% from the same year-ago period, including a 5% increase at KFC and a 3% decline at Pizza Hut.

Going forward, let's also not discount the importance of what Yum! described last month as an "aggressive and comprehensive plan to restage KFC in China." According to yesterday's release, that plan kicked off on April 2 with a massive, customer-driven menu revamp, and will continue with redesigned packaging, contemporary uniforms, and gradual rollout of a new store design.

All things considered, and barring any unforeseen difficulties in the quarters ahead, it looks like China is finally done holding back Yum! Brands' stock.

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