Yum! Brands (NYSE:YUM) has been reeling from negative publicity that hit its KFC brand in China starting last December. KFC's Chinese locations have been in a free fall ever since and management has repeatedly overestimated the brand's performance over the past eleven months. However, KFC's October same-store sales growth figure is a major improvement on recent performance and may be a signal that the long-awaited turnaround has finally arrived.
KFC lays an egg
KFC's China troubles began in mid-December 2012 when it was revealed that a small number of poultry farmers in KFC's supply chain were using excessive levels of antibiotics in the chickens as well as a drug that is banned for use in food. Although the incident affected only a tiny percentage of KFC's operations, the Chinese media went ballistic and KFC same-store sales, or SSS, plummeted.
Negative press over the poultry farmers incident had just subsided when media attention suddenly shifted to an outbreak of the bird flu in China. KFC's chief product is fried bird; Chinese consumers were terrified. Once again, SSS nosedived, falling 36% in April and 25% in May.
Yum! CEO David Novak predicted a sharp recovery after a terrible April. By June, the worst of the bird flu hysteria had come and gone, and SSS were headed toward positive territory.
However, in a puzzling twist, KFC's SSS continued to decline for months after the bird flu publicity -- a possible signal that the KFC brand took a bigger hit than originally thought from back-to-back mishaps. Yum!'s August press release detailing another month of declines for KFC blamed the problem on the poultry supply chain incident -- a problem that many investors had thought was already behind the company. The slow Chinese economy has also created a tough environment for fast food chains. Regardless of the cause, October's relatively strong SSS performance indicates that Novak's prediction of a turnaround may finally be coming true.
KFC bests McDonald's in China
Investors new to the Yum! story may not know that the company has made a significant bet on the emerging economic superpower. There are 4,260 KFC locations in China -- about one quarter of the total KFC store count. McDonald's (NYSE:MCD), by comparison, had only 1,700 locations in China at the end of 2012. Moreover, brand-equity firm Millward Brown ranks KFC as the number one consumer brand in China, six places ahead of McDonald's.KFC is clearly the top fast food chain in China and it is far enough ahead of McDonald's that its lead is not in jeopardy.
However, McDonald's second-place standing in China does not keep it from posing a serious competitive threat to KFC. The world's largest fast food chain plans to have 2,000 locations in China by the end of this year. To do that, it will have to open 275 new locations in 2013 -- more than it has ever opened in China in a single year. Clearly, McDonald's will not let KFC have free reign in the country.
Even though both chains have strong presences in the country, KFC and McDonald's have both had a miserable 2013. Fortunately, they are not the only ones reporting slowdowns in the region. Dunkin' Brands' (NASDAQ:DNKN) international SSS declined 1.4% in the third quarter while U.S. SSS increased 4.2%. This is further evidence that KFC's troubles may be confined to the Chinese economy rather than lasting brand damage from negative publicity.
Despite the poor performance overseas, Dunkin's stock has been on a tear this year; it is up over 20% due to the enormous expansion opportunity in the U.S. and abroad. The company is expanding westward across the Mississippi and it is seeing strong demand from potential franchisees. Dunkin' also plans to double the number of international stores over the coming years, sensing opportunity in China.
KFC has had a miserable year in China; the trifecta of supply chain issues, bird flu, and a slow Chinese economy has dragged its sales down. However, with the bad publicity behind it, investors can stop worrying about the lingering effects on its brand; the poor performances of McDonald's and Dunkin' Brands in the region suggest that the slow economy has more to do with KFC's current SSS woes than anything else. This is good news for investors and it suggests that KFC may be ready to emerge from negative SSS growth.