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Yum! Brands Earnings: China's Indigestion Continues

By Rick Munarriz – Oct 8, 2014 at 4:15PM

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Yum! Brands, Inc. hopes to make Taco Bell, KFC, and Pizza Hut even tastier.

Shares of Yum! Brands (YUM 2.13%) opened higher on Wednesday despite posting problematic quarterly results. Adjusted earnings clocked in at $0.87 a share, missing Wall Street's profit targets by $0.01 for the second quarter in a row. Tweaked profitability improved by 3% on an earnings-per-share basis, but that was partly the handiwork of a reduction in the diluted share count. It also would have been a significant decline if not for a favorably low worldwide effective tax rate this time around. 

Things could be better for the parent company of KFC, Taco Bell, and Pizza Hut. Total revenue slipped 3%, to fall below $3.4 billion for the quarter. Despite several new openings during the past year -- primarily in emerging markets -- worldwide sales inched a mere 1% higher. The path down the income statement gets hairier, with restaurant margins slipping 2.7%, and Yum! Brands' operating profit plunging 12%. 

The good news is that a lot of the quarter's shortfall can be tied to business taking a blow in China after a summertime scare at one of its smaller suppliers. 

Big trouble in big China
Things aren't going well for Yum! Brands in the world's most populous nation. China experienced a 9% plunge in sales, as a 6% uptick in net new KFC and Pizza Hut locations was no match for a 14% drop in comps. 

The catalyst for the wave of patron defections is tied to an undercover report that aired in China on July 20, taking a supplier to task for its improper food handling practices. Yum! Brands severed ties with the supplier, but consumers in China are historically slow to come around. Yum! Brands saw its KFC business take a hit for more than a year after a poultry scare in late 2012. Sales didn't rebound until earlier this year.

One would think that it would bounce back sooner this time. This situation is tied to a single, and now former, supplier selling meat past its expiration date. However, Yum! Brands isn't taking any chances. It's hosing down its bottom-line outlook for the entire year.

It's bracing for improving, but still negative, comps in China, leading it to revise its guidance. Yum! Brands now sees earnings per share climbing 6% to 10% before one-time items in 2014.

Despite the weakness in China, it continues to be a major contributor to Yum! Brands' overall profitability. Chinese eateries accounted for $202 million -- or nearly 37% -- of the $550 million in consolidated operating profit. 

Closer to home
Thing are holding up relatively better elsewhere. Its KenTacoHut empire is humming along.  

  • Taco Bell saw comps move 3% higher. This may actually be disappointing in light of March's breakfast rollout, as well as the recent Dollar Cravings menu introduction. However, operating earnings at KFC actually improved 14%.
  • KFC also clocked in with a 3% uptick in same-store sales growth. Operating profit came in 16% higher than a year earlier.  
  • Pizza Hut experienced a 1% decline in comps. It's a cutthroat world when it comes to chains waging war with pizza cutters. Operating earnings dipped slightly.  

Stability at Pizza Hut and welcome gains at KFC and Taco Bell seem to be offsetting the sting with investors. It helps that the stock is trading closer to its 52-week low than its high. The 2.3% dividend yield is also there to reward patient investors. If Yum! Brands can bounce back in China by early next year -- and barring a new supplier scandal or food scare, it should -- the market's receptive reaction to the overall flattish report makes sense.

Rick Munarriz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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