What: Shares of Yum! Brands (NYSE:YUM) were down 18.3% as of a 1 p.m. Wednesday after the fast-food titan issued disappointing third-quarter results and reduced its full-year earnings guidance.
So what: Quarterly revenue climbed 2.2% to $3.43 billion, and resulted in a 14% increase in adjusted earnings to $1.00 per share. Analysts, on average, were looking for earnings of $1.07 per share on revenue of $3.68 billion.
To blame for the shortfall is a slower-than-expected recovery in China, which itself is due to a combination of macro-economic and foreign currency headwinds, as well as execution of marketing promotions in the country. China Division system sales increased 8% prior to currency translation, driven by 7% growth from new restaurants and same-store sales growth of just 2%. The latter tells the story of its primary weakness; same-store sales increased 3% at KFC in the country, but fell 1% at Pizza Hut Casual Dining.
Now what: Yum! CEO Greg Creed elaborated during this morning's conference call, saying historically Pizza Hut in China has delivered impressive growth by revamping 25% of its menu every six months. But in recent weeks, it became clear these promotions weren't performing at historic levels. In part, that had to do with the value positioning of those new menu options, which included a premium steak product that, in hindsight, was launched just as macros started to weaken. In addition -- and keeping in mind Pizza Hut in China is a much more formal casual-dining affair than here in the U.S. -- Yum! Brands has seen companies cut back on parties, dinners, and entertaining in recent weeks. So while Pizza Hut's weekend business continues to perform well, its weekday dinner results have seen a significant negative impact.
To combat this weakness, Creed says Pizza Hut in China will add a weekday value dinner promotion on top of a scheduled Oct. 19 menu revamp. And going forward to appease Chinese consumers in the current economic environment, Pizza Hut will focus more on promoting its value proposition rather than relying on its recent ability to offer premium menu items at premium prices.
Creed put it another way: "If I look back at our previous success, it's when we've offered five-star service at three-star prices. The calendar this year has had things that are more like six-star products, such as fajitas and premium steak, at six-star prices, at a time when consumers are seeking value."
To be fair, as I pointed out in my initial earnings article yesterday, Yum!'s other segments performed comparatively well. Taco Bell system sales rose 7%, including 3% unit growth and 4% same-store sales growth. KFC outside of China continued last quarter's momentum, with system sales up 6%, including 3% unit growth and 3% same-store sales growth. And while more work remains to be done at Pizza Hut outside of China -- where system sales rose 2%, driven by 2% unit growth and 1% same-store sales growth -- that's roughly in line with the expectations management laid out earlier this year as they work to turn around the business.
Nonetheless, given the headwinds in China, Creed says the company now anticipates growth in earnings per share for the full year to be "well below our target of at least 10%." For perspective, analysts' consensus estimates called for 2015 earnings to rise 13.6% to $3.51 per share.
With that shortfall in mind, it's no surprise the stock has pulled back hard today. But for patient investors willing to bet Yum! Brands' efforts will pay off over the long term, I think now is a great time to consider opening or adding to a position.