Yum's Growth Has a Foreign Flavor

The restaurant operator shrugged off two high-profile mishaps to post a stronger quarterly profit, thanks to rising international sales

After the recent food poisoning and rat video fiascos at Taco Bell, Wall Street analysts were bracing to hear about U.S. sales losses at the fast food chain's Louisville-based parent. But Yum! Brands Inc. (YUM) managed to post a surging profit nonetheless as its business improved overseas. After the news investors bought the stock on May 2.

The company earned 70 cents per share during the three months ended Mar. 31, up 19% compared to the same period last year. Yum's operating profit gained 31% year over year in China and 25% internationally. "We delivered this great performance in the face of two negative and unforeseen incidents at Taco Bell, which shows the tremendous earnings power of our company," CEO David C. Novak said in a press release late May 1.

A consensus of 16 analysts covering the company had forecast only 64 cents per share earned during the March quarter.

Yum has had to deal with months of bad press. In December, news hit about food poisoning at Taco Bell restaurants in the Northeast. Upon discovering that some of the ingredients in its food showed signs of E. coli contimination, the Irvine (Calif.) company moved quickly to clean up its restaurants. But then in late April, soon after a KFC/Taco Bell restaurant had passed a New York city Health Department inspection, a video was broadcast on television and the Internet showing rats scurrying across the unit's floor (see BusinessWeek.com, 3/2/07, "YUM Brands Will Have To Do Better Than Mea Culpa for Taco Bell").

As U.S. customers stayed clear of Taco Bell, its U.S. sales at stores open more than a year fell by 11% during the March quarter. Such losses helped to drive Yum's U.S. operating profit down by 11% compared to last year.

While Wall Street focused on the U.S., Yum's sales continued growing elsewhere -- like China, where the company has expanded rapidly. Total revenue ended up rising 7% year over year to $2.2 billion during the March quarter.

Now the company is promising better times ahead and raised its full-year EPS forecast to 11% growth, or $3.23 per share, from 10%.

"While our concerns about the U.S. business segment after negative publicity from two recent health-related incidents were well founded, as segment operating profit fell 11%, the China and International segments were much stronger than we forecast," Standard & Poor' s equity analyst Mark Basham said in a research note. (S&P, like BusinessWeek.com, is owned by The McGraw-Hill Companies.) While Basham raised S&P's 2007 estimate on the company's earnings by 10 cents to $3.25, he continues to worry about Yum's having further U.S. market share loss. He downgraded Yum to hold from buy, noting that the company's stock price is now near his $72 per share target price.

Yum shares gained 5.9% to $66.86 per share in afternoon trading on the New York Stock Exchange May 2. As investors recover confidence in Yum, the company's shares have been mostly rising since having traded at around $56 per share on March 5.

Yum still faces plenty of competition, both globally and in the U.S. McDonald's MCD, for example, on Apr. 13 announced better than expected first quarter earnings. The fast food giant has already grappled with similar challenges; a slew of public-health scares -- ranging from salmonella to mad cow disease -- had made European consumers increasingly wary of American hamburgers during recent years. In response, McDonald's took initiatives such as publishing the nutritional content of its products and selling only organic milk at outlets in Britain, Germany, Sweden, and Austria. Now the fast food chain has managed to keep turning around sales at its languishing European businesses, at the same time new products helped to snag customers in the U.S. (see BusinessWeek.com, 4/13/07, "Investors Hunger for McDonald's").

Like its rival, Yum appears to have weathered the latest bout of bad news with aplomb.

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