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Yum Beats Baidu as China Bet on Chicken Allure: Riskless Return

Yum Beats Baidu as China Bet on Chicken Allure
Customers eat at a KFC restaurant in Beijing. Photographer: Nelson Ching/Bloomberg

Fiona Yao, a 32-year-old accountant, passed up a bowl of steaming noodle soup in favor of spicy chicken wings and a burger for lunch from a Kentucky Fried Chicken outlet in a Shanghai shopping mall.

“I almost don’t take KFC as a foreign brand,” said Yao who paid 30 yuan ($4.80) for her meal at the SuperBrand mall. “The Chinese love to eat chicken and everyone can afford it.”

Chinese consumers like Yao are one reason that Yum! Brands Inc., KFC’s parent, provided the best risk-adjusted return in the past year among 113 companies that are either based in China or get at least 25 percent of their revenue from there, the BLOOMBERG RISKLESS RETURN RANKING shows. Yum gained 1.63 percent after adjusting for volatility, followed by Mead Johnson Nutrition Co., a Glenview, Illinois-based maker of infant formula, which returned 1.58 percent.

The U.S. consumer companies topped the ranking after China’s emerging middle class turned to western food products as a sign of growing wealth and as safety concerns tarnish some local competitors. While a Hong Kong-based casino venture had the highest total return, multinational companies such as Yum! and Mead Johnson are less volatile because they’re more diversified and viewed as less susceptible to changes in the local economy and interest rates.

‘Safe Play’

“They’re able to tap into China as an additional source of growth at the minimum risk,” said Jeff Papp, a senior analyst in Lisle, Illinois at Oberweis Asset Management Inc. which manages $700 million including Chinese stocks, though not Yum or Mead. “They have a very strong foreign brand and at the same time they don’t get 100 percent of their revenue from China, just the growth part of it. Perception is that it’s a safe way to play China.”

The Bloomberg ranking included 19 U.S. companies that earn at least a quarter of their annual revenue in China, the 54 most-traded Chinese companies with shares listed in the U.S., and 40 mainland Chinese firms traded in Hong Kong.

Shares of Yum!, based in Louisville Kentucky, returned 40 percent in the year through March 30, five times the advance of the Standard & Poor’s 500 Index. Spun off from PepsiCo Inc. in 1997, Yum, which also owns Pizza Hut and Taco Bell, boosted net income excluding certain items by 62 percent over the past five years as the portion of its revenue derived from China more than tripled.

Yum’s volatility, a measure of price swings, came in at 25 over the past year, the second-lowest after China Mobile Ltd., the world’s biggest phone company by subscribers. The 10 most volatile companies in the ranking were all based in China.

KFC Near Tiananmen

PepsiCo acquired the then Kentucky Fried Chicken Corp. in 1986, 22 years after it was sold by entrepreneur Harland Sanders, known as the colonel, for $2 million to private investors. Sanders’ image still adorns restaurants and packaging.

Mead Johnson, the world’s largest standalone baby formula manufacturer, has a volatility of 27, the third-lowest. The company got more than 29 percent of revenue from China in 2011, and profit has climbed 28 percent since 2006.

Yum and Mead Johnson were the only companies that stayed in the top 10 for volatility-adjusted returns over three years. The risk-adjusted return is calculated by dividing total return by volatility and isn’t annualized.

Since opening its first KFC outlet 25 years ago near Beijing’s Tiananmen Square, home to Mao Zedong’s mausoleum, Yum has become the most popular western restaurant company in China.

Outpacing McDonald’s

The company added a new KFC or Pizza Hut restaurant every 14 hours in the world’s fastest-growing major economy last year, extending its reach to 4,500 locations, more than double the number of McDonald’s Corp., the world’s largest restaurant company, according to company filings.

Yum stock has surged 174 percent, including dividends, since March 2009 as 51 percent growth in Chinese revenue offset declines at its U.S. business. While Yum’s same-store sales fell 1 percent in the U.S. last year, they grew 19 percent in China and 3 percent at other offshore locations, according to the company’s filing.

The company has said it plans to open 600 new restaurants in China this year. Yum has 18,000 KFC, Pizza Hut and Taco Bell outlets in the U.S., the company said in its annual report.

Bacon and Mushroom

“We have a long runway for growth in China and other emerging markets,” Steve Schmitt, director of investor relations at Yum, said by e-mail. “With more than half of our operating profit coming from China and 72 other emerging countries, Yum! Brands growth story is about China and a whole lot more.”

The company’s recipe for success has been to adapt menus to local tastes, offering Chinese staples like bacon and mushroom rice and egg tarts at KFC and upgrading Pizza Hut from the delivery outlet known in the west to a sit-down dining restaurant that sells wine, according to Sara Senatore, a senior research analyst at Sanford C. Bernstein & Co in New York, who expects Yum shares -- currently trading at $70.71 -- to climb another 10 percent to $78 in 12 months.

Oak Brook, Illinois-based McDonald’s Corp. has less than half of the stores that Yum has in China, where it offers predominantly the same burger-driven menu found in its U.S. outlets. McDonald’s got 40 percent of its 2011 revenue from Europe, 32 percent from the U.S. and 22 percent from the Asia Pacific region, Middle East and Africa, data compiled by Bloomberg show.

Focus on Consumption

Companies like Yum and Mead Johnson will continue to rally as they push their products into smaller, expanding Chinese cities, according to Sanford’s Senatore and Michael Broudo, managing director of Miller Tabak & Co. in New York.

While China’s government has cut its economic growth target to the lowest since 2004 this year, and the European debt crisis and lackluster U.S. recovery are curbing demand for goods from the world’s largest exporter, Yum and Mead Johnson will benefit as the nation shifts its growth focus to internal consumption, according to Paul Dietrich, director of global research at Washington Wealth Management LLC, a Middleburg, Virginia-based financial adviser.

China’s middle class will double to 600 million over the next decade, Yum’s Chief Executive Officer David Novak told analysts during a conference call in February. The baby food market in China may increase to $20 billion by 2015, from $9.8 billion last year, accounting for one third of the world’s total, according to estimates by research firm Euromonitor International Plc.

Food Scandals

Mead Johnson, whose Enfa brands of pediatric nutrition accounted for 79 percent of 2010 revenue, returned 219 percent over the past three years as sales in China more than doubled to $1.1 billion. China became the company’s biggest market last year.

The largest milk formula provider in the country, Mead Johnson had a 12 percent share of the market in 2010 compared with Paris-based Danone SA’s 10 percent, according to London-based Euromonitor. This leading position allowed the company to boost market share as domestic players dwindled in the wake of food-safety scandals that pushed Chinese parents to foreign formula brands, said Ildiko Szalai, an analyst at Euromonitor in London.

Regulators found toxins in December in milk products of China Mengniu Dairy Co., the country’s largest milk producer. The discovery added to safety concerns already elevated after an illegal additive was found in pork products sold by Shuanghui Group, China’s biggest hog processor, in March last year. Infant formula tainted with the plastics chemical melamine in 2008 killed at least six babies and sickened about 300,000 throughout China.

Most Expensive

“Strong brand equity is very important in China because of the product safety issues,” said Szalai.

Gains in market share drove 75 percent of Mead Johnson’s 40 percent revenue increase in China last year, Chief Financial Officer Peter Leemputte said on a conference call with analysts on Jan. 26. The company expects “mid-teen growth” in 2012, Chris Perille, a company spokesman, said by e-mail.

The advance in Yum’s stock has made it the most expensive relative to earnings in four years. The company trades at 22 times estimated net income, compared with an average valuation of 14 times for S&P 500 companies. Mead Johnson’s valuation is 27 times earnings estimates, near the highest premium since September over stocks listed in the MSCI China Consumer Staples Index, which has an average ratio of 22.

Bolstering Growth

“Investors need to be careful taking stocks that have already performed very well,” said Christopher Palmer, who helps manage $2.5 billion of assets as director of global emerging markets for Henderson Global Investors Ltd. in London and doesn’t hold Yum or Mead Johnson stock. “They are managing their growth very well, but that doesn’t necessarily mean that will be the case going forward.”

Melco Crown Entertainment Ltd., a Hong Kong-based casino venture between billionaires Lawrence Ho and James Packer, had the highest absolute return of the 114 companies tracked by Bloomberg over the past year, gaining 78 percent. With a volatility level of 71, it had a risk-adjusted return of 1.1 percent, the third-highest and equal with China Mobile.

The People’s Bank of China is moving its focus from containing inflation back to bolstering growth after the nation’s economy, the world’s second largest, expanded the least for ten quarters in the last three months of 2011. Banks’ reserve ratios have been cut twice since November as policy makers work to free up lending.

‘Tastes of the Chinese’

Multinational companies active in China are less touched by shifts in the nation’s monetary policy than local firms, a big factor in their reduced stock volatility, said Washington Wealth’s Dietrich.

While Baidu Inc., owner of the biggest search engine in China, surged 743 percent in U.S. trading over the past three years, the stock’s volatility level of 45 is more than double that of Yum and Mead Johnson. Baidu’s risk-adjusted return was 0.1 percent for the past year.

Back at the KFC outlet at Shanghai’s SuperBrand mall, accountant Yao sits by young people feasting on mushroom rice and chicken burgers. Twice as many people queued at the KFC as at the “Real Kungfu” soup shop next door, which also sells Chinese-style pork ribs with herbal broth for about 20 yuan.

“KFC is more catering to the tastes of the Chinese than McDonald’s,” Yao said. “That’s why KFC is so successful.”

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