A Finger-Lickin' Good Time In China

KFC, a laggard at home, is making buckets of profit in the Middle Kingdom

After 50 years of chowing down on Kentucky Fried Chicken, Americans seem to be losing their taste for Colonel Sanders' secret recipe. Same-store sales at KFC's 5,335 stateside outlets declined 2% in September, and have risen only twice in the last six months. Worse for KFC's parent, Yum! Brands Inc. (YUM ), its other big chains -- Taco Bell and Pizza Hut -- are also in a slump.

So why is Yum's stock trading near its all-time high? Sheng Yejiang and tens of millions like her could give you the answer. Late one recent afternoon, the 17-year-old and a half-dozen friends were grabbing a quick bite at a crowded KFC in Beijing's swanky China World Shopping Mall. Sheng says she drops in every couple of weeks because "the service is very good and the food is great."

That sort of loyalty is fueling growth for Yum, which has 1,700 KFCs spread across 400 cities on the mainland. On Oct. 11, Yum reported that its third-quarter operating profit in China jumped 26%, to $105 million, on a 28% increase in sales, to $445 million. In the U.S., where Yum has 20,000 restaurants, operating profits rose less than 1%, to $183 million, while sales fell 7%, to $1.3 billion. For the year, the Louisville company says, it now expects worldwide earnings to rise 14%, thanks almost entirely to China, where it opens a new restaurant every 22 hours. "We're on the ground floor of a booming market, just like when Colonel Sanders started KFC and Ray Kroc started McDonald's," says Yum Chief Executive David C. Novak, who one day wants to have as many restaurants in China as he does in the U.S.

WHAT ABOUT BIG MAC?

Yum isn't the only American multinational looking to China as an antidote to slowing growth at home. Wal-Mart Stores Inc. (WMT ) is reported to be offering $1 billion for a chain of 100 Chinese hypermarkets, the huge grocery-department store hybrids. Sales growth at its U.S. outlets, meanwhile, has slackened in the past two years. And General Motors Corp., troubled at home, (GM ) saw its unit sales in China soar 37% in the first nine months of the year.

That's not the case for KFC rival McDonald's Corp. (MCD ) While bigger globally and ascendant in the U.S., McDonald's trails Yum in China, with just 770 restaurants in some 120 cities. And while Yum's profit margin in China rose 3 points, to nearly 24%, in the third quarter, McDonald's puts its return in China in the high single digits. "We admit that's much lower than it should be," says H. Matthew Paull, McDonald's chief financial officer.

Yum is winning partly because it got an early start. PepsiCo Inc. (PEP ), which spun off Yum in 1997, opened its first KFC in Beijing in 1987, three years ahead of McDonald's. Yum then set up its own supply and distribution system, allowing it to expand quickly into ever-smaller cities. The company has also tailored its menu to local tastes with items such as the Dragon Twister, a sandwich stuffed with chicken strips, Peking duck sauce, cucumbers, and scallions. Yum even has a Chinese mascot: a kid-friendly character named Chicky, which Novak boasts has become "the Ronald McDonald of China."

Things might get tougher for Yum. Competition could heat up as a result of a recent deal McDonald's inked with China's Sinopec (SNP ), giving Big Mac rights to build drive-through outlets at the oil company's 30,000 gas stations. Also, fast-food chains would be near the top of the list of business casualties in the event of an avian flu epidemic. KFC's China sales plunged last winter during a flu scare. But for now, bird by the bucket in China translates into money in the bank back home.

By Michael Arndt and Dexter Roberts

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