Yum's Still Lickin' Its Burned Fingers in China: Matthew Brooker

There’s something rancid in Yum! Brands’ third-quarter report, and it’s not just the expired meat allegedly supplied to the company in China last year.

Chief Executive Officer Greg Creed blamed “unexpected headwinds” for a 2 percent gain in same-store sales in China that fell well short of analysts’ estimates. The stock plunged as much as 19 percent in late Tuesday trading.

One setback identified by the company was foreign exchange. The yuan’s surprise 3 percent devaluation in August will have hurt U.S. dollar earnings. Not that much, though. China’s currency was on average 1.5 percent weaker in the third quarter than in the year-earlier period. Factoring this in, China sales were still way below analysts’ projection of a 9.6 percent increase.

Creed said, improbably, that Yum’s growth fundamentals in China remain intact. Its challenges look deep-seated.

The proximate cause of weak sales is the fallout from a Shanghai supplier that was alleged to have been providing chicken and beef past their sell-by date. The government investigation, which also affected McDonald’s, helped drive Yum’s same-store China sales down 14 percent in the third quarter of 2014.

Given that low base of comparison, 2 percent for the current period looks even more anemic. Nor can China’s ailing economy be blamed. The catering services segment of retail sales accelerated in July and August, jumping 12.4 percent in the most recent month for which official data are available:

Much has changed in China since throngs gathered outside KFC’s first outlet in Tiananmen Square, in 1987. Then, American fast food offered an exotic taste of the capitalist West to a mostly impoverished people who had been largely walled off from the outside world.

Three decades on, per-capita disposable incomes have risen more than 20-fold in towns and cities, a vast middle class has sprouted, and tastes have become more sophisticated.

Like McDonald’s, KFC has adjusted its menu over the years in China to appeal to local palates, adding dishes such as beef rice and chili black fungus. The risk is that such localization dilutes its attraction as a foreign company, undermining the cachet that was once the brand’s chief selling point.

Food-safety scares from avian flu to a banned dye hurt U.S. and local brands alike. Why go foreign when the quality may be no better than widely mistrusted Chinese products?

The third-quarter numbers show Yum is still grappling with this conundrum. While restaurant margins in China widened 4.7 percentage points to 19.6 percent, investors won’t be satisfied until they see some healthy top-line growth in the company’s biggest market. Creed has plenty to chew on.

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