Yum! Hit By Softening Sales In The Mainland

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The shares of the restaurant chain known for franchises like KFC, Pizza Hut, and Taco Bell witnessed a drastic fall of nearly 10% on Friday. Fast food king Yum! Brands’ (NYSE: YUM) shares witnessed their biggest drop in ten years following the news that  same store sales in China would decline in the fourth quarter and its growth in the mainland may slow down.

Diving into the number pool
The fast food operator presented its outlook for the current year as well as the coming year. As per the company’s previous guidance, the same store sales in China would remain flat or show single digit improvement in the fourth quarter. However, the recent updates say that the same store sales would fall around 4% in the quarter compared to 6% growth rate in the previous quarter and last year’s 21% rise. As per the company’s annual guidance, the same store sale growth for the year would be 6%. The company believes that opening up new stores would be helpful in driving profits. The company opened a many as 800 new outlets during the year and plans to open 700 more in 2013.

Though the current numbers are a bit depressing, Yum! is confident about its future operation in the mainland. It expects  earnings per share to grow by at least 10% in the next year and estimates an operating growth of 15% in China, which would be driven by  single digit same store sales growth. International operations are expected to grow about 10%, attributable to same-store sales growth of 2-3%, the opening of new outlets, and better margins.

What pulled down the company’s revenue in the mainland?
The quick-service restaurant operator’s revenue in the mainland has softened. The world’s number two economy, China, is showing signs of weakness, and growth has been sluggish in the past seven quarters. The uncertain macroeconomic conditions have made consumers grow cautious, which is why they have restricted their spending. This has had an impact of the company’s revenue and profit from the region. One cannot ignore the fact that Yum! earns a major chunk of its revenue from this powerhouse, and any slowdown in the mainland could put a brake to the restaurant chain’s growth model. The economy accounted for about 44% of Yum!’s total revenue in the previous year. Customer traffic in the food outlets have been declining, but the company is hopeful regarding a mid-single digit same store sales growth in the long run.

Yum!'s dearest rival McDonald’s (NYSE: MCD) also witnessed a 1.8% fall in the same store sales in October, as the fast food chain is facing difficulty in fighting the sluggish consumer demand in the face of the economic uncertainty. The company experienced a 2.4% decrease in the Asia/Pacific, Middle East, and Africa market, which was due to depressing results from the Chinese, Japanese, and Australian markets. In addition, the fast food service operator is facing stiff competition from peers like Burger King (NYSE: BKW) and Wendy’s who are revamping their menu to attract customers.

The fast food industry is getting extremely competitive. Burger King reported strong US and Canadian restaurant sales in the latest quarter, compared to McDonald’s soft sales growth. The Miami-based burger chain’s business strategy is to offer value priced and family-friendly food that attract customers, which is taking away business from McDonald’s.

My takeaway – positive outlook in the long term
The weakening Chinese sales may have shaken Yum!’s future outlook and raised concerns about the company’s growth story in the mainland, but the long term prospects of the fast food chain remains bright. The company’s reliance on the Chinese economy may worry investors as nearly half the revenue comes from China where the growth rate is stabilizing around 7%. Yum! has been one of the best performing foreign companies in this emerging market, with about 5,000 outlets. The current slowdown is a temporary thing that is being reflected in the same store sales growth. It is of a cyclical nature, and should not make investors lose their confidence.

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