This Fast Food Giant Looks To Restore Its Reputation

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Yum! Brands (NYSE: YUM), the quick-service restaurant chain, has warned of a decline in profits in 2013 as the company is experiencing the backlash of a controversy with respect to its chicken suppliers in China. The Kentucky-based company gave a grim outlook for the current year given the issue it is facing in China. The fast food chain has about 5,300 outlets in the mainland, most of which are KFCs. The success of its China division is extremely critical to the company’s growth as it accounts for over half its revenue and around 40% of its operating profits. What is the issue that Yum! is facing in this emerging nation?

The issue
Yum!’s difficulty began when the government food safety agencies of China started investigating about the company’s supply chain. They discovered that poultry suppliers of both Yum! and McDonald’s (NYSE: MCD) supplied chicken which had high levels of antibiotics. McDonald’s says that customer safety is its priority and it ensures through sample testing of the raw material that it receives. Both the fast food giants are co-coordinating with their suppliers to ensure the safety of their food and have stopped purchasing chicken from these problematic units.

Yum! and McDonald’s are not the only companies that experienced supply chain issues, recently fellow rival Burger King (NYSE: BKW) also faced raw material concern. Silvercrest Foods, the company’s UK beef supplier had mixed horsemeat with the beef supply. The company too, like its fellow rivals, boycotted the supplier as a ‘precautionary measure’.

The Food safety authorities in China did not fine Yum! however the negative publicity by the media has defamed the fast food restaurant chain. The company apologized to its Chinese customers and is presently undertaking various steps to re-build its reputation in its biggest market. It has planned to hold an aggressive marketing campaign in order to regain consumer confidence and restore their brand perception regarding KFC. This had an impact on the fourth quarter results of the company’s China division.

What do the numbers say?
The owner of KFC, Pizza Hut and Taco Bell witnessed a 5% decline in profits to $337 million for the fourth quarter. This is majorly attributable to the negative impact of its poultry supplies in China. The total revenue for the quarter saw a marginal rise of 1% to $4,153 million while the total revenue for the entire year increased 8% to $13,633 million.

The same store sales increased 5% in US, 4% in China, and 3% at Yum! Restaurants International (YRI) during the year. However, the same store sales suffered from the food safety issue in China and turned negative in the second half of December 2012. In fact, the same store sale fell 6% for the fourth quarter in China.

The China division faced difficulties at the end of the year; but the YRI business gave solid performance and is expected to continue fetching solid numbers for the fast food restaurant chain. Even the US business of the company was pretty strong. Taco Bell was the key driver to Yum’s domestic success in 2012 as the new restaurant additions worked in favor of the company. In addition, the company also added 150 new Pizza Hut outlets and this is of great importance as the investment cost is low while returns are pretty attractive. The company is confident about its current year outlook for US as it has some innovative offerings across all its three brands. However, is the overall outlook for the current year getting hampered due to the issues faced in the mainland?

The road ahead
The Kentucky company is confident about its US and YRI businesses, however the uncertainties surrounding China have made the overall outlook a bit gloomy. The scandal is going to negatively affect its sales in China from where the company amasses a great chunk of its revenue. This would hurt the overall sales growth of the company which could result in a decline in profit in the current year.

The Chinese business continued to suffer in January as the food safety issue had an impact on both KFC and Pizza Hut outlets. While KFC’s same store sales fell as much as 41%, Pizza Hut suffered a decline of 15%. This is expected to improve with time and give favorable results in the last quarter of 2013. David Novak, the company Chief Executive is positive about the popularity of KFC in China and believes that it would soon contribute to the sales in full force.

My takeaway
Yum! may have more outlets in US, but China is a more profitable market as the cost of operation is lower. The company’s growth heavily depends on its Chinese operation. It is therefore essential for the company to restore it reputation in this emerging market which has a lot more growth potential given the rising disposable income.

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