Yum! Brands Sees Growth in China Despite Sales Decline

Rajesh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Things are changing for Yum! Brands (NYSE: YUM), the owner of KFC, Pizza Hut and Taco Bell, as an aggressive decline in sales is improving in its biggest overseas market, China. The fast-food giant is gradually recovering after being hit by the chicken scandal in December and the adverse effects of avian flu, which made Chinese customers stay away from KFC. Though the sales figures continued to tumble in May, the magnitude of the fall has mellowed down compared to previous months.

The Louisville, KY-based company is expected to witness further declines in the next two months, but not at such drastic rates as in the first quarter. Let’s take a brief look at the current performance of the company.

The current status

KFC continues to be a victim of the chicken scare and the bird flu outbreak, but numbers have started to rebound for the company. Yum!’s same-store sales plunged 19% for May, but the good news is that the fall wasn’t as steep as the previous month, which saw a sharp drop of 29%. KFC, Yum!’s largest brand in the mainland, experienced a fall of 25% in May while Pizza Hut grew 12%.

Sales in the next couple of months are expected to fall at a lower rate. UBS global equity research forecasts that Yum!’s same-store sales should plunge in the range of 10% to 15% for June. Yum! is positive about its future outlook in the emerging economy as the company has weathered such storms in the past as well. Patrick Grisme, Yum!'s chief financial officer, expects the company to experience a strong comeback in 2014.

Yum! is not the only sufferer

Yum! is not the only company caught in the blizzard--McDonald’s (NYSE: MCD) is experiencing the same difficulty in the Chinese market. McDonald’s also complained that the bird flu scare is adversely affecting its revenue from China's emerging economy. Though the Oak Brook, IL-based company witnessed overall growth of 2.6% in May, its Asia Pacific regional performance saw growth of just 0.9%, majorly due to a revenue decline in China.

The company's sales trend in the mainland has been negative in the past few months, but it hasn’t been much of a concern for investors. This is because only 3% of its overall operating profits comes from the region, compared to Yum!’s major chunk. The fast-food restaurant giant is concentrating on adding new value items in its menu, which include chicken wraps and egg-white sandwiches. This is also a part of its effort to effectively contend with KFC, which occupies a much bigger chunk of the Chinese appetite.

Positive outlook

Yum! is expected to recover in the second half of the year and to see positive trends in sales in the fourth quarter of the year. China is the most critical market for this fast-food chain as it sees tremendous growth potential in this budding economy. When an emerging economy grows, it signifies the rising disposable income of the middle class, which bolsters the growth of the quick-service restaurant industry.

In 2012, Yum! reported $13.5 billion in revenue of which more than half came from China. This is precisely why Yum! plans to open about 700 KFCs and Pizza Huts at different locations during the year despite the ongoing struggle.

The company was a little slow in taking action with respect to suppliers who were identified of distributing contaminated chicken but later acted aggressively and severed ties with as many as 1,000 poultry suppliers from its distribution network. Just when the company started experiencing some relief from these efforts, it got hit by the avian flu outbreak.

Chief executive David Novak is working hard to regain Chinese customer confidence in the KFC brand by ensuring that chicken is safe to eat. The company has put in huge effort to advertise and promote the safety and quality measures that it has undertaken.

Exploring the emerging market

Not only Yum!, but both McDonald’s and Burger King Worldwide (NYSE: BKW) have plans for international expansions, particularly in the emerging markets in Asia Pacific with keen eyes on China. By the end of 2012, Burger King had only 86 outlets in the Chinese mainland. It formed a joint venture to increase the number of outlets to 1,000 in China.

Other than opening restaurants in China, both Yum! and Burger King are exploring other emerging markets as well, particularly as the fast-food industry scenario appears pretty challenging in the domestic market. Burger King got its first outlet opened in Cape Town, South Africa and proposes to open 12 outlets in South Africa in the coming year. McDonald’s entered South Africa way back in 1995 while Yum! has been in this market for the past 42 years. Yum! is also focusing on the African market, where it expects to grow "exponentially" as the number of KFC outlets have increased at a rapid pace.

The bottom line

Overseas expansion is one of the avenues that fast-food giants like Burger King and Yum! are looking for, as the domestic market is getting saturated. Accordingly, Yum! is working to set up a stronger business in emerging economies with a prime focus on China, which is its biggest and most profitable market. China has been the key to Yum!’s success in the past few years and undoubtedly stands to be the most essential market in at least the next few years. Setbacks are part of the game, and the company is gradually recovering in China.

Quality programs, as well as promotional and advertising campaigns, are some of the aggressive techniques that Yum! is adopting to boost sales in China. This shall weigh on its profit margins because of rising costs. However, as China accounts for a huge chunk of the fast food giant’s top- and bottom-line performance, such expenses do not remain optional. China is Yum!’s key to success.

Yum! must be appearing like a questionable stock to own but I believe its strength and penetration in the emerging markets are positive signs indicating future growth. The company has witnessed a similar situation concerning the avian flu in the past and has recovered. Although Chinese consumers may be a little panicky now, they will soon embrace KFC. In fact, Yum!’s expansion in different markets, particularly China, is its biggest strength for future growth. The stock might appear a bit overvalued given the tough situation in China; however, I see considerable potential and feel that it is a solid long-term investment once the Chinese market regains momentum and the African market expands further.

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Rajesh Marwah has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide and McDonald's. The Motley Fool owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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