A Game Of Chicken In China

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

Yum! Brands (NYSE: YUM) just warned that next quarter's results will see same store sales fall 6% in China. That's a bad sign in a country that management has pegged as its number one growth engine. Since the problem only came to light in late December, there could be lingering repercussions in the quarters ahead. Foreign expansion sounds great, but it can harder than it seems and it isn't just YUM! that investors need to keep an eye on.

The Yum! Details
The problem at Yum! is related to chicken from a supplier that KFC actually stopped using that authorities claim failed to meet China's health standards. Although KFC ceased its dealings with the company before the government inspection, it obviously hasn't spared KFC from bad press and public reaction.

This is notable because an investigation by a television station sparked the government review. Clearly having the quality of its food questioned on national television is something that Yum! Brands will have to work hard to overcome.

The company is likely to be spending more on advertising in the country to shore up its image and reassure customers of the quality of its food. At the same time, since the effects of the government inquiry only impacted the last two weeks of the quarter, there's likely to be a notable drop in same store sales for at least the first quarter, as well, if not longer.

More expenses and less revenue will likely add up to be a notable drag on performance. In the end, this may be a buying opportunity for those with strong stomachs, but it highlights one of the big risks of going abroad.

China Problems
Yum! isn't the only company that has exposure to the chicken mess in China. So, too, does Dow-30 component McDonald's (NYSE: MCD). Although clearly not as associated with chicken as KFC, McDonald's well-known chicken nuggets are also susceptible to a sales decline.

The burger giant has also reportedly stopped working with some suppliers because of concerns about the quality of their products. This is a big problem in a country that doesn't have as mature a regulatory system of checks and balances as do more developed economies. While the current flap is over chicken, the next one could be about beef.

Not Just Food
Food isn't the only area on concern when it comes to China. It wasn't that long ago that Apple (NASDAQ: AAPL) was forced to deal with issues surrounded the treatment of workers at its contract manufacturer Foxconn (FXCNY). The conditions at that company's plants were reportedly so bad that employees had turned to public suicides in protest. While the bad press didn't stop the Apple juggernaut from its steady upward march, it was a very public black eye for a company seen as an upstanding citizen.

Not Just China
It could have been much worse for Apple, like when companies from Martha Stewart (MSO) to Nike (NKE) were hit with accusations of child labor being used to make their products. More recently, Limited Brands' (NYSE: LTD) Victoria Secret store has been tainted by accusations of child labor being used to harvest the cotton it sourced from Africa. While the company denies any knowledge of the matter, and has largely kept it out of the headlines, it goes to show that a global world can lead to global problems.

This is the same reason why some companies trade at a discount to others when they make notable moves into sometimes questionable countries. For example, France's Total (NYSE: TOT) suffers from its association with the weak economies of Europe, but also from dealings with Russia. The same concerns linger over England's BP (BP), which is still trying to regroup after the massive oil spill in the Gulf of Mexico. Russia isn't known for treating foreigners particularly well on the business front, let alone its own citizens, and while the long-term benefits might be material, there are risks that investors are taking into account.

Back To China
Investors have willingly overlooked the risks associated with expanding in China because it is the current “hot” investing story. For anyone who takes the time to read about the industrialization of the United States, the struggles that China is going through shouldn't be surprising. Such transitions are fraught with abuse and risk.

More problems will arise in the country over time and any company that operates there is susceptible, even though the long term story is still a good one. But the risks of expanding abroad aren't limited to China and investors need to keep this fact in the back of their minds when buying stocks.


<img height="91" src="/media/images/user_14110/signiture_large.jpg" width="224" />

ReubenGBrewer has no position in any stocks mentioned. The Motley Fool recommends Apple, McDonald's, and Total SA. (ADR). The Motley Fool owns shares of Apple and 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!

blog comments powered by Disqus