From Bad To Worse

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Yum! Brands (NYSE: YUM) has been hard hit by a recent food scandal in China. Management is regrouping, but has openly said that only time will heal this wound. Is Yum! destined to lose in China or is this a buying opportunity?

The Chicken Issue

The problem at Yum! is related to chicken from a supplier that KFC actually stopped using. Authorities claim that the chicken provider failed to meet China's health standards. A second supplier has also proven problematic, though KFC continued to take product from the company, at reduced levels.

An investigation by a television station sparked the government review of KFC's suppliers. 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.

The bigger problem for Yum! is that there appears to be spillover into its other food concepts, particularly Pizza Hut. So, when management reported that January sales were down over 40% at KFC and 15% at Pizza Hut, the markets acted swiftly. This problem is going to be around for a little while.

Time Heals All Wounds

This was the message from the company's management, which basically said as much in an analyst conference. In fact, it indicated that there wouldn't be an increase in ad spending in the country based on the event because it would probably just be wasting shareholder money. While that may be true, it will certainly be spending more money on a new type of ad—one that stresses food quality and, perhaps, offers an apology.

With the shares off notably on the news, more aggressive investors might want to consider this still well positioned franchiser. Indeed, with thousands of restaurants in the country and a long history of dealing with both good and bad publicity, it is hard to believe that financially strong Yum! will not be able to weather this crisis. That said, there might be some more downside as the problem lingers. Moreover, investors need to keep close tabs on sales in China to make sure this doesn't turn into a blood bath.

Not the Only Company to Stumble

Yum! isn't the only company to stumble and it has a strong core business to keep it going while the damage heals. Other companies that have taken their turn in the fire for various reasons include:

Johnson & Johnson (NYSE: JNJ)

JNJ has had to deal with many quality issues throughout its long history. The biggest being a poisoning scare in the early 1980s surrounding the company's Tylenol brand. That event caused the Tylenol franchise material financial pain. JNJ recalled all of its Tylenol capsule products and saw the pain reliever's sales plummet across the board regardless of the tablet style. However, taking quick action helped the company's Tylenol sales recover over the next year or so.

More recently, the company has had to deal with questions about manufacturing quality at some of its facilities, though these problems haven't grown to the same level as the Tylenol scare or theYum! chicken fiasco. At the end of the day, however, Johnson & Johnson was able to live to fight, and thrive, another day.


CA, once known as Computer Associates, also went through a public relations nightmare and lived to tell the tale. Only in this company's case it was a highly publicized and fairly ugly scandal involving high ranking company employees. The company was accused of falsely recording sales from future periods in just ending ones to allow it to meet Wall Street expectations, and laid the blame at its ousted chairman's feet. Some people even found themselves doing jail time over the issue.

While all of this was going on, Computer Associates had a hard time keeping the business from being tarnished by association. Worse, business issues arose that made some question both management and product. After fighting through a tough period, the company is now solidly back on track. It took longer than JNJ's return, but CA was able to recover from the scandal and refocus itself on growing its business and adjusting to changing market conditions.

It has even been working to gain traction with shareholders of late, upping its dividend from $0.20 per share annually to $1.00 per share annually in 2012. That's a huge jump that caught the eye of a different breed of investor than had previously purchased CA stock—dividend hunters. While still not IBM, CA is a large player with a solid market position that seems poised for slow-to-modest growth over the foreseeable future despite its past improprieties.


YUM! Brands also lived through a problem period. In fact, in the company's recent earnings call, it highlighted the sales drop that KFC lived through during the avian flu scare. When that public relations nightmare hit, though not specific to KFC, sales fell around 40%. The company didn't miss a step on its expansion plans despite the revenue drop and, in the end, came back stronger than before. So, basically, the company's been down this road before.

Give a Guy a Chance

Yum! Brands is in for a rough ride, there is no doubt. However, it is a massive company that has executed well over time. There could be more downside in the shares, but this is likely a buying opportunity.


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Reuben Gregg Brewer has no position in any stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson. 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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