Will China Drive Fast Food Sales Growth?

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

I’m writing this article in a café in on the corner of a boulevard in Central Eastern Europe. It is a square shape building that has an L-shaped KFC surrounding it. As I write this article on Yum! Brands (NYSE: YUM) the allure of the Zinger Tower is increasingly tempting me. By the end of this I suspect I’ll be partaking in the hospitality of the Colonel’s finest home cooking. I’ll let you know if they have any paprika flavored specials later.*

Okay the pat journalistic intro is over so it’s time to get to the beef of the argument or rather the chicken and pizza of the matter. Yum delivered a pretty solid set of results. I suspect many commentators will look at the sharp rise in the share price and immediately conclude that things are on fire here.  It’s certainly hard to be downbeat about a company that just reported EPS growth of 18% and raised full year EPS guidance to 13%, however, our role as investors is to be objective and I think there is some cause for caution here.

 

Visions of China

The first thing to understand about Yum! is that it now makes the majority of its profits from China.

 

 

The company now has 4,952 restaurants in China with another 750 planned for 2013, but I was more impressed with the 6% sales growth recorded in the US then the same amount put up for China. Its US operations have been restructured amidst fierce completion from the likes of Domino’s Pizza (NYSE: DPZ) and others. Despite revenues declining in the last quarter Domino saw same store retail sales increasing 1.7% in the second quarter. This may not sound like much, but it is within its long term 1-3% expectation.

But back to Yum! and China! In listening to the associated commentary around the results it’s clear that China is slowing and we can see that in the evolution of same stores growth in China.

 

 

Spot the slow down?

Or is it? Investors need to recall that this year’s growth is coming off some spectacular rates last year.  And here is the key question. We all know that China’s growth is moderating and this is having an effect on growth but will it settle down to a level that allows for the kind of profit expansion that is baked into Yum’s valuation? The latest figure of 6% same store sales growth is actually a bit lower than GDP growth and certainly lower than nominal GDP growth. Will it snapback?

 

Competition Heats Up

I’m a bit cautious on this front. No one likes investing in the tail end of a retail investment boom where suddenly everyone is fighting for a bigger piece of a smaller pie and I find it hard to conclude that this is not what will be happening in China.

This is especially a concern because Yum’s slowing same store sales growth is confirmed with how McDonald's (NYSE: MCD) has been finding things in China (APMEA) this year.

The Big Mac meisters managed to record 5.7% same store sales growth in APMEA in August but it has been tough going this year. It is continuing to expand store growth in China and its rival Burger King (NYSE: BKW) is doing the same.  Burger King has signed a joint venture with a ‘proven franchisee’ who has committed to opening 1000 restaurants within the next 5-7 years.  Add this to the 750 that Yum! are planning for China next year and it starts to add up to a lot of new fast food outlets. It’s great when the going is good, but not so fine if the economy slows.

 

Where Next for Yum?

As impressive as the performance was in the US with operating margins expanding over 400 basis points as it cuts back on company ownership levels. As a consequence US profits were up 13%. This is fine but the long term story is really about China. Yum has tied its colors to the China mast and its fortunes will be decided by its performance there.  

So far Yum! is doing very well, but its rivals are expanding store growth and the market is slowing. Unless you are a China bull, I would suggest looking for a bit of stability in same store sales growth trends and/or some slowdown in overall industry expansion plans in China before piling in. At some point comparables are going to get very tough to beat and unless China picks up growth there could be overcapacity down the line.

 

 

 *I couldn't see any paprika specials although I suspect they do something. However, they do seem to be pushing this odd KFC Kebab? thing in the light of the local fixation with kebabs with yogurt.


SaintGermain has no positions in the stocks mentioned above. The Motley Fool owns shares of McDonald's. Motley Fool newsletter services recommend Burger King Worldwide 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.If you have questions about this post or the Fool’s blog network, click here for information.

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