Yum Sliced By China’s Double-Edged Sword

by Alyssa Oursler | November 30, 2012 1:38 pm

Ah, the appeal of China: A large, fast-growing economy that offers expansion opportunities for American companies that have already tapped out the domestic market.

That’s been the gameplan for years. McDonald’s (NYSE:MCD[1]) has expanded to roughly 1,400 locations in the nation, and most recently, Starbucks (NASDAQ:SBUX[2]) — already the country’s largest coffee chain — announced plans to triple its store count there by 2015[3].

However, one of the biggest names in Chinese expansion — Yum! Brands (NYSE:YUM[4]) — gave us still more proof that a pile of chips in China doesn’t mean a straight line to the top.

China Hut

Few companies touch Yum!’s presence in China, with more than 4,000 KFC locations and nearly 750 Pizza Hut restaurants — that’s triple MCD’s store count and quadruple the mere plans of Burger King (NYSE:BKW[5]) to open around 1,000 locations there in the next decade[6].

Heck, Yum! added nearly that many stores in the past year alone.

Subsequently, Yum has been the darling of the fast-food sector. Since January, Wendy’s (NASDAQ:WEN[7]) and McDonald’s are almost double-digits in the red, and BKW is up 13% since going public in late June. And YUM? 26% returns year-to-date, clubbing ’em all and doubling the broader markets.

Well, at least as of yesterday.

YUM’s 2012 returns have been whittled down to just around 15% thanks to a healthy drop Friday. And the primary culprit?


Nothing New

Yum! isn’t the first company to cry “China” this year. Other American companies to feel the effects of the nation’s slowdown[8] include Caterpillar (NYSE:CAT[9]), Alcoa (NYSE:AA[10]) and — hey! — even McDonald’s. But YUM is starting to feel a prolonged effect to heavy exposure.

The company took a slight slip this summer after Q2 earnings missed estimates, in part thanks to a 4% drop in Chinese profits[11]. While YUM regained those losses, news of softening sales in the region — not just at Pizza Huts and KFCs, but some of Yum!’s rivals — again have investors reconsidering their stake.

The company expects same-store sales in China to fall 4% in the fourth quarter as customer traffic continues its decline. The last time the company reported a drop in Chinese same-store sales? Q4 of 2009, according to Reuters[12].

That number is weighing on the bigger picture. Yum sees 4% fourth-quarter total same-store growth of 4% — far behind previous quarters of up to 20% growth — and just 6% growth for the full fiscal year. Earnings expectations of $3.24 also came in 4 cents shy of expectations.

Even 2013 could be iffy.

Despite talk of a comeback in China, experts expect China’s GDP growth to decline to below 7% next year[13], while the official estimate is around 7.5% — nice headline numbers, but they’re far below the 9% growth of 2011 and the frothy expectations it created. That almost certainly is behind Yum’s expectations for 10% YOY growth in 2013, which is 4 percentage points lower than what analysts have targeted.

For what it’s worth, Yum! remains optimistic about coming quarters, saying that stronger-than-expected performance of its domestic division will offset Chinese struggles. It also plans to speed up store development — a move it claims will further drive profits despite slowing sales. It took a similar tack in June, when it raised its new-unit forecast for the year to 1,700 international units (including 700 in China).

Bottom Line

Yum! is struggling, and despite being a somewhat “safer” way to play Chinese growth than China-based equities, it’s losing its allure.

Chinese stocks have become very inexpensive, trading at an average trailing P/E around 9[14]. Yum has outsized exposure compared to other U.S. firms, sure, but less than the domestics, and it doesn’t have the benefit of a cheap price tag, at trailing and forward valuations of nearly 20.

That’s after its year-to-date gains were nearly halved in the blink of an eye.

For today, at least, investors of this year’s fast-food darling have been left with a not-so-pleasant taste in their mouths — all thanks to the emerging market they once cheered.

As of this writing, Alyssa Oursler did not hold a position in any of the aforementioned securities.

  1. MCD: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCD
  2. SBUX: http://studio-5.financialcontent.com/investplace/quote?Symbol=SBUX
  3. triple its store count there by 2015: http://investorplace.com/2012/11/3-reasons-why-starbucks-stock-will-be-even-better-in-2013/
  4. YUM: http://studio-5.financialcontent.com/investplace/quote?Symbol=YUM
  5. BKW: http://studio-5.financialcontent.com/investplace/quote?Symbol=BKW
  6. open around 1,000 locations there in the next decade: http://www.huffingtonpost.com/2012/06/15/burger-king-china-expansion_n_1601531.html
  7. WEN: http://studio-5.financialcontent.com/investplace/quote?Symbol=WEN
  8. American companies to feel the effects of the nation’s slowdown: http://slant.investorplace.com/2012/10/china-slowdown-doesnt-mean-china-shutdown/
  9. CAT: http://studio-5.financialcontent.com/investplace/quote?Symbol=CAT
  10. AA: http://studio-5.financialcontent.com/investplace/quote?Symbol=AA
  11. 4% drop in Chinese profits: http://investorplace.com/2012/07/yum-brands-q2-growth-overshadowed-by-china-woes/
  12. according to Reuters: http://www.reuters.com/article/2012/11/30/yum-outlook-idUSL1E8MTHA520121130
  13. expect China’s GDP growth to decline to below 7% next year: http://slant.investorplace.com/2012/11/is-china-back/
  14. trading at an average trailing P/E around 9: http://investorplace.com/2012/11/china-be-bullish-but-be-prudent/

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