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?

China.

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.

Endnotes:
  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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