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.
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.
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).
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.
Source URL: https://investorplace.com/2012/11/yum-sliced-by-chinas-double-edged-sword/
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