by Alyssa Oursler | February 4, 2013 1:47 pm
Yum! Brands (NYSE:YUM) is slated to report earnings tonight, and chatter about China — and chicken — has lowered the bar on expectations.
While the parent company of Taco Bell, Pizza Hut and KFC still expects double-digit earnings growth for full-year 2012, same-store sales in China are expected to slip 6% for Q4. That would mark the first such drop in the emerging market since 2009, and comes in stark contrast to the 9% growth reached in the first nine months of 2012.
Consumer traffic has slowed amid the country’s slowdown in growth, but that’s not the only issue. An expose in the local media claimed that Yum uses “45-day chicken” — fast-growing birds allegedly full of dangerous hormones. As The Wall Street Journal put it, there is a “danger that Yum’s Chinese customers keep saying ‘yuck’ for a prolonged period.”
To be blunt, I don’t buy it.
“45-day chicken” is hardly the first food scandal to make it way to the airwaves in China. Last year, The New York Times referred to the country as a “food safety mess,” listing off countless examples: formaldehyde on cabbage, imitation soy sauce made of hair clippings, kebabs made from cat meat … you get the point.
Consumers mind-sets in the wake of such a mess, though, is hard to pin down. On the one hand, the prevalence of food scandals could mean each one is magnified as Chinese consumers become more concerned about what they are putting in their bodies. In theory, that would be bad news for KFC and Yum. On the other hand, the effect could be the exact opposite: Citizens are so used to hearing horror stories that they have begun to tune such news out.
I find it hard to believe this will heavily weigh on consumers’ consumptions of Yum’s snacks. Even if the former mind-set is prevalent now, it shouldn’t be long before it fades into the din of numerous other food-safety issues.
While the Times reported that “a string of food-safety scandals, especially in the dairy sector … led to falling share prices,” last year, one has to wonder how much of it was causation, or just correlation. Countless fast-food examples here in the U.S. come to mind.
For instance, Supersize Me — the Morgan Spurlock documentary slamming the McDonald’s (NYSE:MCD) nutritional transparency and adverse health effects — was released in May 2004. The film was everywhere — I was shown in it countless classes throughout my high school and college education — and led to countless follow-up slam pieces. Yet from the May release until the end of the year, MCD shares climbed nearly 18% — double the S&P 500‘s gain during that period.
Then there was McDonald’s “pink slime” controversy — for years it had been known that McDonald’s and other fast-food restaurants had used the product in some of their foods, but it was brought back into the spotlight in April 2011 — a year MCD led the Dow Jones with 30%-plus gains. Pink slime was removed from the menu in early 2012 … however, McDonald’s sank more than double digits into the red that year.
A lack of correlation is a reminder of something true for both McDonald’s and Yum Brands: They’re fast-food companies, and they’re fast-food giants.
Most consumers (I hope) don’t really expect high-quality food from McDonald’s and the like, because they’re more company or factory than restaurant. Even Yum’s Taco Bell — despite a recently added gourmet line in the U.S. — has never been associated with quality, which is why it survived similar controversy and a lawsuit regarding imitation beef in the U.S.
Not to mention, these companies aren’t storing all their eggs in one basket. While China is an important driver of growth for Yum, it is far from the company’s only region. Heck, the company was lifted last quarter thanks to strong sales of the Doritos Locos taco and Cantina Bowl here in the good ol’ U.S.
All of that being said, slowing sales in China — whether you’re blaming the macro landscape or controversial chicken — already seem built in to Yum’s share price. In late November, Yum sold off heavily when it announced that it expected a 4% drop in same-store sales in China (before the food scandal broke). Sure, those expectations have now worsened to a decline of 6%, but the stock’s losses also have continued, to 13% since the original warning.
So, despite continued growth potential — the company didn’t revise down its projection of double-digit full-year earnings improvement — shares are trading for just 18 times forward earnings. McDonald’s is a bit cheaper at 15 times forward earnings, but that’s partially thanks to the Golden Arches shedding as much as Yum gained in 2012.
McDonald’s aside, Yum is still cheaper than fast-food rivals Burger King (NYSE:BKW) and Wendy’s (NASDAQ:WEN). Each trades for 25 times forward earnings despite having significantly less exposure to emerging markets — and thus seemingly less potential for the huge growth Yum enjoyed before this quarter.
The bottom line? Investors have been baking in Chinese struggles for months, and the chicken controversy should fly over sooner than later. YUM might be overly burnt.
As of this writing, Alyssa Oursler did not own a position in any of the aforementioned securities.
Source URL: http://investorplace.com/2013/02/yums-chinese-chicken-problem-is-overblown/
Short URL: http://invstplc.com/1nvSh8K
Copyright ©2015 InvestorPlace Media, LLC. All rights reserved. 700 Indian Springs Drive, Lancaster, PA 17601.