Why Yum’s China Problem Is Your Problem

by Alyssa Oursler | June 12, 2013 11:36 am

Before Yum Brands (YUM[1]) reported earnings in early February, I made a prediction[2]: Chatter about its chicken supply would blow over soon, while concerns about China were baked into its stock price.

The day after Yum’s report, I seemed wrong, as the stock shed 6% .

And then things started to turn around. Despite that initial selloff and a bumpy April, YUM has tallied an overall gain of 9% since my prediction — not as good at the broader market’s 15% gains during that period, but hardly anything to sneeze at considering the alarming Yum headlines everywhere.

I wish I could be happy about that.

Instead, things look much worse at this stage in the game. While bad news seemed baked into the stock price four months and a few reports ago, now it doesn’t seem to be baked in enough.

To start, the antibiotic chicken I talked about earlier in the year was followed by an even worse food supply scare: a bird flu outbreak.

Enter ugly numbers out of China, like the 19% drop in May same-store sales Yum reported this morning[3].

Sure, the company maintains — as I said about its last chicken scare — that the food supply concerns will blow over shortly. And it’s not that I don’t believe them. Today’s news was better than April’s numbers. KFC same-store sales specifically tumbled 36% in April, but “only” 25% in May.

But that recovery won’t mean growth until Q4 of this year, according to the company’s predictions. That’s still a decent ways off … and is hardly enough to justify the stock’s current premium.

Yum looks frothy, currently trading for a price over 23 times fiscal 2013 earnings and for a price/earnings-to-growth ratio of 2.

Heck, the stock is less than $2 away from analysts’ median price target of $74 as it is — hardly room for much upside.

This is worrisome … especially considering we haven’t even gotten to the biggest red flag of all. As investors get over Yum’s chicken problems, they seem to be overlooking the bigger problem: China itself.

While China is still expected to be one of the world’s fastest-growing economies — the seeming favorite BRIC emerging market that countless companies have bet big on — the possibility of a hard landing for its slowdown is becoming more and more real.

Recent PMI reports show that both the services and manufacturing sectors have been slowing[4], while InvestorPlace‘s Daniel Putnam reports that “China-sensitive investments are displaying weakness right now[5]” despite “a time of unprecedented central bank support globally.” InvestorPlace Editor Jeff Reeves even thinks China’s Sky City[6] — which will be the world’s tallest building when built — is a sign that things are about to take a turn for the worse.

Hardly good news for Yum, a company that gets half its sales from that market … and that is already facing an uphill battle with the bird flu hangover.

Plus, the impact of China’s growth — or lack thereof — extends beyond a few thousand KFC restaurants. Reeves noted that commodity stocks and automobile makers are at risk from China’s weak economy, while Putnam thinks U.S. stocks overall won’t survive without a soft landing.

With that in mind, whether you’re investing in Yum Brands or not, keep a close eye on China. Even if China’s bird flu outbreak is over, the worst may not be.

As of this writing, Alyssa Oursler did not own a position in any of the aforementioned securities. Follow her on Twitter: @alyssaoursler[7].

  1. YUM: http://studio-5.financialcontent.com/investplace/quote?Symbol=YUM
  2. I made a prediction: http://investorplace.com/2013/02/yums-chinese-chicken-problem-is-overblown/
  3. reported this morning: http://www.chicagotribune.com/business/breaking/sns-yums-china-restaurant-sales-decline-moderates-in-may-20130611,0,2705551.story
  4. have been slowing: http://investorplace.com/2013/06/chinas-big-run-is-done/
  5. are displaying weakness right now: http://investorplace.com/2013/06/the-real-threat-to-the-markets-this-summer/
  6. even thinks China’s Sky City: http://slant.investorplace.com/2013/05/more-china-warning-signs-skyscraper-shenanigans/
  7. @alyssaoursler: https://twitter.com/alyssaoursler

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