Yum! Brands, Inc. (YUM): Is There An Issue In China?

Yum! Brands, Inc. (NYSE:YUM)’s Chinese empire is falling apart. It runs around 4,400 KFCs in the country and some 1,000 Pizza Huts. It also owns two small Asian chains by the name of East Dawning and Little Sheep.

China is the company’s single largest market and accounted for over half the group’s revenue last year. But recently Yum! Brands, Inc. (NYSE:YUM) has been struggling with a series of setbacks. This is worrisome for investors.

The story so far

Trouble started in China late last year when two of the company’s wholesellers were found to be supplying chicken meat with high antibiotic and hormone levels. People stopped going to KFCs and even abandoned Pizza Huts.

The negative trends continued through the first quarter and resulted in a 20% drop in comparable store sales in China. The drop at KFC was 24% and at Pizza Hut it was 2%. The company launched its “Operation Thunder,” whereby it severed ties with 1000 odd suppliers and started promoting the safety of its food through television ads and social media.

Just when sales were improving in March, Yum! Brands, Inc. (NYSE:YUM) faced the second setback in the form of an avian flu scare. Despite the company insisting over and over again that its products are perfectly safe, people at large have chosen to remain reluctant. This significantly washed off sales in April.

Same store sales in China in April were down 29%, roughly in line with the 30% drop predicted by the company and slightly worse than the negative 27% estimated by analysts.

Digging deeper

Yum! Brands, Inc. (NYSE:YUM) expects to get the situation under control over the next two quarters and to return to positive comparative store sales in the fourth quarter. But gaining back lost ground will be difficult.

KFC is one of China’s most loved brands. According to Euromonitor, Yum! Brands, Inc. (NYSE:YUM) held a 39% share in China’s fast food market in 2011, way ahead of McDonald’s Corporation (NYSE:MCD), which had 15.6%. But as a result of its recent setbacks the group is losing valuable market share to both Western and local chains.

Aside from McDonald’s Corporation (NYSE:MCD), which is planning to open another 300 restaurants this year, there are many local Chinese chains that are growing rapidly. Euromonitor predicts that in 2013, the combined number of Asian and Western-style fast-food chain outlets will increase by 10% in China, and this will be on the back of a 13% rise last year. Yum! Brands, Inc. (NYSE:YUM) will face severe competition.