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The Chinese Don't Find Yum! So Yummy

August 18, 2014 | About:

Yum! Brands, Inc. (YUM), reported Q2 earnings for the current fiscal year last month. The company reported earnings of $0.73 per share on sales of $3.24 billion. Yum! derives a large part of its revenue from China so investors watch for clues on the health of the Chinese consumer. Yum! took a hit last year on concerns stemming from bird flu and food safety.

The company might just experience the nightmarish days of 2012 in China. The company's stock slid by almost 5% in the trading session on Thursday, as the company declared that the latest food safety scare is testing local consumers' loyalty to its KFC and Pizza Hut brands.
In a regulatory filing Yum! stated that adverse media reports in mid July relating to chicken quality standards significantly hurt traffic at its KFC and Pizza Hut restaurants in China in just 10 days thereafter.

Further, the quick-service chain stated that, if the sales decline persists over an extended period of time, it will dent the full-year earnings per share results.

Adverse publicity

Local Chinese television media uncovered a new scandal in July blaming workers at Shanghai Husi Food Co. – unit of U.S.-based OSI Group LLC – of reusing meat that had fallen on the factory floor as well as mixing fresh and expired meat. Notably, Shanghai Husi Food Co. supplied meat to both KFC – a division of Yum! – and McDonald's Corp. ( MCD ) in the Shanghai region.

As Chinese regulators started investigating Shanghai Husi, Yum! Brands reportedly apologized and announced a change in meat suppliers. The Shanghai Food and Drug Administration also reportedly closed down Husi's operations, according to a Forbes report. However, the damage is already done as is clearly evident from the declining sales.

Bad news

The slowdown in sales is bad news for Yum! especially because its China division had seemingly recovered from the 2012 food safety ordeals and an avian flu outbreak. The millions that the company spent over the past two years on promotions, trying to boost sales and getting a clean bill were successful as customers returned to its restaurants. In fact, the China Division recorded a 15% rise in comps in its last reported quarter.

Another cause of concern for Yum! is its dependence on China for a major part of profit, especially when its U.S. business is suffering from intense competition, lowered spending and increasing preference for healthy and nutritious foods among Americans.

Another victim of circumstances

McDonald’s said sales in markets including China and Japan are experiencing a “significant negative impact” since a food safety scandal in China last month ago forced it to halt the sale of items such as Big Macs and Spicy McWings.

The affected markets account for about 10 per cent of its total revenue, the world’s largest burger chain said in a regulatory filing on Monday.

McDonald’s said that, while the scandal would hurt results in the near term, it could not currently estimate the impact on earnings for the full year, saying only that the company’s global comparable sales forecast for 2014 is now “at risk.”

This announcement from McDonald’s follows a similar announcement from Yum! Brands on July 30.

In that announcement, Yum! said it was unclear what the impact to its sales in China would be as a result of the supplier scandal, which broke out following a report on Chinese television. Yum! also said the Shanghai FDA has launched an investigation into the company’s relationship with supplier Shanghai Husi as a result.

This latest announcement also follows what was a disappointing second quarter for McDonald’s, which on July 22 reported earnings per share that missed expectations on global comparable store sales that were flat year over year.

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