Yum! Brands (YUM, Financial) is in a tough spot in China since 2012 December when the company suffered from a food scandal. Its reputation has been hit so hard that the company sales haven’t yet recovered. The latest chicken scare got revealed in July this year when one of Yum’s chicken suppliers, Shanghai Husi of Illinois-based OSI Group, was found to be supplying expired meat.
China is a crucial market for Yum! and a prolonged depression in this market can turn out to be harmful for the company. In fact in the first half of December, Yum! announced that comparable stores sales in China will be in the red this year. The reason being the company’s reputation has been adversely affected by negative publicity.
Apart from that, Yum! has also trimmed its full-year earnings guidance from 6%-10% to mid-single digits. The fast food company saw a 15% drop in same store sales in November, and the revised sales comps suggests that the fourth-quarter sales have been hit quite hard.
Source: Wikimedia Commons
Investors have, quite understandably, reacted to this news, making shares tumble in after-market trading. Under these circumstances, what are the steps Yum! is undertaking to fix the problem? Does it plan to pull back from the market? Let’s try and find answers to these questions.
Yum!’s attempt to cling to China
China may be increasingly becoming a difficult market for Yum!’s KFC, Pizza Hut or even McDonald’s (MCD, Financial), but future prospects are too attractive to give up and withdraw from the market. Yum! is showing no signs of slowing down its activities in China and its investment plans in the mainland stay intact. The fast-food giant operates around 6,400 outlets in nearly 1,000 cities in the emerging market. In 2015, the company proposes to open 700 new restaurants and cater to a greater population.
But the question is, why is Yum so keen on the Chinese market? This is because the fast service restaurant earns more than 40% of its consolidated operating income from China. Moreover, the country accounts for over half of Yum’s consolidated sales. To fuel its growth, the company has been acquiring local chains so that its menu can be more appealing to the Chinese taste buds. The company puts in special effort by adding Chinese dishes to localize its menu.
Data taken from Yum 10Q
The opportunity that’s hard to resist
The challenges in China may have been a drag on Yum!’s results, but the market provides immense opportunity. If the company is able to cash in on this by regaining customer confidence and capitalize on the budding restaurant market, China can boost Yum!’s top and bottom lines by leaps and bounds.
China’s consumer base visiting restaurants is estimated to grow to twice as much as the current size of 300 million by 2020. Being the most popular Westerner in the market, Yum! stands to gain massively from this. Quite obviously, the company’s working hard to develop its brand image to reinstate the fact that the quality of its ingredients are safe for consumption.
While several investors might be disappointed with the company’s performance, but it’s probably time to consider the stock particularly with the fall in share price due to the lowered guidance. The company is trading at a P/E ratio of 22.99 compared with Chipotle Mexican Grill’s (CMG, Financial) P/E ratio of 53.66, or Buffalo Wild Wings (BWLD, Financial) P/E ratio of 36.57. This shows the stock is cheap, giving a good opportunity to consider it for your portfolio. Yum! has significant upside potential if it’s able to recapture the Chinese market. It’s now time to wait and watch how things work out for the company in due course of time.
