Number One Growth Opportunity Tarnished
Yum! Brands, Inc. (NYSE:YUM) made it quite clear that China is its primary growth focus. CEO David Novak called China the company’s “number one growth opportunity in the world.” In 2012 the country accounted for 42% of the company’s profits. The size of the country and its quick ascent toward developed market status are clear reasons to be optimistic. And for years, Yum! Brands, Inc. (NYSE:YUM)’s focus was well rewarded. However, since mid 2012 bad news out of China has been the norm.
Chicken Issues
In late 2012 a couple of the company’s suppliers were accused of selling chicken that didn’t live up to the government’s quality regulations. Yum! wasn’t accused of wrongdoing, but its image was sorely damaged. Sales at KFC plummeted, with January same store sales off by a massive 40%. Pizza Hut, tarnished by association, saw sales fall 15%. At that point, the CEO warned that Yum! was likely to fall short of its 2013 goals.
As if that weren’t enough, an outbreak of avian flu in early 2013 added fuel to KFC’s fire. March same store sales at KFC were down 16%. That’s bad, but a massive improvement over the 40% January decline. Sadly, those numbers didn’t include the avian flu impact, which brought April sales down 36% at KFC. The numbers are again headed in the wrong direction. Luckily, Pizza Hut saw a 5% sales increase. It’s too bad that there are four times as many KFCs in China as Pizza Huts.
First quarter earnings declined 8% largely because of the problems in China. Although the company asserts that the chicken quality issue is likely to be short lived, with such steep sales declines, it could be a year before KFC returns to sales growth.
Bigger Issues?
Meanwhile, Bloomberg recently ran an article hinting that KFC’s problems go beyond chicken quality. The article suggests that KFC has veered too far toward Chinese food in an attempt to attract customers. That, in turn, has left it with an undifferentiated product at the very time that competitors are increasingly mimicking its fried chicken offering.
Steady as She Goes
That means McDonald’s Corporation (NYSE:MCD)’s isn’t as reliant on China and that it likely has more room to grow than Yum! In fact, Yum! is more likely to lose share over time than increase its lead. By the end of 2013, McDonald’s Corporation (NYSE:MCD)’s is looking to have around 2,000 stores open in the country, less than half of Yum! Brands, Inc. (NYSE:YUM)’s total.
McDonald’s has seen a couple of quarters of top line declines and the big issue has been increasing competition in mature markets. In mature markets, McDonald’s Corporation (NYSE:MCD)’s is the target in the same way that Yum! Brands, Inc. (NYSE:YUM) is the target in China. However, with around $2 billion in cash and debt at less than half the capital structure, McDonald’s Corporation (NYSE:MCD)’s can hold its own in developed and developing markets. And it hasn’t been tarnished by food quality issues.
While earnings may hit a soft patch, long-term investors should take a look at this industry giant with an around 3% dividend yield. A long history of annual dividend increases only adds to the allure.
Just the Opening it Needed
For more aggressive investors, Burger King Worldwide Inc (NYSE:BKW) might be a good option. After yet another restructuring effort, the company just came public again late last year. Debt makes up about 70% of the capital structure, so it has less financial wiggle room, but the company is refocused on growth. That includes aggressive expansion in China, where it is a bit player today.
The problems at KFC could be just the opening that a foreign concept like Burger King needs to get a better footing in the nation. Although the first quarter wasn’t as good as Burger King’s management hoped, they were confident enough about the future to increase the annual dividend by 20% and initiate a share buyback. Trading in the high teens or so, this perennial also-ran could be a turnaround play for more aggressive investors.
No Easy Answer
Yum! has no easy or immediate answer to its China problems. More conservative investors should shift to McDonald’s, which has hit a soft patch that seems easier to resolve. Aggressive types might look at Burger King Worldwide Inc (NYSE:BKW)’s turnaround. Although Burger King Worldwide Inc (NYSE:BKW) faces an uphill battle, Yum’s stumble might be just the opportunity it needs to gain scale in a key market.
The article Is the Chicken Issue Turning Into a Disaster? originally appeared on Fool.com is written by Reuben Brewer.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide and McDonald’s. The Motley Fool owns shares of McDonald’s. Reuben is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
