Just when their businesses in China appeared to be resuming rapid growth after putting a food safety scare from last year behind them, Yum! Brands Inc. and McDonald’s Corp. are dealing with more negative publicity from a Chinese meat vendor.

Both companies announced Sunday that they have dropped Shanghai Husi Food Co. Ltd. as a supplier, after the Shanghai Municipal Food and Drug Administration shut down the vendor for alleged violations of food safety regulations. The closure followed a report on Chinese state television that showed Husi workers mixing fresher meat with expired meat, as well as picking up some meat from a factory floor to be sold to chain restaurants, including McDonald’s, KFC and Pizza Hut.

Yum and McDonald’s apologized to Chinese consumers through media statements.

“Food safety is the most important priority for us,” Yum Brands China said in a translated statement provided by Louisville, Ky.-based Yum! Brands Inc. “We will not tolerate any violations of government laws and regulations from our suppliers. Yum China has immediately started the investigation on Husi and will collaborate with government proactively.”

The company added that severing ties with Husi would cause temporary shortages for two breakfast products, as well as the Cheese Pork Hamburger and BBQ Hamburger at KFC; and the Stone Pan Texas Flavor Beef at Pizza Hut. Yum China is sourcing meat from other suppliers to alleviate the shortages.

“We are committed to the highest standards of food safety, and our customers are always our No. 1 priority,” McDonald’s said in a statement. “If confirmed, the practices outlined in the report are completely unacceptable to McDonald’s. … The matter is being thoroughly investigated, and we are cooperating fully with the authorities.”

Yum, which operates or franchises more than 40,000 locations of KFC, Pizza Hut and Taco Bell in more than 125 countries, has more exposure to the ups and downs of the Chinese economy than any other restaurant company. In fiscal 2013, Yum derived 35 percent of its operating profit from its system of more than 6,000 restaurants in the country.

Yum reported in its June 14-ended second quarter a 188-percent increase in operating profit in its Chinese division to $194 million, compared with $68 million in last year’s second quarter, when consumer fears of avian flu and the safety of the country’s poultry supply sent traffic and sales at KFC plummeting. Yum also recently reported a 15-percent increase in same-store sales for the China division in the second quarter of 2014, lapping a 20-percent decrease a year earlier.

Though it has a smaller system in China of about 2,000 restaurants to Yum’s more than 6,000 units, McDonald’s nonetheless experienced similar troubles in its restaurants last year amid the same poultry supply controversy. However, in its first quarter of 2014, McDonald’s had reported a same-store sales increase of 6.6 percent, lapping a 4.6-percent decrease in the first quarter of 2013 and making a big sequential leap from the 0.9-percent decrease it recorded in the trailing fourth quarter.

Securities analyst David Tarantino of Robert W. Baird & Co. wrote in a research note that the investment firm had lowered its price target of Yum’s stock from $87 per share to $84 per share, in light of the new supply chain issue. However, he added, the firm views potential sales issues from the controversy to likely be temporary and it is keeping projections for fiscal 2015 earnings intact for Yum.

“We would encourage patient investors to use any meaningful pullbacks as a buying opportunity,” he wrote.

Tarantino could not rule out the possibility of a loss of traffic and sales in the short term, noting that KFC’s reliability and trust scores in China could lose the big gains they had made since plummeting in December 2012 at the start of the last supply chain controversy.

“On the surface, the current situation looks less severe than the issues experienced in late 2012 and in 2013,” Tarantino wrote. “However, our ability to predict the potential magnitude and length of any consumer backlash admittedly is low at this stage.”

Contact Mark Brandau at mark.brandau@penton.com
Follow him on Twitter: @Mark_from_NRN