Yum! Brands Inc.’s continued struggles in China appear to be putting pressure on the company to take more aggressive steps to reduce its reliance on the quickly growing country for its sales and profits.
Analysts intensely questioned Yum executives during the company’s third-quarter earnings call Wednesday, after the Louisville, Ky.-based quick-service operator acknowledged that sales in China will be disappointing for the third straight year, this time due to a sudden drop in sales at its Pizza Hut brand there.
Analysts suggested that Yum might need to look more forcefully at spinning off its China business or other structural changes as a result of the earnings report.
Bernstein Research analyst Sara Senatore suggested that a strategic action is “more likely” after the quarter, suggesting that the poor performance could generate a “groundswell of support” for proposed strategies to separate the China business.
Nomura analyst Mark Kalinowski called it a “disaster of an earnings release,” and suggested that there are a number of actions the company could take to increase shareholder value. He mentioned a spinoff of Taco Bell —not China — which he said investors would gobble up.
“We hope that this Q3 earnings miss serves as a blunt call to action that the company may need to heed our suggestions in this regard,” he wrote.
Yum executives would not discuss corporate structure, but CEO Greg Creed suggested that the company is “always open to looking at alternatives.”
Still, he said, “The key for us is to turn this business around, with a specific focus on China. We are absolutely focused on these brands.”
Yum executives were clearly frustrated with the performance in China, which has struggled for three years after a pair of food safety scares involving its KFC brand. KFC’s sales have fallen well into the double digits over the past year, and executives predicted a rapid improvement toward the end of 2015 as the company moved past those comparisons.
But KFC’s same-store sales in China have improved more slowly than executives expected, rising 3 percent during the third quarter. In September, KFC’s same-store sales rose 9 percent there, executives said.
Pizza Hut has also become a problem in the country. Executives said there was a “sudden, unexpected slowdown” in the chain’s business starting in late August and continuing into September. The company now expects same-store sales for Pizza Hut in China to decline into the double digits.
Executives partly blamed the Chinese economy, which has slowed. They also blamed competition in the country from aggressive discounters, and also suggested that Yum’s marketing efforts failed.
“We did not foresee this confluence of events,” CFO Pat Grismer said. “We were very surprised by the business trends that began to unfold at the end of August.”
“With the recent macro-environment, it’s difficult to forecast sales for both brands,” he added. “We make the best judgment for both brands, based on the best information available.”
Yum’s sales performance in China, coupled with a strong impact from foreign currency translation, led the company to reduce its earnings projections for the year. Yum had hoped to reach double-digit earnings growth for the year.
Yum is a big company: It has three brands, 42,000 locations and a heavy presence in international markets. It has less than 7,000 units in China, but because the company operates its own units there and largely franchises everywhere else, those operations are vital to its sales and profits.
As such, every question on the earnings call was related to China. And investors hammered the stock on Wall Street — it fell 19 percent by early Wednesday afternoon.
“The way Yum is structured today, China is all that matters, and we know that,” Oppenheimer analyst Brian Bittner said during the earnings call.
Weakness in China has overshadowed the performance of the company’s other brands — as well as the weak performance of Yum in India.
All three of Yum’s brands — KFC, Pizza Hut and Taco Bell — experienced same-store sales growth, but Creed said, “We clearly have our work cut out for us at Pizza Hut,” where same-store sales grew just 1 percent and were flat in the U.S.
Taco Bell in particular has been growing, with same-store sales rising 4 percent in the quarter and margins over 21 percent. “This brand is doing all the right things in all the right places,” Creed said.
That includes breakfast, which Taco Bell has been aggressively marketing, and which now represents 6 percent of the chain’s sales.
KFC same-store sales rose 3 percent, and the brand has generated momentum in the U.S. behind a new marketing push featuring a pair of comedians playing Col. Sanders. In addition, “Our innovation pipeline is starting to be a force,” Creed said.
On the flip side, sales at Yum’s India division, where the company has 800 locations, have struggled, including an 18-percent same-store sales decline in the third quarter.
Regardless, China remains the biggest part of Yum, and will continue to be, absent a spinoff or other structural change. Executives said they are working to reverse slipping sales there. In August, the company named Micky Pant CEO of Yum China, following the retirement of Sam Su.
Despite its sales performance, Yum continues to rapidly add locations in China. Yum opened 108 new units there in the third quarter.
“It continues to be the fastest-growing economy in the world,” Grismer said. “It provides strong tailwinds for the restaurant industry there, and when you step back, we’re still in the early innings of that growth.”
Contact Jonathan Maze at [email protected].
Follow him on Twitter: @jonathanmaze
