Yum bullish on China recovery, Taco Bell breakfast

Yum! Brands Inc.’s second quarter, in which its net income grew nearly 19 percent, showed mixed results across brands and across the world, with a “bounce back” underway in China, an encouraging start to breakfast for Taco Bell and the need for a new turnaround at Pizza Hut, particularly in the United States.

But during an earnings call with analysts, chief executive David Novak reiterated Yum’s confidence that it could deliver earnings per share growth of at least 20 percent on the strength of major initiatives around new-unit growth and building same-store sales growth.

“On the whole, we’re pleased with our overall performance in the second quarter,” Novak said.

Louisville, Ky.-based Yum expects to open at least 700 restaurant locations this year in China and another 1,250 units outside China and the United States.

China: Focus on rebuilding

Yum officials had predicted 2014 would be a year of robust recovery in the company’s all-important China division, which has nearly 6,400 units and reported a 188-percent increase in operating profit to $194 million, compared with $68 million in the second quarter of last year.

Following 2013’s struggles in China, when a public panic over the safety of the country’s poultry supply and avian flu sent KFC’s sales plummeting, Yum launched a menu revamp in China earlier this year that complemented a quality-focused marketing campaign. The 15 new menu items that debuted this year skewed toward higher-quality, higher-margin offerings, and they helped produce a 21-percent gain in same-store sales at KFC’s 4,650-plus-unit system in China in the second quarter.

“We’ve been focused on rebuilding the brand and making it more contemporary for a changing China,” Novak said. “We’re getting significant same-store sales growth, some traffic growth, but also a much better business model we can build from.”

Chief financial officer Patrick Grismer noted that, of KFC China’s 21-percent same-store sales growth in the second quarter, a favorable shift in sales mix to higher-margin items drove about half the gain. Another 4 percentage points of that increase came from price hikes taken before Chinese New Year and before the rollout of the new menu, and the final 6 percentage points of the gain came from increased traffic.

“Despite a significant lift in average spending and a contribution from pricing, our value scores with consumers still improved,” Grismer added.

The China division also includes 1,134 locations of Pizza Hut Casual Dining, where same-store sales were flat, dragging down the entire China division’s second-quarter same-store sales to a 15-percent increase. But Novak noted that Pizza Hut Casual Dining was lapping a 7-percent increase from a year earlier, and Yum is optimistic the brand will continue its rapid unit growth in China, where it faces practically zero competition in a midscale casual-dining space.

The division also finished with 215 Pizza Hut Home Service units, which deliver a broad menu in which pizza makes up less than half of total sales.

“We’ll have another weapon in the arsenal with Pizza Hut Home Service,” Novak said. “It’s a small-box format, and we’ve backed our way into a Chinese fast-food format with great unit economics that will allow for expansion in the future.”

United States: Taco Bell continues to innovate

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On the domestic side of the business, Yum officials were bullish about the “one-two punch” Taco Bell could deliver this year with momentum from its March 27 breakfast launch and other new products around the lunch and dinner dayparts, like the Quesarito or the Cantina Power line of protein-heavy dishes.

“We have these assets that had been empty till 11 a.m., and now we’re leveraging them on a profitable basis,” Novak said. “It took McDonald’s eight years to make money on breakfast, and we’re already above break-even. … We have a very inventive group out of Taco Bell, and there will be a lot of news. Unlike some brands wondering what to do next, we have all kinds of innovation we can bring into the hopper.”

The reported results for the Taco Bell division consist almost entirely of the approximately 6,000 U.S. locations for the brand. Same-store sales for Taco Bell rose 2 percent during the quarter, compared with same-store sales decreases in the United States of 2 percent and 4 percent, respectively, at KFC and Pizza Hut.

Novak noted that the morning menu for Taco Bell achieved a sales mix of 7 percent. Breakfast still is expected to add a highly incremental layer of traffic and up to $120,000 of sales per unit, he said. Novak added that the marketing campaign for the new platform has done a lot to enhance the brand’s positioning with Millennial consumers.

“So the big question you’re probably asking is, why did same-store sales increase only 2 percent?” he said.

For starters, Taco Bell faced its toughest comparisons in the second quarter because it lapped the launch of Cool Ranch Doritos Locos Tacos a year earlier, which had lapped the debut of the first Doritos Locos platform from March 2012. Also, when the brand’s marketing shifted from two months of breakfast advertising to promoting the Spicy Chicken Doritos Locos Tacos limited-time offer, the product “frankly underperformed.”

“Nevertheless,” Novak said, “Taco Bell’s same-store sales were positive, and we said all along it would be a first-half-second-half story. Sales trends are already improving with the Quesarito.”

Taco Bell will be ready to launch mobile ordering some time in the second half of 2014, and more menu innovation around value and breakfast items is planned, Novak said.

He added that Yum officials were “obviously disappointed” in Pizza Hut’s negative performance, particularly in the United States. The company’s initiatives planned to turn around the domestic Pizza Hut business include a major advertising campaign to reposition the brand due in the fourth quarter, as well as a “sharpened focus” on value offerings.

Large investments in digital ordering and marketing are on Pizza Hut’s budget for the year, in the United States as well as around the world, Novak said, adding that the brand wants to “catch our competitors on the digital front and surpass them in 2015.”

Yum operates or franchises more than 40,400 locations of KFC, Pizza Hut and Taco Bell in the United States and 125 foreign markets.

Contact Mark Brandau at [email protected].
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