Yum: China, Taco Bell breakfast off to good start in 1Q

In its first-quarter earnings report, Yum! Brands Inc. showed green shoots of recovery in China, momentum for growth in emerging markets around the world and positive initial results for Taco Bell’s breakfast platform in the United States.

The China system’s operating profit fell 23 percent in fiscal 2013 after fears of a contaminated poultry supply and a renewed outbreak of avian flu sent same-store sales at the country’s more than 4,000 KFC locations crashing. For the March 22-ended first quarter of 2014, China’s operating profit had recovered 85 percent from the year-earlier first quarter, officials said.

Chief executive David Novak said Louisville, Ky.-based Yum also initiated a major repositioning of KFC in China April 2, with upgrades to its menu, marketing and service.

“The overall objective is to restage KFC as more youthful and more energetic, in keeping with the changes going on in China,” Novak said.

Also included in the new reporting structure were global results for Yum’s three major brands — KFC, Pizza Hut and Taco Bell — for their thousands of units in more than 100 countries, excluding China and India. KFC and Pizza Hut showed same-store sales growth internationally, especially in emerging markets, but their domestic performance dragged down overall sales. Domestic same-store sales fell 3 percent at KFC and 5 percent at Pizza Hut.

Taco Bell, which has the vast majority of its units in the United States, recorded a 1-percent same-store sales decrease, which Novak attributed in large part to severe winter weather in the United States and lapping a 6-percent increase from the first quarter of 2013.

Margins make a comeback in China

The China system’s restaurant-level margin in the first quarter rose nearly 7 percentage points from a year earlier to 23.4 percent, benefiting from the segment’s 9-percent increase in same-store sales, as well as from gains to labor productivity that began with several labor initiatives implemented during last year’s crises.

However, chief financial officer Patrick Grismer said the profit improvement would not extrapolate to the full year, especially given further inflation expected for labor and wages in China. He forecast a full-year profit margin in China around 17 percent, which would be about a 2-percent improvement over the full-year margin of 15.4 percent for fiscal 2013.

Over time, Yum will get back to the 20-percent margin levels it enjoyed in China before 2013’s supply chain crisis, “and we think we’ll get there primarily through sales leverage,” Novak said.

Yum’s China system spent four months retraining every crew member on service standards, Novak said, adding that “branded service” elements at KFC would include more attention to detail, like having all crew members raise their hands and greet every customer that walks in the door. Another facet would be cashiers handing back change to customers with two hands and thanking them for coming — “which we picked up from Chick-fil-A in the United States,” Novak said.

The menu revamp in China included the removal of seven items and the addition of 14 products that were either brand new or were reintroductions of popular limited-time offers from the past, Novak said.

“These products are more premium in nature,” he said. “We want to still have entry price points that are value-oriented at breakfast, lunch and dinner. But we want to obviously trade people up as much as we can into higher-quality products.”

Taco Bell breakfast rising, shining

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Taco Bell’s breakfast performance in the United States would depend on how many people would trade into the Irvine, Calif.-based chain for the morning meal, Novak said.

He was bullish that Taco Bell’s breakfast — launched on March 27, subsequent to the close of the first quarter — would pick up further once its national advertising spread awareness for the menu. For example, Novak was “startled” on a recent visit to the Phoenix market, where breakfast had been in test for two years, by how many people didn’t know Taco Bell had breakfast at those units until they saw recent commercials.

“We’ve already achieved break-even levels [for breakfast in Phoenix], but customers didn’t even know about it,” he said. “We have to break major habits, because people do the same thing every day, and it’s hard to get even our current customers to give us a try. But we’re doing innovative things on the marketing front. …

“We’re not in it to be in breakfast,” he continued, “we’re in it to win breakfast. We have a lot more products that we can go to when we want to.”

Grismer noted that Taco Bell had been developing breakfast over several years, but the adjustments of the past 18 to 24 months produced the menu lineup that ultimately gave Yum the confidence that the platform would produce a sales mix in the mid-to-high-single-digit range that would make the unit economics work.

“That mix is what we saw in test, and it was highly incremental,” Grismer said. “If we achieve and maintain that mix, that’s what we need to deliver our same-store sales target for the year. The breakfast offering at that mix level is dilutive to margins, but only slightly, and as it builds over time, it will be accretive to margins and put us in the position to accelerate the pace of new-unit development.”

Novak added that Taco Bell would introduce another “major” product platform in the second half of 2014.

Home improvement needed

Yum’s chief executive expressed disappointment with Pizza Hut’s and KFC’s domestic performance, especially when compared with results in the China division or emerging-market countries.

But he added that Yum would turn around sales at Pizza Hut and KFC by importing the best practices and ideas from some of their outperforming international markets, such as the United Kingdom and Australia, where KFC recorded first-quarter same-store sales gains of 12 percent and 3 percent, respectively.

“When you look at the U.K. business and the Australia business, those are two businesses that are more successful in the portable-food arena, particularly with sandwiches,” Novak said. “We’re looking at how we can develop the right sandwich platforms and be effective in the United States.”

He added that the return of Dip ’Ems at KFC in the United States in a $5 boxed combo meal was one example of a deal developed in Australia and imported to the domestic system to get a more portable item to customers at the $5 price point.

“We constantly share product news that travels,” Novak said. “We’re going to see a lot more sharing with those [global-brand] teams now reporting together to more focused CEOs.”

Yum operates or franchises more than 40,000 restaurants in more than 125 countries.

Contact Mark Brandau at [email protected].
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