Yum: Effects of China supplier scandal could deepen

Yum! Brands Inc. warned late Wednesday that the sales impact of the recent Chinese meat-vendor scandal could deepen.

“The result has been a significant, negative impact to same-store sales at both KFC and Pizza Hut in China over the past 10 days,” said David E. Russell, Yum’s vice president of finance, in a statement filed with the Securities and Exchange commission.

Louisville, Ky.-based Yum! Brands, as well as McDonald’s Corp. and several other restaurant brands, have been dealing with negative publicity from the scandal.

Both companies announced July 20 they had dropped Shanghai Husi Food Co. Ltd., a division of OSI, 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.

“Subsequently, the Shanghai FDA launched an investigation into this matter, alleging illegal activity,” said Russell in the SEC filing. “Upon learning of this, we immediately terminated our relationship with OSI globally, with minimal disruption to our menu offerings in China.”

Russell added that, while the meat supplier was not a major source for its Chinese units “these events triggered extensive news coverage in China that has shaken consumer confidence, impacted brand usage and disparaged the hard work of our over 400,000 Chinese employees.”

He said the company, which also owns the Taco Bell brand, was outraged and reserved the right to take legal action when the Shanghai investigation was completed.

“At this point, it is too early to know how quickly sales will rebound in China and the corresponding full-year financial impact to Yum! Brands,” Russell said. “However, if the significant sales impact is sustained, it will have a material effect on full-year earnings per share. We will provide additional perspective on this matter during our third-quarter earnings call in October.”

Mark Kalinowski, an analyst with Janney Capital Markets, said in a note late Wednesday that Yum’s China market earned it the most profits of all the regions in which it conducts business.

“Yum also notes that it plans to provide an update on issues during its October earnings release conference call, suggesting (since October is quite a ways away) that it is difficult to predict with specificity just how long-lasting or to what degree these issues may last,” he said.
“Risks have definitely increased,” he added, noting that McDonald’s and Papa John’s International also face similar risks.

David Tarantino, an analyst with Robert W. Baird & Co., said in a note that “Husi was a relatively small supplier for YUM (providing only two breakfast items to KFC, stone pan steaks to Pizza Hut) and seemingly a more important vendor for other brands (including McDonald's).”

Tarantino added that despite formal apologies by Yum “the negative media coverage appears to have broadly impacted current Chinese demand for fast-food occasions.”

Contact Ron Ruggless at [email protected]
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