China problems may challenge Yum! Brands in 2013

by Monica Watrous
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LOUISVILLE, KY. — A spate of negative press in China regarding the use of excess antibiotics in chicken has embroiled Yum! Brands, Inc., and its KFC operations in the country. The issue came to the forefront in mid-December and only began to die down on Jan. 25, according to the company. The controversy and its aftermath will have a negative effect on the company during fiscal 2013.

“These events significantly impacted consumer confidence in KFC,” said David Novak, chairman and chief executive officer of Yum! Brands, in a conference call with financial analysts on Feb. 5 to discuss the company’s fiscal year-end results. “This onslaught of negative media coverage has been longer lasting and more impactful than we ever imagined, lasting over six weeks.

“The media coverage is beginning to wind down because on Jan. 25 of this year, the Shanghai F.D.A. reported its concluding findings of the investigation. The Shanghai F.D.A. identified issues and provided supervisory recommendations to Yum! China to strengthen our poultry supply chain practices, including improved voluntary self-testing procedures, improved reporting and communications and enhanced supplier management.

“It is important to note that Shanghai F.D.A. did not bring a case against Yum! China, and no fines were assessed. We have wholeheartedly accepted these recommendations and appreciate the thorough review by the Shanghai F.D.A.”

To restore consumer confidence in China, Mr. Novak said Yum! Brands will launch an enhanced product quality assurance program along with an aggressive marketing campaign shortly after the Chinese New Year.

“Now, looking back, history gives us confidence that we have the capability to fully recover and grow,” he said. “We have faced SARS, avian flu, Sudan Red, and in every case we have bounced back. As an example, in 2005 when our China business was severely impacted by Sudan Red and avian flu, our same-store sales in KFC China were down as much as 40% during the crisis. Our full-year operating profit was down 5% but we stayed the course and kept building new units.

“In 2006, we bounced back and reported system sales growth of 28% and our profits grew 47%. I think this demonstrates the historical resilience of the brand. Now, no two crises are the same, and we don’t know how long it will take us to recover. However, we expect to weather this storm and come out stronger.”

For the year ended Dec. 29, the company had net income of $1,597 million, equal to $3.46 per share on the common stock, which compared with income of $1,319 million, or $2.81 per share, during the previous year. Sales for the year were $11,833 million, up 9% from $10,893 million the previous year.

Yum! Brands opened a record 1,976 international restaurants and grew U.S. same-store sales in all three brands during the year.

But net income dropped in the fourth quarter to $337 million, or 74c per share, from $356 million, or 77c per share, a year ago, as China’s KFC sales declined sharply in December following the negative publicity in China. The company estimates a mid-single digit decline in earnings per share in 2013, said Mr. Novak.

“Putting our current short-term China sales issue aside, we will continue to build shareholder value by aggressively developing new units around the world, driving same-store sales growth and generating high returns on investment capital,” he said. “I’m confident our China business will bounce back strongly and lead the way to restoring out track record of double-digit e.p.s. growth in 2014, 2015 and beyond.”

Yum’s U.S. Division had an operating profit of $666 million, up 13% from $589 million the previous year. Same-store sales for the division increased 5% for the year, with 8% growth at Taco Bell, 3% growth at Pizza Hut and 3% growth at KFC. In the fourth quarter, same-store sales increased 3%, with a 5% growth at Taco Bell and 4% growth at KFC with a 1% decline at Pizza Hut.

“We believe that the U.S. is set up for success in 2013 because Taco Bell has momentum, because new units are now working in our favor and because we have meaningful innovation plans at all three of our brands,” said Rick Carucci, president of Yum! Brands. “Our three U.S. businesses are significantly stronger now than they were a year ago.”

Innovation at Taco Bell led the charge, with introductions of the Cantina Bell menu and Doritos Locos Tacos, one of the most successful product launches in quick-service restaurant history with 325 million sold last year, Mr. Carucci said.

Yum! Brands plans to build on that momentum with the March launch of Cool Ranch Doritos Locos Tacos and more Cantina Bell items at Taco Bell, in addition to rollouts at Pizza Hut and KFC. This week, Pizza Hut launched Big Pizza Sliders, customizable miniature pizzas with up to three toppings.
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