Yum Takes Massive Sales Beating After Chinese Chicken Scare

Bad News Abroad Overshadows Positive Developments in U.S.

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Yum Brands' China division, the fastest-growing division in the company in the last couple years, took a beating in the fourth quarter, thanks in part to news from China Central Television in December that reported that some KFC suppliers had been using unusually high levels of antibiotics in its chickens.

Yum said during a conference call today that the impact of negative media coverage had a massive impact on KFC, much larger that the chain had ever anticipated.

For the fourth quarter, the Yum's China's sales "turned sharply negative" during the last two weeks of 2012 because of the chicken-supplier revelation. Same-store sales in the quarter grew 3% at Yum's international division, 3% in the U.S., and sales declined 6% in China. But for the full year, same-store sales grew 4% in China, 3% at Yum's international division and 5% in the U.S. Overall, worldwide system sales grew 5% in the year.

Although Yum China's continuing sales declines can be attributed to the chicken scare, the division had already been posting a sales decline earlier in the fourth quarter. The company said in the conference call that it cannot predict when a recovery will happen, but that it hopes sales will turn positive in the fourth quarter of 2013. Apparently the worst quarterly results have yet to be officially reported, as the company said that KFC's sales in the country were down a staggering 41% in January, but that for the first quarter the China will division will likely post a 25% sales decline.

In the wake of the chicken-supplier scandal, the company said that it will launch a more rigorous quality-assurance program in China and a significant marketing campaign after the Chinese New Year. When asked if by waiting until after the Chinese New Year that the company may have waited too long to reassure Chinese consumers, Yum CEO David Novak said that there's "not a whole lot" that the company can do right now, and that launching a massive marketing offensive now would be a waste of money. "We need time," he said.

During the call, executives from the company repeatedly said that the chain has bounced back from other PR crises, particularly two from the mid-2000s: one in which Sudan 1, a dye used to color oils that was outlawed because of fears that it caused cancer, was found in some of KFC China's products; and another when the Avian flu spread quickly in countries where KFC does business, which impacted the chain's sales. In the case of the latter, the company launched a campaign reassuring consumers that its chicken was safe to eat.

Yum's China division has been by far the favorite division of the company on Wall Street because of its rapid and significant sales and store-count growth in recent years. Analysts have long been marking the company with a buy rating because of the company's success in China, largely because of KFC's success in the country.

But that's changing.

"We are lowering our rating on Yum shares due to unusually low visibility related to the outlook for the China division, which has shown extreme comps weakness amid negative media coverage surrounding Yum's chicken supply chain," said Baird analyst David Tarantino in a note this morning. "Although we continue to believe Yum's China issues ultimately will prove to be a temporary road bump on its positive long-term growth trajectory, we now are less comfortable recommending Yum on a near-term basis, given that the sales impact from the issue has been worse than we previously feared and the timing of the expected recovery is highly uncertain."

The issues in the company's China division overshadowed the good fortune it's been experiencing stateside. In the U.S., same-store sales increased 5% for the year, including growth of 8% at Taco Bell, 3% at Pizza Hut and 3% at KFC. In the fourth quarter, same-store sales increased 3%, driven by growth of 5% at Taco Bell, 4% at KFC and offset by a decline of 1% at Pizza Hut.

Taco Bell, the company's most profitable chain in the U.S., has seen a substantial turnaround from 2011, a year when the chain posted negative sales because of a lawsuit that questioned the integrity of its ground beef; the suit also alleged false advertising. The company said today that in 2012, it sold 325 million Doritos Locos Tacos. Cantina Bell, its offering the chain positions as upscale, helped to broaden the Taco Bell brand, the company said, though it did not go into detail on the success of the endeavor. The company added that Cool Ranch Doritos Locos Tacos are coming in March, and more Cantina Bell innovations are coming. Taco Bell last year launched a new tagline, "Live mas," and also bought a Super Bowl spot for the first time since 2010. Sibling chain Pizza Hut unveiled a new product week: pizza sliders, or in other words, mini pizzas.

Yum isn't the only company under fire for supply-chain issues. Burger King in the last couple weeks has been facing consumer concern after it was revealed that one of its UK beef processors, Silvercrest, had been working with a supplier that had been including horsemeat in its ground beef supply.

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