YUM! Brands (YUM) is moving back toward normal in China, according to second quarter earnings announced after the market close today.
But is “normal” enough for a stock that’s trading—even while the China problem continues to hurt sales—near an all-time high?
At the end of 2012 sales at YUM! Brand’s KFC stores in China fell off a cliff when government officials discovered that some suppliers had fed their chicken more antibiotics than permitted under Chinese rules. By April 2013 sales were down 29% from April 2012.
In the months since sales have clawed their way back toward normal. In May sales were down just 19% from May 2012. In June, the company announced today, the decline had been trimmed to just 10% year to year. And, the company continued, by the fourth quarter of 2013 growth in China will have turned positive.
For the second quarter the company announced earnings of 56 cents a share, two cents a share better than Wall Street projections. Sales came in at $2.9 billion, slightly short of the $2.93 billion consensus, and an 8.3% drop from the second quarter of 2012.
What’s hard to tell from these results—and what has been hard to tell about YUM! Brands ever since the hatching of the China chicken disaster—is what is the underlying growth trend for YUM! Brands. Before the huge drop in sales in China overwhelmed all the other numbers from the company, YUM! Brands was showing strength on a turnaround at its Taco Bell stores.
But the company faced important questions about future growth. Read more
You and I aren’t Warren Buffett. And that means we aren’t going to get the kind of deals that Buffett gets.
Nobody is offering you or me preferred stock yielding 9% in a safe consumer Blue Chip like that Buffett got as part of last week’s $23 billion ($28 billion if you include assumed debt) buyout of HJ Heinz (HNZ.) To get 9%, you have to be Warren Buffett, Sage of Omaha, with a name that brings investment bankers flocking to finance any deal that includes you. (Part of Buffett’s profit from a deal like Heinz is in essence a fee from making the financing of a $28 billion deal easier for his other partners.)
But that doesn’t mean there’s nothing that you and I can learn from a Buffett deal like this. In fact, I think this particular Buffett deal is very educational. The Heinz buyout is confirmation, in case you needed it after looking at other recent Buffett deals like his buyout of railroad Burlington Northern, that he believes in what Pimco bond guru Bill Gross has called “the new normal market” and that I’ve called “the paranormal market.”
The Heinz deal makes the most sense if you see the next decade offering relatively modest returns. The new normal and the paranormal paradigms call for, at best, 5% annually from equities. And a continuation of the high volatility of recent markets. In the paranormal market I point to the extreme volatility of 2011 as something we can expect with frequency. For a description of the new normal and the paranormal paradigms see my posts http://jubakpicks.com/2012/03/02/call-it-the-new-paranormal-market-youll-need-some-new-investing-tools-but-the-profits-are-out-there/ and http://jubakpicks.com/2012/05/18/3-buys-for-this-sideways-market-and-more-thoughts-on-the-new-paranormal/
Why do I put the Heinz deal in this camp? Read more
The Shanghai Food and Drug Administration concluded its investigation into chicken sold by Yum! Brands KFC stores in China on January 25, the company said in today’s, February 4, fourth quarter earnings release. The Chinese agency did not fine the company or decide to bring a legal or regulatory case for higher than permitted levels of antibiotics in chicken sold by KFC from supplier Liuhe Group.
That doesn’t mean that investors, though, have cleared the company. The stock fell 1.99% today before the earnings report and then another 5.38% in after-hours trading post for a total loss on the day of 8.2%.
The problem wasn’t fourth quarter earnings—the company actually beat expectations by a penny—or revenue—at $4.15 billion slightly ahead of the $4.12 consensus. Read more
Yum! Brands (YUM) dropped the other drumstick yesterday.
An 8-K report filed with the Securities & Exchange Commission (SEC) on December 21 said that a December 17 Chinese TV story about high levels of antibiotics found in KFC chicken in China from on two Chinese suppliers would have a moderate impact on sales in China. Moderate, the company told Wall Street analysts in guidance ahead of the company’s February 4 earnings report, would amount to a 4% drop in same store sales in China in the fourth quarter.
Yesterday, the company filed another 8-K report that lowered guidance to a 6% drop in same store sales in the quarter. That’s a huge decrease in sales during the last two weeks of the quarter. Credit Suisse estimates that same store sales must have showed a 15% to 20% decline in the last two weeks of the period to produce this large a shift for the quarter as a whole.
It’s not clear to me that Wall Street earnings estimates have yet caught up to the shift. 60 days ago the consensus for 2012 earnings at Yum! Brands was $3.27. Today it’s $3.25. Estimates for the fourth quarter have dropped to 83 cents from 85 cents 60 days ago.
The shares did drop 4.2% today to close at $65.04 but that is still substantially above the $63.88 low on December 21 and only partially reverses the climb to $68.32 on January 4 from that post-guidance low.
I think we’re likely to see more—if modest—downward pressure on the stock through earnings as investors fret about the very real possibility of an earnings miss or negative guidance for the first quarter of 2013. Or both.
I’d wait on these shares.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/, may or may not now own positions in any stock mentioned in this post. The fund did not own shares of Yum! Brands as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
Shares of Yum! Brands (YUM) continue to take a beating today—they’re down another 1.46% as of 1:30 p.m. New York time—on reports from China alleging that suppliers to the company’s KFC chain had injected antiviral drugs and growth hormones into chickens they sold to Yum! Brands restaurants. China’s Internet sites such as Sina Weibo have seen outrage and calls for a boycott of KFC until consumes can be sure KFC food is safe. (The alleged actions by suppliers would be in violation of Chinese food safety regulations.)
McDonald’s (MCD) operations in China have been hit by similar allegations but the company has responded with a statement saying that its chicken in China was tested by a third-party laboratory ad complied with government regulations. That, plus McDonald’s lower profile in China—KFC is by far the dominant fast-food brand in China—has left McDonald’s shares relatively undamaged. (China accounts for about half of Yum! Brands’ revenue and profits. McDonald’s is a member of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ )
Before you decide to treat this scare as a temporary glitch in Yum’s China growth story—and an opportunity to pick up shares—remember that even before this incident Yum! Brands looked to be having trouble in China. And that the stock has been falling since it closed at $74.47 on November 29. Shares of Yum! Brands are down 11.2% from that date through today, December 20.
On November 30 Yum! told investors to expect a 4% drop in same-store sales in China for the fourth quarter of 2012. That’s a shocking decline from the company’s 21% gain in same store sales in the fourth quarter of 2011.
Although part of the reason for the decline is a tough comparison with that 21% gain in the fourth quarter of 2011, and although part of the reason is related to the slowdown in China’s growth from 2011 to 2012, Wall Street analysts immediately noted that some of Yum! Brands competitors in China weren’t reporting the same kind of sales declines. For example, Starbucks (SBUX) said on December 5 that it hadn’t seen a slowdown in same-store sales growth over the past two months.
Is there a problem in China? And what might it be?
Perhaps Yum has a pricing problem with higher menu prices deterring customers. It might seem odd that this should crop up as a problem now—as opposed to, say, last year—but it could be related to Yum’s expansion to China taking the company into a greater number of Tier 2 and Tier 3 cities with lower per capita incomes than China’s Tier 1 cities. The company denied that pricing is a problem at the same time as explaining that it had introduced a new “more thoughtful” pricing scheme that looked at menu price changes on a city-by-city basis as opposed to across-the-broad price increases.
Analysts have also speculated that Yum’s China expansion has reached a stage where the company’s new restaurants are cannibalizing sales at existing restaurants. The company has also denied that this is a problem—but at the same time Yum has said it will open 700 restaurants in China in 2012 down from 800 in 2011.
All this is discouragingly speculative—but I think that investors should be able to draw more informed conclusions in a few months. That would move Yum! Brands closer to easier comparisons on same-store sales. It should also move China’s economy toward somewhat faster growth as China reaccelerates, modestly, from the September growth bottom. That would provide some better perspective for figuring out how much of this is a China problem and how much is a Yum! problem. (It will also give investors a chance to see how much lasting damage has been inflicted in the current chicken uproar.
And remember that from a purely investing angle, the current bad news on same-store sales and on chicken resets expectations. Yum! Brands has said that it expects to see China return to same-store sales growth in 2013, but same-store sales growth will be in the mid-single digits in 2013 and that most of that will come in the second half of the year.
Since same-store sales comparisons get easier then too, Yum! Brands might be shaping up as a second-half of 2013 story.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/, may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/