Yum says profit slump to be short-lived in China

[July 20, 2012]  LOUISVILLE, Ky. (AP) -- Yum Brands Inc. dished up assurances Thursday that its recent profit slump in China will be short lived, as top executives for the fast-food restaurant company stood behind their growth strategy in Yum's most important overseas market.

The owner of the Taco Bell, KFC and Pizza Hut chains overcame a rare setback in its China operations on the strength of a rejuvenated U.S. business, especially at Taco Bell. Yum said Wednesday its second-quarter net income grew by 5 percent. Excluding one-time items, Yum's earnings were 67 cents per share, falling short of the 70 cents per share forecast by industry analysts.

Operating profit in Yum's China business sagged 4 percent in the second quarter, when adjusted for currency fluctuations. Yum pointed to rising commodity and labor costs, plus higher start-up costs for its record pace of restaurant openings in China.

"We expect this to be short lived as our menu initiatives, including pricing, begin to take hold and inflation moderates," Yum Chairman and CEO David C. Novak told industry analysts during a conference call Thursday.

Yum recently raised menu prices in China, where KFC is a leading fast-food chain and Pizza Hut has become a big player. The price increases, in the range of 3 percent to 4 percent, come as China's economic growth has fallen to a three-year low.

Novak shrugged off any concerns that the price hikes could turn away some Chinese consumers in the competitive market.

"The last thing the customer is going to see in China is sticker shock," he said. "We've done a very prudent job of managing pricing, with the primary objective of being affordable."

Louisville-based Yum said it expects a return to double-digit profit growth in China in the second half of the year. Novak forecast sales growth in the mid-single-digit range at established stores in China during that period.

Sales weren't the problem during the three-month period ending June 16. System sales surged by 27 percent, adjusted for currency fluctuations. Sales at restaurants open at least a year rose 10 percent in the second quarter. That figure is an important measurement of restaurant performance because it leaves out stores that have recently opened or closed.

"Strong topline results in China should allay recent concerns of a sharp demand deceleration in Yum's most important market," Bernstein analyst Sara Senatore said in a note to investors.

The problem was on the cost side. Restaurant margins decreased by just over 4 percentage points as higher costs for commodities and labor squeezed restaurant profitability. The company also incurred higher start-up costs from its rapid pace of restaurant openings in China.

The company ramped up 24-hour operations and delivery services at more KFC stores in China, adding to labor costs. Nearly all KFCs in China now offer breakfast, about half make deliveries and more than half are open around the clock.

Yum also accelerated its expansion in China, putting it on course to open a record number of restaurants there this year. It opened 160 new units during the second quarter and now forecasts at least 700 store openings this year, up from a prior projection of at least 600.

"Clearly, we're not happy with a 4.1 percentage point margin decline in China, even though this is short term," said Yum Chief Financial Officer Patrick Grismer. "However, our pricing is now in place. And we look at the process we've used as a responsible investment in the long-term growth of our business."

The company expects stronger restaurant margins in the second half as commodity inflation subsides.

Yum expects to open a record 1,700 new international units this year, with India and Africa among the emerging markets.

While profits in China struggled, Yum benefited from a continued rebound in its once-slumping U.S. business, where operating profit was up 26 percent in the second quarter. Taco Bell led the way with a 13 percent jump in sales at U.S. restaurants open at least a year.

But Yum still sees China as the key driver behind long-term profit growth. The company has relied on a combination of strong sales at its existing overseas restaurants and the rapid pace of new store openings to orchestrate its profit growth.

"What I continually tell the team is keep polishing the diamond," Novak said of the China business. "We've got great brands there. Keep making our brands affordable, make sure we have great operations, make sure the assets look great and the numbers will take care of themselves."

Shares of Yum rose 45 cents at $66 in trading Thursday afternoon.

[Associated Press; By BRUCE SCHREINER]

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