Yum Brands China operations pique analyst interest
‘I am tempted to say KFC’s best days in China are probably behind them’
Analysts last week descended on Yum Brands in Shanghai with a volley of tough questions after billionaire investor Dan Loeb suggested the US fast-food chain consider hiving off its Chinese operations.
The annual Shanghai investor conference, scheduled long before Loeb’s intervention, came as the fate of the woe-laden China operations of the owner of KFC and Pizza Hut are uppermost in investors’ minds.
What Loeb dubbed a play on a “unique open-ended middle-class growth story in China” is valued at some $20 billion-$22 billion (Dh73.4 billion-Dh80.7 billion) by analysts. But the view from the streets is rather less gung ho, with restaurants as likely to be stuffed with thrifty grannies as the upwardly mobile middle class patrons that Loeb envisions.
For the past quarter century, KFC was the gold standard for foreign brands among Chinese. But now its restaurants, especially in big cities, play host to grannies entertaining an only grandchild or elderly matchmakers running impromptu dating agencies alongside the more lucrative customers.
“I am tempted to say KFC’s best days in China are probably behind them. They are dealing with a lot of tough trends,” says James Roy, consumer analyst at China Market Research in Shanghai.
These challenges include rising labour costs and rents, labour shortages, changing consumer tastes and increasing competition. This suggests that Yum faces more structural problems than simply a blip caused by the recent food safety scandals.
“Yum China has recovered from previous downturns in its business. However, each time the recovery has taken longer and requires more marketing expenditure,” says Li Junheng of JL Warren Capital.
“Yum’s challenges in China are mostly structural, rather than one-off. These structural issues are unlikely to disappear with financial engineering that focuses on expanding the stock multiple and ignores fundamentals.”
KFC faces growing competition from more innovative start-up fast-dining concepts.
“China is evolving away from that type of restaurant. They need to do something to remain relevant — and they aren’t doing it as well as, for example, McDonald’s,” says Roy.
Struggling
Yum recently reported a 12 per cent annual same-store sales decline in the first quarter and weaker margins. But Greg Creed, its chief executive, predicted a better second half to the year.
KFC’s decline comes at a time when foreign retail brands are struggling in China not just in the fast food sector, but in many areas including supermarkets, electronics and home improvement retailing. Big international brands such as US retailers Best Buy and Home Depot have been forced to abandon China in recent years.
But Sara Senatore, restaurant analyst at Bernstein, who attended the conference, sees a brighter future for Yum in China. “They appear to be recovering from the supply chain scandals.
“While they acknowledge the market has become more competitive ... because of the advantages they have always had here, scale, brand recognition and supply chain, there is every reason to believe they can retain their market share leadership,” she says.
Torsten Stocker, greater China retail partner at AT Kearney, the professional services firm, says it is too soon to predict the demise of one of the mainland’s most famous brands. “It is natural that a ‘market creator’ like Yum will have to work extra-hard to stay ahead of the competitors that it often spawns itself,” he says.
