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Yum blindsided by KFC chicken scare in China

February 5, 2013

NEW YORK (AP) — When KFC was hit by a controversy over its chicken suppliers in China late last year, parent company Yum Brands offered free drinks and ice cream to bring diners back.

The company, based in Louisville, Ky., apparently didn’t realize the severity of its problems; the promotion did little to assuage fears about its chicken and on Tuesday the company said it expects its earnings per share to decline 25 percent in the first quarter. Yum had already warned on Monday that a key sales figure for the region would plummet by the same percentage during the period. Profit for the full year is now expected to decline as well, snapping an 11-year streak of growth of at least 13 percent.

“The onslaught of negative media coverage has been longer lasting and more impactful than we expected,” CEO David Novak said in a conference call with investors Tuesday. Although Novak said he expects the KFC brand to recover eventually, he could not say exactly when that would be.

He noted that the company will need the “gift of time” for the controversy to subside, because diners have plenty of other places where they can go while the issue is fresh in their minds. Yum said it plans to mount a marketing campaign to start rebuilding trust next week, after the Chinese New Year.

The company, which also owns Pizza Hut and Taco Bell, has many more locations in the U.S. and around the world than in China. But the company is the biggest Western fast-food chain in China, with KFC accounting for most of its 5,300 restaurants. The nation’s economic growth had until now been a boon for the company and China accounts for about 40 percent of its profit.

Since Dec. 18, however, the company has been reeling from a report on Chinese television that said its suppliers were ignoring regulations and giving chickens unapproved levels of antibiotics. Yum says a subsequent investigation by Shanghai regulators concluded on Jan. 25, with the company agreeing to adopt stricter oversight of its suppliers.

But even before the chicken scare, Yum’s China business had been slowing, with sales trending negative as early as October. Yum says that weakening was the result of broader economic conditions and tough comparisons from its growth a year earlier. The trends “turned sharply negative” in December after the news report, the company said.

The steep sales drop for the first quarter would follow a 6 percent drop in the fourth quarter, which was the first decline since 2009. To keep investors updated on its efforts, Yum said it will start reporting monthly sales figures for China until business rebounds.

Despite the setback, Novak said Tuesday that Yum’s ambitious expansion plans for the country remain intact and that the company continues to see the country as a key market for its long-term success.

As with McDonald’s in the U.S., he said that Yum in China plans to be “everywhere that matters” and “have the best locations.” In 2013, Yum plans to build 700 restaurants in the country, concentrating more on the second-tier cities outside of Shanghai, Beijing, Guangzhou and Shenzhen to become a more ubiquitous presence.

Novak also noted that Yum has overcome major ordeals in the past, such as an avian flu scare in 2005 that dragged down sales by as much as 40 percent. In the U.S., the company was also hit by a lawsuit in 2011 that alleged Taco Bell beef shouldn’t be labeled as such because of its other ingredients. Yum hit back hard against the suit, taking out advertisements defending its products, and the lawsuit was later dropped.

The assurances weren’t enough for Goldman Sachs analyst Analyst Michael Kelter, who downgraded his rating on the company to “Neutral” from “America’s Buy List,” noting that the impact on sales was “much greater than we anticipated.”

Given the unprecedented nature of the drop, Kelter said it would be “hard to gauge what a recovery may look like.”

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