Analysis: China diners say more than economy hurting Yum's KFC

NEW YORK Thu Dec 6, 2012 1:50am IST

People dine at a Kentucky Fried Chicken (KFC) outlet in Shenyang, Liaoning province June 2, 2010. REUTERS/Stringer

People dine at a Kentucky Fried Chicken (KFC) outlet in Shenyang, Liaoning province June 2, 2010.

Credit: Reuters/Stringer

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NEW YORK (Reuters) - A slowdown in China's economy is not the only strain on Kentucky Fried Chicken's business in the country, where competition is getting tougher and customers are getting pickier.

KFC parent Yum Brands Inc warned last week that it expected sales at established restaurants in China to fall 4 percent in the fourth quarter, despite an improvement in economic indicators such as consumer confidence and retail sales. Yum shares are down more than 11 percent since the warning.

Interviews with diners in Shanghai and Beijing, and a review of comments on Sina Weibo - China's equivalent to Twitter - show many diners are unhappy with KFC's half a dozen or so price increases in recent years, as well as changes in the local menu.

The new products "are horrible, not as good as before," said Queen Hu, 24, a consultant at accounting firm PwC. She used to eat frequently at KFC when she was in college, but has since cut back to about two to three times a year.

Yum will hold an investor day on Thursday where it is likely to face tough questions about its China business, which contributes more than half of its revenue and operating profit. Investors want to know whether the fourth quarter decline is a one-off, or a sign of real problems in the China market.

Many analysts expect the company to successfully navigate the slowdown, even as some forecast the rough patch could stretch into the middle of next year as Chinese consumers grapple with cooling economic growth and a once-in-a-decade leadership transition.

"It has yet to be seen what measures the country's new leadership will take to stimulate demand, but it is quite possible that the Chinese consumer will remain cautious over the near to medium term," UBS analyst David Palmer wrote in a client note.

The U.S. company was a pioneer in China and remains the largest Western restaurant operator there, with roughly 4,800 (mostly KFC) outlets in the country.

Yum shares were trading 0.4 percent higher at $66.17 on Wednesday afternoon. Just before the China performance warning, the stock closed at an all-time high of $74.74 on November 29.

RUMOR MILL BITES

Yum's problem is not just bad reviews - a false rumor about food quality also appears to be dogging the company.

A Yum spokesman dismissed as "untrue" media reports from late November that the supplier of 1 percent of KFC's chicken in China was giving its birds feed containing toxic additives. He declined to say whether the rumors hurt Yum's sales results.

Chinese agricultural officials have also dismissed the rumors and said publicly the supplier was safe.

Food safety is a hot issue in China, where there are daily reports in local media about toxins found in various food products.

As a foreign brand, generally considered higher quality in China, the KFC rumors triggered an outsize reaction, one that has not completely died down on popular Internet forums.

"Foreign food companies are powerful because people trust them - they trust that their food is safe," Hu said. "But now they have the same problems as Chinese companies, which mean that a price increase is unreasonable."

Competition is also on the rise, including from U.S. powerhouses such as McDonald's Corp, Starbucks Corp and Subway.

Jiao Guang, 25, a driver in Beijing, said he eats fast-food all the time and prefers McDonald's over KFC, which is generally more upscale in China than in the United States.

"I like more snack foods, McDonald's has snacks whereas KFC is a full meal," he said.

Chains from China and other parts of Asia are also turning up the heat. They include Taiwan-owned Dico's, a fried chicken chain that takes direct aim at KFC; Ajisen (China) Holdings Ltd, a Japanese-style noodle chain; and a host of Chinese chains such as Golden Jaguar, Yonghe King and Country Style Cooking.

Even as Yum broke the bad news about China to investors last week, Chief Executive David Novak vowed 2013 would be a strong year for the China division.

Still, Yum faces daunting hurdles through the second quarter of 2013 because it has to post growth that compares with the double-digit percentage same-restaurant sales gains of recent years.

"They've had very strong results for a long time and now they're lapping that. All the signs point to this being a temporary ... deceleration," Bernstein Research analyst Sara Senatore said.

(Additional reporting by Reuters Shanghai and Beijing newsrooms.; Editing by Ben Berkowitz and Andre Grenon)

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