Yum stumbles badly in China, warns on profit

A man walks out from a KFC restaurant in Taiyuan, Shanxi province, January 17, 2013.

REUTERS - KFC parent Yum Brands Inc (YUM.N) warned on Monday that it expects 2013 earnings to shrink rather than grow as it struggles to manage a food safety scare in China, and sees no return to growth in restaurant sales there until the fourth quarter.

Yum shares fell 5.6 percent in after-hours trading, as Wall Street analysts and investors digested the disappointing news from the company that is widely seen as a model for how to do business in the complex Chinese market.

"This is going to take all the experts they have in public relations to stem the tide. I don't think anyone saw this coming," Edward Jones analyst Jack Russo said.

Yum reported a 6 percent drop in fourth-quarter sales at established restaurants in China due to "adverse publicity" regarding chemical residue found in some of its chicken supply.

Its China business continued to suffer in January, when same-store sales dropped 37 percent, including a 41 percent fall for KFC and a 15 percent decline for Pizza Hut Casual Dining.

Yum expects China's same-store sales to be down 25 percent for the first quarter, which includes only the months of January and February. It said KFC same-store sales in China should turn up by the fourth quarter.

As a result, Yum forecast a "mid-single digit" percentage decline in earnings per share for 2013. Yum previously forecast 2013 earnings per share growth of at least 10 percent, and analysts polled by Thomson Reuters I/B/E/S on average had expected the same.

Yum has nearly 5,300 restaurants in China, mostly KFC, and the region accounts for more half its sales and 40 percent of total operating profit. Its strong reputation for high food quality helped it grow briskly in a country that has been rocked by serious and persistent food safety scandals.

Yum's China sales first took a hit in mid-December when government food safety agencies began probing the company's supply chain. The investigations were prompted by a report on China Central Television, which found that two of Yum's suppliers purchased chicken from farmers who used excessive levels of antibiotics in their animals.

Yum stopped sourcing from one of those suppliers and cut purchases from a problematic plant used by the other.

While the company was not fined by food safety authorities, it has suffered a huge backlash in the mainstream media and on Weibo, China's equivalent to the popular U.S. social media site Twitter.

In early January, Yum apologized to customers in China over its handling of the food scare.

On Monday, it said it would begin an aggressive marketing campaign after the Chinese New Year on February 10 to restore KFC's brand image.

The company would do well to shake off all corporate "hubris" and fall on its sword, said branding expert Robert Passikoff, president of Brand Keys.

"If your same store sales are down by more than one-third, something's not working," Passikoff said.

Fourth-quarter net income at Yum fell to $337 million, or 72 cents per share, from $356 million, or 75 cents per share, a year earlier.

Excluding special items, Yum had a profit of 83 cents per share. That topped analysts' average estimate by a penny, according to Thomson Reuters I/B/E/S.

Total revenue rose to $4.15 billion from $4.11 billion.

Through Monday's close at $63.94, Yum shares were down 14 percent from late November, when they hit an all-time high, but then sank on the initial China sales warning.

Following Monday's warning, after the regular market close, shares of Yum slid 5.6 percent in late trade to $60.33.

(Reporting By Lisa Baertlein in Los Angeles; Additional reporting by Kazunori Takada in Shanghai; Editing by Leslie Gevirtz and Tim Dobbyn)