Yum! Brands: Pizza Hut China not affected by KFC supply chain crisis

For the past several years, Yum! Brands has leveraged its China business for staggering gains on the bottom line. So important is that market to the Louisville, Ky.-based company, its KFC and Pizza Hut China systems make up more than half of Yum!'s total sales.

Accordingly, the "crisis" that broke in December, implicating KFC for having excessive levels of antiobiotics in its poultry supply (a practice that expedites chicken's growth cycle), has had a huge impact on the company and isn't expected to dissipate any time soon.

To underscore its effect, January same-store sales declined 41 percent at KFC in January.

"Our customers feel that we have let them down. We don't know how long it will take us to recover. We underestimated the impact of this and we've concluded that the consumers need time," said CEO David Novak, during the company's Q4 and full-year 2012 earnings call Tuesday. "History has told us we need time. We expect to weather this storm and to come out stronger."

Pizza Hut's January sales in China were also down 15 percent, however Novak said it's not because of a spillover effect of the KFC crisis. Rather, the timing of the Chinese New Year has had a negative impact, and results are expected to reverse in February. Pizza Hut is also facing difficult comps from the prior year, as well as some weakness in its broader retail environment, Novak said.

"We saw the decelerating trend across the back half of last year. Now in addition to that you have to bear in mind that as we enter 2013, we are continuing to face significant comparables from prior year. For Pizza Hut alone in the first quarter we recorded 18 percent same-store sales growth in 2012," he said.

Details of Yum!'s China's crisis

The KFC issue emerged when the Chinese Central Television (CCTV) broadcasted an investigative report about some poultry farmers ignoring regulations by using excessive levels of antibiotics in chicken. Some of the product was purchased by two of KFC China's suppliers. The story led to an investigation by the Shanghai FDA and snowballed into a negative media and social media firestorm.

"This onslaught of negative media coverage has been longer lasting and more impactful then we ever imagined, lasting over six weeks," he said. "It is important to note that the Shanghai FDA did not bring a case against Yum! China and no fines were assessed."

In response, Yum! China has taken supervisory recommendations from the Shanghai FDA and will strengthen its supply chain quality assurance protocol, including voluntary self-testing, improved reporting and enhanced supplier management.

Yum! Brands will also launch an aggressive marketing campaign outlining its improved practices in an effort to win back consumer trust.

"Every dollar we spend behind reinforcing what we're doing to enhance our quality is a dollar well spent," Novak said.

A 'banner year' for U.S. business

It wasn't all bad news for the company. Domestically, same-store sales grew 5 percent, margins improved by over 4 percent and operating profit grew 13 percent. All three brands — Pizza Hut, Taco Bell and KFC — grew their same-store sales.

Taco Bell was the big story from 2012, buoyed by its Doritos Locos Taco launch in March. The company sold 325 million Doritos Locos Tacos, making it one of the most successful product launches in QSR history, according to Richard Carucci, president.

Taco Bell is also taking a page from Pizza Hut in developing more rural new units.

Supported by its smaller, lower-investment Delco Lite model, Pizza Hut added 150 net new units in the U.S. last year, marking the second consecutive year of positive net unit growth for the brand, after a decade of decline.

Pizza Hut is positioned to add a similar number of new units in 2013, relying heavily on its Delco Lite models. The brand's new unit growth is positively contributing to its growth in U.S. sales and profits, Carruci said. And new products, such as the "Big Pizza Sliders," have the potential to add new occasions.

Yum! International continues to target emerging markets

Yum! Brands also fared well in international markets to finish out the year. Carucci said Yum! Brands International developed a record 949 units during 2012, with more than 65 percent of them located in emerging markets. The emerging market strategy grew system sales 12 percent last year. This pace is expected to continue in 2013.

"In 2013, we are targeting similar growth building an even stronger foundation," Carucci said, citing Russia and Africa as examples. Last year, Russia system sales jumped 46 percent and added nearly 40 new restaurants.

During 2012, Yum! opened almost 50 restaurants in Africa and ended the year with restaurants in 14 countries.

"We intend to further expand across Africa in 2013 by building restaurants in Tanzania, Uganda and Zimbabwe," Carucci said. "Our breakfast expansion is doing great as we now have more than 270 restaurants offering breakfast and plan to add another 100 restaurants this year. Africa is one of the world's fastest growing regions, and KFC plans to be the clear restaurant leader on the continent."

Late last year, Yum! sold its Pizza Hut UK Diner business to a franchise partner, which is expected to improve YRI's profits this year. Yum! also announced today that it has agreed to the terms to acquire its franchise partner in Turkey. There are currently 60 KFCs and 40 Pizza Huts in Turkey.

"At YRI, we will invest behind high growth markets and accelerate new unit development of both KFC and Pizza Hut, particularly in the rapidly growing Pizza delivery space," Carucci said.

Cover photo provided by Gene Zhang.

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