On Feb 26, we downgraded our recommendation on
Yum! Brands Inc.
) from Neutral to Underperform based on the dim outlook for
Yum!'s flagship China division, which in turn, compelled the
company to slash its 2013 outlook.
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Why the Downgrade?
After contributing immensely to the growth of Yum! Brands in the
last few years, the Yum! China division, which holds the key to
the company's overseas expansion plans, faltered in the fourth
quarter of 2012 mainly due to allegations regarding the quality
of chicken supplied to KFC as well as economic slowdown.
In Dec 2012, China's state television CCTV reported that two
poultry farms in the Shandong province of China that supplied
chickens to KFC and competitor
) had fed the chickens with unapproved levels of antibiotics. The
Shanghai Food and Drug Administration (SFDA) investigation
followed soon after. SFDA reported that 8 out of 19 chicken
batches supplied to KFC, which were sent for examination in 2010
and 2011, contained a very high amount of the antibiotic
Though the company claimed to be concerned regarding the safety
of its food products, the negative publicity led to a steep fall
in the company's sales during the last two weeks of December.
Management is unsure about how long it will take to recover sales
at KFC and expects the negative sales scenario to remain
unchanged in the first quarter of 2013 in China.
Further a tough year-over-year comparison and muted consumer
discretionary spending in the wake of a slowdown in China added
to Yum!'s woes,. Additional costs associated with the
acceleration of restaurant openings are also hurting the
company's margins persistently,
Owing to the China issues, management expects mid-single digit
earnings per share decline in 2013 much lower than its long-term
target of at least 10% earnings per share growth. According to
management, solid results from the US and YRI businesses will not
be able to contain the decline in earnings per share.
Other Stocks to Consider
Some other restaurant industry stocks with a favorable Zacks Rank
AFC Enterprises Inc.
Krispy Kreme Doughnuts Inc.
) with a Zacks Rank #2 (Buy).