Conclusion: Yum has seen strong sales performance lately in its China division. The downturn in consumer confidence in the People’s Republic is worth monitoring for a view to how 4Q is trending.
Chinese consumer confidence fell for the first time in six quarters in the third quarter. The drop is believed to be largely attributable to inflation expectations. Pan Jiancheng, deputy-general of the National Bureau of Statistics’ monitoring center, said, “Inflation has been triggered mainly by increases in food prices which has pushed up inflation expectations, especially among low-income workers”.
Specific to YUM, management has consistently called out consumer confidence in China as a key driver of sales. On October 6th, from the 3Q10 earnings call transcript: “we continue to benefit from the improvement of the Chinese consumer where consumer confidence has now been positive year-over-year in the last nine months”. During the 2Q09 earnings call, in discussing the top line trends of -4% in China, management said, “when you look at consumer confidence, actually it’s kind of bumping along the bottom. So that may be a reasonably good indicator of the consumer side of the equation”. Later, during the 4Q09 earnings call, management again called out the bottoming of consumer confidence in China in the early part of 2009 and same-store sales subsequently posted strong gains in 1Q10. Just as the inflection in consumer confidence proved to be an indicator of Yum China sales in 2009, the recent sharp downturn should also be taken into account when thinking about future quarters.
While 4Q09 was a difficult quarter from a top line perspective, and therefore may be easily comped by Yum in the upcoming quarter, 1Q11 will present a difficult challenge for Yum China if consumer confidence does not rebound in the interim. Additionally, MCD announced yesterday that it has increased prices in China by between 0.5 yuan and 1 yuan to offset higher raw material costs. YUM management stated on the most recent earnings call that it expects inflation to be a headwind in 4Q10 and 2011. Should margins compress under rising costs, that would obviously present an additional challenge for the company. Alternatively, following MCD’s lead and raising prices could negatively impact sales trends, particularly if consumer confidence does not rebound.