We continue to be buyers of the negative headlines in China.



July Sales Disappoint...


YUM is trading down following yesterday’s release of July comps for the China Division.  While it is important to see the China Division return to positive same-store sales, we believe how they get there is more important than when.  YUM’s management continues to warn investors that the Chinese business will be spotty, but expects same-store to turn positive in 4Q.  At this point, we believe management may be regretting guiding to a 4Q13 recovery in China comparable sales.


YUM estimates that same-store sales in July were down -13% in the China Division versus expectations of a -4% decline (StreetAccount), with KFC down -16% and Pizza Hut up +3%.  We were secretly hoping for the company to come off the long standing expectation of a 4Q13 recovery to positive same-store sales.  After two consecutive months of sequential improvements (in May and June), expectations have risen for a continued sequential improvement in comparable sales trends moving forward.  The difficulty in projecting these trends comes in the face of conflicting macro data points in China, but, the continued easing of Avian flu issues and very easy comparisons will certainly benefit the reported results for the balance of the year.


Attempting to parse the macro environment in China and its implied impact is a significant challenge, but the underlying tone of the more discretionary +3% same-store sales at Pizza Hut certainly raises a red flag.  Perhaps even more so than the KFC numbers, as it is obvious the brand is still seeing the lingering effects of December poultry issues and other supplier concerns.



Buy the Dip


With the reality of a soft top-line now common knowledge, we believe the real driver of sentiment moving forward will be the slope of the line in the margins of the China Division.  China margins held up better than expected in 1H13, despite significant declines in traffic and mix, as YUM benefitted from lower food costs and improved labor productivity.  We expect margins in 2H13 and 2014 to improve concurrently with an improvement in same-store sales.  The company has previously acknowledged that they need mid-single digit same-store sales growth in China in order to fully offset inflation, and we believe a continued internal focus on margin management will lead to better than expected earnings in 4Q13 and 2014.


Buying into negative news is never an easy task, but YUM’s management team has proven over time that this is the right course of action to take.







Howard Penney

Managing Director


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