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Fast-food giant Yum Brands (NYSE: YUM) – which operates the KFC, Taco Bell and Pizza Hut chains – posted better-than-expected second-quarter financial results Tuesday after the market closed. However, when the market opened on Wednesday, shares of Yum declined as much as 4% in early trading and closed the day down 3%.
The reason? Although the company’s revenue and profits satisfied investors, Yum disappointed on a specific metric crucial its future growth prospects.
China Troubles Persist
Unfortunately, Yum’s China same-restaurant sales, which measures sales open at least one year, fell 10% last quarter, much worse than the 8% decline expected by analysts. The weak China sales sent investors rushing for the sidelines, which is understandable, because the stock has had an incredible run in recent months. Heading into earnings, Yum shares had rallied 25% just since the start of the year.
Yum has enjoyed an incredible turnaround, since just one year ago, the company’s sales were collapsing in China after a series of issues related to food quality and safety. China is a critical growth opportunity for Yum, as it is for many large U.S. multinational companies.
Overall, EPS came in at $0.69 per share on revenue of $3.2 billion. Both figures beat analyst projections. Analysts expected Yum to earn $0.63 per share on revenue of $3.19 billion.
This did not seem to matter as much to investors, partly because on a year-over-year basis, Yum’s financials are deteriorating. Revenue and net income declined 3% and 30%, respectively.
Recovery May Be Off the Rails
Yum’s operating results were ugly, although it’s clear investors were willing to look past its current troubles as long as the recovery remained on track. This is why the stock had done so well, even though the company’s revenue and profits were still declining.
That bullish thesis now looks significantly weakened, however, because it appears China is not recovering as investors had expected.
For what it’s worth, Yum management reiterated its belief in the long-term growth opportunity in China. The company remains on track to open 700 new restaurants in China this year.
It makes sense why Yum still wants to pursue China so aggressively, since it is the largest nation in the world. Its population exceeds 1 billion, and it has an emerging middle class with tens of millions of potential new customers.
More broadly, the emerging markets in general are still of great interest to Yum, despite the lack of meaningful results thus far. Last quarter, the company opened 291 new restaurants, 75% of which were located in the emerging markets. Outside of China, one market that it’s still focusing on is India, where it grew its unit count 16% last quarter.
Even the U.S. cannot be counted on to fuel Yum’s recovery, as sales in the U.S. rose just 1% for the KFC and Pizza Hut brands last quarter.
Based largely on growing restaurant counts, Yum stuck to its forecast of at least 10% earnings per share growth this year. But this growth may not materialize, if same-restaurant sales continue to decline in China and the other major emerging markets.
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