Fried chicken as a proxy for Chinese consumption

07/02/2012 | Matthew Plowright

US fast-food conglomerate Yum! Brands' latest China sales figures and Chinese expansion efforts serve as an imperfect bellwether for the Asian nation's retail outlook

It’s fair to say that many investors tend to treat official Chinese statistics with a very large handful of salt.

Consequently, whether it's cooking oil prices, rail freight throughput or electricity stats, China watchers are constantly searching for proxies for Chinese growth, consumption and inflation.

Well, how about fried chicken? Those searching for an alternative measure of consumption growth could do worse than look to US-headquartered fast-food conglomerate Yum! Brands.

With almost 4,500 stores across the country, Yum, which operates three brands in China – KFC, Pizza Hut and the rather unfortunately named Chinese fast-food chain East Dawning (cue adolescent sniggers, or maybe that’s just us) – is far-and-away the largest “restaurant” operator in China and its sales and profit numbers therefore offer valuable insights into the state of the Chinese real economy.

Here are some China-related nuggets (sorry, couldn’t resist) from Yum’s fourth-quarter numbers, which were released yesterday: 

- Yum!’s China division revenues totaled $1.9 billion in the fourth quarter and $5.6 billion in 2011 as a whole, up 39% and 35%, respectively

- Yum!’s China division accounted for 45.7% total revenues in the fourth quarter and 44.1% of total revenues in 2011 as a whole, up from 45.3% and 36.5%, respectively, in 2010

- China Division system sales increased 29% for the year and 33% in the fourth quarter, prior to foreign currency translation, driven by same-store sales growth and new-unit developments.

- China division same-store sales growth was driven by a 21% increase in same-store transactions for the year, including 20% in the fourth quarter.

- KFC same-store sales grew 19% for the year and 22% in the fourth quarter.

- Pizza Hut Casual Dining same-store sales grew 17% for the year and 15% in the fourth quarter.

- Pizza Hut Home Service same-store sales grew 19% for the year and 25% in the fourth quarter.

- China opened a record 656 new units during the year, including 327 in the fourth quarter.  

That last zinger is worth pondering for a second: that means that Yum opened more than three new KFCs or Pizza Huts a day in China during the final three months of last year. Pretty good going in a country that many see as having repressed consumer spending. Imagine how many more Sichuan Pepper Hot Wings and Old Beijing Twisters they could sell if China would only liberalise its currency and capital account.

Anyway, we digress. What’s notable is how correlated these numbers seem to be with China’s official retail sales numbers, which reported 18.1% y-o-y growth in December and 17.1% y-o-y growth in 2011 as a whole.

Perhaps those “dodgy Commie" numbers aren’t so cooked after all...

Rising inputs
Slightly less correlated, however, was Yum!’s reporting of wage inflation and commodity price numbers, which it blamed for a 2.1% y-o-y decline in restaurant margins.

Quoting again from the earnings release:

Restaurant margin decreased 2.4 percentage points to 19.7% for the year, driven by commodity inflation of 8% and wage rate inflation of 20%. Consistent with expectations, restaurant margin decreased 2.4 percentage points to 15.8% in the fourth quarter. This decline was driven by 11% commodity inflation and 18% wage rate inflation. 

Yum’s inflation calculations are higher than the official numbers, which reported year-on-year wage growth of 12.4% in urban areas (where the vast majority of Yum!’s China stores are located), and 21.9% wage growth in rural areas. The government reported that the purchasing price of agricultural products rose by 9.1% y-o-y in 2011, while ag commodity prices rose 16.5% on the year.

Declining margins due to rising input costs may raise more general profitability concerns about Chinese business operations and cost-competitiveness.

A ‘safe’ EM play?
But despite the shrinking margins, Yum! chairman and CEO David Novak was unsurprisingly keen to stress the company’s strong China performance – and its EM credentials more generally – in the earnings release, describing the company’s performance in China as “exceptional”.

He added:

Clearly, our KFC and Pizza Hut brands in China continued to strengthen their category-leading positions. At the same time, Yum! Restaurants International opened 905 new units, including 622 in high-growth emerging markets. We are on the ground floor of growth in India, Russia and Africa, where system sales grew at strong double-digit rates. For the year, our emerging market businesses at Yum! Restaurants International grew system sales 13%, prior to foreign currency translation, including new-unit growth of 7%.

Emerging markets contributed nearly 50% of operating profit at Yum! Restaurants International. The Yum! growth story is clearly about China and a whole lot more. 

In other words: hey, nervous retail investors in the US and Europe, if you want to benefit from EM (and in particular China) growth without having to deal with all of the complexities of investing in equities in underdeveloped markets with often dubious reporting requirements and legal frameworks and, you know, foreigners, we’re your perfect sideways EM play.

Growing domestic competition

But, before you call your broker, it is perhaps worth remembering that Yum is a business operating in an increasingly crowded fast-food market in China, with a rising number of local competitors jostling to take a bite out of its massive market share. And perhaps at some point Chinese consumers will realize that eating fried chicken several times a week does not a balanced, healthy diet make.

But, for now at least, there seems to be no quenching China’s insatiable appetite for the Colonel’s secret recipe, which some might see as an imperfect proxy for Chinese consumption trends. 

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