After warning that same-store sales could decline as much as 25% during the first quarter in the wake of a poultry supplier scandal that shook consumer confidence in China, Yum! (NYSE:YUM) reported a same-store sales decline of 20% in its China division. Same-store sales at KFC dropped 24%, while Pizza Hut's sales fell just 2%. We gathered that after McDonald's (NYSE:MCD) results in China were "strong," KFC might show some signs of stabilization, and that appears to be the case.
More importantly, Yum!'s China division reported same-store sales growth in February. Although aggregate same-store sales grew just 2%, same-store sales at Pizza Hut jumped 13%, and same-store sales were flat at KFC during February. We were uncertain how Chinese consumers would react to the situation in the long-term, but it appears the issue has mostly blown over, or at least KFC has done a good job of repairing its reputation in light of the scandal. The recent trends at Yum!'s China division suggest the company could return to same-store sales growth at KFC sooner than anticipated, making the road to increasing profits look much more attractive. It is important to remember that the company said same-store sales were positively impacted in the mid-teens by the timing of the Lunar New Year, so we aren't certain the decline will completely disappear just yet.
Regardless, our valuation remains where it was prior to the poultry scandal. We believe the Chinese business could improve as the year goes on, and we also think the firm is doing a fantastic job executing in the US, particular at Taco Bell. In the US, during the most recent quarter, same-store sales jumped 3% year-over-year. Pizza Hut and KFC grew same-store sales 3%, but Taco Bell remained the standout, with same-store sales jumping 8% year-over-year. We think the Mexican themed chain is stealing share from both Chipotle (NYSE:CMG) on the high-end and McDonald's on the low-end, making it one of the best performing fast-food chains in the country. Yum!'s segment operating margins in the US soared 290 basis points year-over-year to 19%, and restaurant margins jumped 330 basis points during the period to 16.7%. A horse meat scandal recently rocked Europe, so we think YUM!-and other US quick-serve restaurants will be vigilant in monitoring domestic product safety.
Yum! will likely continue to focus on food safety in China, decreasing the odds of another scandal. Yum!'s business fundamentals look solid, but it simply doesn't trade at a discount to our fair value estimate range, so we aren't interested in adding shares to the portfolio of our Best Ideas Newsletter at this time.