David Novak, CEO of Yum! Brands (NYSE:YUM), said during the fiscal second quarter conference call, "We expect a strong bounce back year in China and solid full year performance in KFC." The bounce back he was referring to was a recovering from a chicken supply scandal that hit the chain hard last year. Little did he know that just a few days later a new one would surface.
And sales in China were starting to go so well.
Pat Grismer, CFO of Yum! Brands, added during the conference call, "And consumers in China are ecstatic. Their expectations are increasing." Higher expectations can be a double-edge sword. Hopefully consumers don't take a fool me once, shame on you, fool me twice shame on me attitude.
Yum! Brands reported its fiscal second quarter results on July 17. Its KFC China saw sales soar 21% including 15% of same-store sales. In the year-ago period, KFC China same-store sales got slammed 13% mostly due to a poultry supply scare broadcasted in the Chinese media beginning in December 2012.
Just this last quarter seemed to mark a full recovery from that panic after much hard work, promotions, and innovation to get customers back in the doors. Now Yum! Brands may have a round two to deal with.
It was reported on July 20 by the Chinese media, just three days after the Yum! Brands earnings results, that OSI Group workers were caught repacking expired meat including chicken. The December 2012 incident involved the finding of high levels of antibiotics in the poultry supply that KFC China uses. Now the problem is expired meat. It doesn't exactly sound appetizing.
Yum! Brands moved swiftly to attempt to save face - and customers - by cutting off ties with OSI Group entirely. Five individuals were arrested over the incident, but the damage to public perception, be it right or wrong, may have already been done. "Here we go again," the consumers might be thinking. Once is easily forgivable but twice now can be concerning.
The new menu has a new problem
Part of the reason for the surge and recovery in same-store sales of KFC China this past quarter had to do with a "comprehensive restage of the KFC brand with the debut of a new menu." That was on April 2. It was a smart method to help consumers forget the past and look at KFC in a new light with new food.
Now what is Yum! Brands supposed to do - start all over with yet another menu? It can't play musical chairs with its menus forever. During the 2012 round, China Central Television stated, "KFC's control and management over food safety cannot be trusted completely by customers."
Call it propaganda maybe but it obviously was effective. We may see an encore. Last time one of the solutions was to slash prices in half for a bucket promotion. It seemed to have worked. Maybe it will again.
I wouldn't bet against Yum! Brands figuring things out long term with the KFC China brand, but the market hates uncertainty either way. I agree with the market. However, if Yum! Brands has disappointing results related to the KFC China division with the next quarterly report in about three months, it may actually be worth considering a contrarian long term position at that time.
If you're a long-term investor, look at the long term picture and if we don't think short-term stock-price-hurting events matter for the long term, then consider taking a closer look. Yum! Brands should be able to win but it will be important to pay attention to what plans it has to tackle this publicity problem if indeed sales take a big hit from scandal.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.