Yum! Brands Downplays Avian Flu Concerns; Proceeding with Massive China Expansion (YUM)

Earlier this week, Yum! Brands (ticker: YUM) which owns, operates and franchises Kentucky Fried Chicken, Taco Bell and Pizza Hut restaurants reported Q4 2005 earnings results. Discussion of China dominated management's conference call with analysts. Here are some key quotes from the call (but you might want to read the full conference call transcript):

David C. Novak, Chairman, President and Chief Executive Officer

For 2005 prior to option expense, worldwide operating profits was up 7% and worldwide system sales grew by 7%. Given all the challenges we had last year with the ingredient issue in mainland China, the consumer concerns about avian flu, Hurricane Katrina and record gasoline prices, we were obviously pleased to be able to deliver 13% EPS growth behind the strength of our global business. Still we look back on 2005 and think what might have been. You can see that only if China had stayed on its normal growth path we were on our way to a fabulous year. Having said that, stuff happens every year and we still keep hitting the 13% growth level.

First, in our high return China division we are aggressively expanding in the fast food category with KFC and the casual dining category with Pizza Hut new restaurants. Year-over-year unit growth for 2005 was 19%. In mainland China alone, our unit growth rate was 25%, and we expect to open another 400 new units in 2006.

Now let me talk in a little more detail about our global portfolio. As we have said, our number one key strategy is to build dominant restaurant brands in China. So let’s look at our China business first.

The January results show that we continue to make slow but sure improvements in sales trends, since the ingredient issues we had in Q2 2005. Based on our research, KFC brand strength in China has returned to previous strong levels, so we expect KFC sales will fully recover over time. As you saw from the release last night, we’re expecting solid double-digit growth in system sales for Q1 and that is lapping plus 26% growth a year ago. We think that goes well for the future. There is still some concern about avian flu, but consumers seem to be getting more and more used to all the press and becoming less and less concerned about eating fully cooked chicken, which we are aggressively communicating is perfectly safe to eat. We are continuing to move ahead in China with a business-as-usual posture. As a result, you can count on KFC in mainland China to continue to build on its QSR leadership position. If things change in our outlook we will let you know.

We ended 2005 with 1557 KFC’s in mainland China, far exceeding any other similar business there. We are clearly the dominant QSR brand in China. Importantly, KFC in China continues to be a leader in innovation. We were first to bring franchising to mainland China in 1992, first to open a drive-through restaurant in 2002. And we have been very proactive in bringing to our Chinese customers the types of foods that address their concerns for a balanced lifestyle. Now, with all the marketing effort to address the supplier issues behind us our marketing thrust in 2006 is to do what we do best, reemphasize the fun experience of eating our delicious chicken.

Our calendar has lots of product news and we will continue to roll out breakfast, expand our unique line of desserts which we intend to drive an additional sales layer. Our Pizza Hut casual dining business in mainland China had another exceptional year with 35% unit growth and positive same-store sales growth. Our Pizza Hut business in mainland China is even more entrenched as the number one leader in the branded casual dining category. Branded competition, as a matter of fact is virtually nonexistent. And yet we are now in over 50 cities. Clearly, Pizza Hut is the dominant casual dining brand. Given that our China division continues to generate the highest return on incremental capital, we are especially pleased that we set a new record with over 400 new restaurant openings for 2005. We expect a similar development level again in 2006. There is no one else in China expanding at this level with the returns we are generating, and we continue to outpace McDonald’s 3 to 1 in expansion.

Our leadership is unquestioned and the gap is growing. We are confident China will grow profits at least 20% this year because of our dramatic new unit expansion in 2005 and because sales are recovering. We are also expanding Pizza Hut Home service and East Dawning concepts and we will update you on our expansion progress later in the year. Again, our goal is to dominate in these two categories. You can count on us to continue to aggressively execute our number one strategy, to build a portfolio of dominant restaurant brands in China.

Richard T. Carucci, Chief Financial Officer

Our China division results were a major drag on the fourth quarter with weak sales due to avian flu concerns and lingering consumer concerns related to the earlier supplier ingredient issue.

China had a difficult fourth quarter due to sales performance below our target, but we experienced slightly better than expected December performance. It was good to end the year in China on an upside.