Yum Still Sees a Tasty Future in China

Yum Still Sees a Tasty Future in China

REUTERS/Claro Cortes

Hard or soft? That’s been the big question surrounding the slowdown expected in China, the great hope of the global economy. Worries that the Chinese economy may be in for a “hard” landing – one that would leave it unable to buoy other regions of the world – were fueled by the news Monday that the International Monetary Fund slashed its estimate for China’s growth for this year to 8.25 percent from 9 percent. That lower estimate – a contrast to the 9.2 percent growth recorded in 2011 – would be the logical result of weakening exports as the economic climate in Europe deteriorates.

Meanwhile, back in the United States, Yum Brands (YUM) reported a 21 percent surge in same-store sales in China – its largest market, where it opened new KFC fried chicken and Pizza Hut stores at a rate of one approximately every 13 hours in 2011. That translated into a 30 percent surge in the company’s bottom line for the fourth quarter – and a 2.5 percent gain in the company’s share price in after-hours trading late yesterday afternoon.

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So who’s right? Investors willing to bet that Yum’s big investment in China will continue to generate outsize profits, or the economists worried that that country’s economy could hit a trough?

Chinese insiders certainly seem bearish. In an interview with Reuters last week, Zhu Baoliang, chief economist at the State Information Center (a government-run think tank) urged the central bank to follow its initial cut in reserve requirement ratios for Chinese financial institutions with another one, something that would help ignite new lending activity. “I believe the slowing trend in China’s economy has not changed,” Zhu told the news organization. The IMF, meanwhile, said that 8.25 percent growth rate could actually prove to be far too rosy. If the European debt crisis worsens this year, the ripple effects could wipe another four percentage points from China’s growth, the IMF said while recommending that policymakers prepare for massive stimulus measures to offset that kind of blow.

Why, then, is Yum doing so well? It boosted its dividend payments to shareholders, bought back $773 million worth of stock and reported a 15 percent increase in operating profit margins in China in the fourth quarter. That gain in margins was 50 percent higher than the company recorded on its U.S. operations – which make up an ever-smaller portion of the company’s business. Indeed, Yum Brands is rapidly becoming one of the easiest ways for investors to gain exposure to China without having to buy a Chinese stock or a volatile ETF tied to the Shanghai index.

The company’s earnings release offered few forward-looking details, so it’s a safe bet that investors will be quizzing CEO David Novak and his team on how well Yum will fare if Chinese growth falls off a cliff later this year. True, the company now appears to be making the same kind of concentrated push into India that it did in China – it announced it will be begin reporting results of its Indian outlets separately this year – but the same catalysts that would erode China’s growth won’t spare India, or other emerging economies in which Yum is building a presence.

Yum appears to be banking on the fact that the demographic changes that have already taken place within China won’t evaporate simply because growth slows. Perhaps Chinese consumers will buy fewer luxury cars and less designer clothing; they already are backing away from the real estate market. But now that they have developed a taste for fast-food outlets, and for fried chicken and pizza in particular, that won’t change in a hurry. The Chinese KFC may be more upscale than those in the United States – it’s fine to take a girl there on a date, for instance – but the prices aren’t crippling. Growth rates may slow, as it takes longer for Chinese moving into the cities to begin earning wages that allow them to sample the wares of the Yum brands, but the trend isn’t likely to reverse course.