Even as Yum! Brands’ net income rose 7 percent in the third quarter to $383 million, the company said commodity and labor inflation around the world will continue to pressure margins.
In response, the Louisville, Ky.-based Yum will focus on building its China division and turning around Taco Bell in the United States, chief executive David Novak said in a call discussing third-quarter earnings.
In China — where Yum is on track to open 600 restaurants this year, and where the company recorded a 19-percent increase in same-store sales for the third quarter — several initiatives are underway to spur transaction growth.
However, restaurant margins in China, which have been impacted by food and labor inflation, fell to 21.3 percent for the quarter ended Sept. 3, compared with 25.3 percent in the third quarter of 2010. While breakfast and value offerings drove down the average check slightly, Novak said Yum is pleased with the transaction growth it has encouraged.
Taco Bell, Yum’s largest and most profitable brand in the United States, continued to struggle in the third quarter, logging a 2-percent decline in same-store sales. But Novak said a “breakthrough” product introduction scheduled for the first quarter of next year — the brand will celebrate its 50th anniversary and “reinvent the taco” — plus a gradual extension of its breakfast platform in 2012, are expected to drive positive sales for the chain.
“In terms of next year, I don’t think we look at it as a year of reinvestment, but rather a year when the investments we’ve made start paying off,” Novak said. “We’ve made investments in our pipeline, and we expect those breakthrough products to drive the top line.”
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Turning around Taco Bell
It’s been a tough year for Taco Bell, which has battled falling sales ever since the filing of a since-dismissed consumer lawsuit in January. But Yum officials are optimistic for a turnaround early next year, Novak said.
“Taco Bell is making steady improvement, but it’s slow improvement, and we’re obviously not pleased with our same-store sales,” Novak said. “We went from down 5 percent [in the second quarter] to down 2 percent [this quarter]. It’s been more of the same without any significant breakthroughs.”
Through the balance of the year, Taco Bell will focus on operational excellence, and early next year Yum will unleash new products meant to spur positive same-store sales, he said.
“What we think is going to get Taco Bell back on the growth track is more category innovation,” he said. “We’ve proven in test marketing that we have exactly that. We’ll be reinventing the taco. So you’re going to see some blocking and tackling until we get to the end of the first quarter, then we’ll see a significant uplift.”
Novak added that Taco Bell would extend its test of a breakfast platform to more states in the western United States, “and we think that will begin a march toward the long-term rollout of breakfast on a national basis.” The company is expecting a gradual rollout of breakfast and a gradual impact on sales, Carucci added.
Carucci also noted that Yum’s recent corporate transactions — the sale of A&W and Long John Silver’s and the refranchising of Pizza Hut U.K. — would not significantly affect its bottom line.
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China chugs along
Novak reiterated four key initiatives to drive sales at KFC’s China restaurants: breakfast, delivery, 24-hour operations, and lunch and snack value offerings. Same-store transactions grew 27 percent in China in the third quarter, he said.
“Our breakfast daypart has seen its transactions double this year, accounting for about 30 percent of total transaction growth,” he said.
Yum opened 329 restaurants in China in the first three quarters of 2011 and expects to raise that to 600 by the end of the year, a record number for Yum in China and a slight acceleration from previously stated plans, Novak said.
Food and labor inflation had been higher than projected in China, he said, pressuring margins. Yet in the face of that, Yum still pursued aggressive value offerings at breakfast and the afternoon snack daypart, slightly accelerated unit growth, and waited until the end of September to raise menu prices 2 percent there, he said.
“Our strategy is a brand-building, asset-leveraging strategy,” Novak said. “What we’re trying to do is make our brand as compelling, relevant and ubiquitous as it can possibly be in China. The real success factors in this category are a broad menu, leveraging your asset throughout the day, and making sure it’s affordable on an everyday basis.”
“In terms of how to deal with inflation, we’re in a better position to do it than anybody else,” said chief financial officer Rick Carucci. “We have all the different levers we can pull, like different dayparts and strong distribution systems, so we could take pricing in different parts of the country. We will gradually take pricing and catch up to inflation, and when inflation abates, we’re expecting at least 20-percent margins [in subsequent quarters].”
Yum anticipates even higher food inflation in the fourth quarter of 2011, Carucci added.