Yum dismisses activist investors’ urge to spin off China business

Yum! Brands Inc. activist investors are pushing for a spinoff of the company’s China business, but the quick-service operator said Wednesday that it is instead focused on turning around performance in that market.

Activist investors who have taken significant positions in Louisville, Ky.-based Yum publicly suggested that the company spin off its China business, which has been struggling over the past year amid a health scare there.

But during an earnings call Wednesday discussing second-quarter earnings, Yum executives said they are not currently considering a spinoff.

“We don’t want to talk about it,” Yum CEO Greg Creed said, noting that the company reviews shareholder ideas and proposals to increase shareholder value. “The China team is focused on one thing: Their No. 1 priority and my No. 1 priority is getting China back to stronger sales growth.”

Yum stock fell nearly 3 percent in Wednesday morning trading.

Yum operates the KFC, Pizza Hut and Taco Bell chains worldwide, and has 42,000 restaurants.

The company’s China operations have been problematic for more than three years, following a pair of health scares. The most recent scare, about a year ago, led to a steep decline in sales there for Yum’s concepts, particularly its flagship KFC brand.

Sales have stubbornly refused to recover in the 12 months since then. Same-store sales in China declined 10 percent in the second quarter ended June 13. The result was only slightly better than the 12-percent decline in the first quarter. Yum executives admitted that recovery in China has been slower than expected.

“We’ve had two safety issues,” Creed said. “We’ve never had to model two safety issues.”

But executives also suggested that the environment in China is tougher than it has been.

“The environment has changed in terms of becoming more competitive,” Yum CFO Patrick Grismer said during the call. “Consumers have more choice. They’ve raised the bar on us to innovate more than we have in the past.”

The decline in China has been a huge blow to Yum’s revenue and profits over the course of the year because the company owns most of its restaurants there. The company mostly franchises everywhere else.

China’s operating profit fell 26 percent in the second quarter, to $144 million, but remains 40 percent of Yum’s total operating profit. Total revenue for the company fell 3 percent, to $3.1 billion, in the quarter, from $3.2 billion the same period a year ago. Net income fell 30 percent in the quarter, to $235 million, from $334 million.

Yum is still opening new units at a rapid clip, and expects to add 700 locations in China this year, as returns on those units remain high.

Activist investors have suggested that Yum spin off the China business so that it acts more like a franchisee of the company and is separate from the main corporation.

Profits need to double in second half

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Activist hedge fund Corvex Management bought $1.5 billion of Yum’s stock, and its founder, Keith Meister, suggested the spinoff at a conference in May. Meister called a spinoff “a clear, obvious way to create value,” according to Bloomberg.

But Yum executives said its business in China could improve rapidly this year. Executives said sales growth will return once Yum begins comparing its performance to the brutal quarters during 2014, when sales plunged. They also said efforts to improve margins will lead to a quick recovery in earnings.

Earnings per share has declined 7 percent this year, executives said during the call, but growth should result in a 10-percent increase in earnings for the year.

Some analysts suggested that the prediction might be conservative. But Yum executives dismissed that idea, acknowledging the difficulty to reach their earnings growth target.

“Absolutely not,” Grismer said.

Earnings would need to grow 30 percent in the second half of the year for Yum to reach its targets.

In China, Grismer said, profits during the second half of the year would need to double for the company to meet its target.

Executives said they are working to increase innovation at KFC in particular, with new menu items and a focus on more healthful fare and breakfast. The chain added premium coffee to its menu in China to lift sales.

Yum is also working to share information from regions like the United Kingdom and Russia, where sales are strong.

“The recovery is taking longer than we’d like,” Creed said. “We’re 100-percent committed to recovering unit volumes in China. We must innovate our way to recovery.”

Contact Jonathan Maze at [email protected].
Follow him on Twitter: @jonathanmaze