China food scandal takes bite out of Yum

New setbacks by Yum and Metro underscore the challenges the foreign firms face in the China retail market due to stiff local competition and the potential for food scandals

PUBLISHED : Wednesday, 09 January, 2013, 10:57am
UPDATED : Wednesday, 09 January, 2013, 10:57am

Two news items from the retail space are showing how China remains a challenging and competitive market despite its huge potential, with KFC operator Yum Brands (NYSE: YUM) and German retailer Metro (Frankfurt: MEO) both suffering setbacks for different reasons. In Yum's case, the company is quickly discovering the meaning of the word "saturation", as its rapid expansion in China has forced it to open restaurants in less profitable locations that are ultimately hurting its performance. Adding to its woes, KFC recently found itself at the center of China's latest food safety scandal, which I'll discuss shortly. In Metro's case, the company simply discovered that the Chinese retail market is quite competitive, especially in the electronics space where Metro was trying to find a niche in a partnership with the consumer products unit of Taiwanese manufacturing giant Hon Hai (Taipei: 2317).

Let's start off with the Yum news, which had the operator of KFC and Pizza Hut restaurants saying that its Chinese same-store sales fell six per cent in the fourth-quarter, a bit worse than the already downbeat four per cent drop it had previously forecast about a month ago. Yum blamed the worse-than-expected drop on negative publicity during the last two weeks of December, when Chinese media reported that chicken from one of KFC's suppliers contained excessive levels of antibiotics. 

Yum shares had been on a rally for the last 12 years, rising more than eight-fold over that period before a recent sell-off, due in large part to the huge China growth story. But the company's stock is proving that the old saying "what goes up must come down" is still true. Yum shares are down 12 per cent since its first warning in early December, including a four per cent decline after its latest warning.

Frankly speaking, the kind of food safety scandal that led to this latest sales drop for Yum has become all too common in China these last few years, and the effects of such scandals usually do only last for a few weeks before business returns to more normal levels. But there's no doubt that Yum's days of heady China growth based on its KFC expansion do appear to be largely in the past now, and the company will need to develop some of its other brands and products if it wants to reignite investor excitement based on the China story.

In the meantime, let's take a quick look at the Metro news, which has foreign media reporting the German company wants to scrap expansion plans for its retailing joint venture with Hon Hai's Foxconn Technology, which sells electronics under a chain of stores called Media-Saturn. There doesn't appear to be any final decision yet, but the reports say that Metro favors ending the expansion plan after discovering the China market was more difficult than it expected.

I'm not at all surprised by this development, which would follow the high-profile closure of China-based Best Buy (NYSE: BBY) electronics stores in China two years ago. I was never convinced that Foxconn was a very good partner for Metro when the two sides announced the tie-up in 2010, as Hon Hai has always been a strong manufacturer but has never been able to develop strong consumer brands despite a long-term effort in that direction.

What's more, China's electronics market is already dominated by Gome (0493.HK) and Suning (Shenzhen: 002024), two massive chains that have incredible muscle in the market. These latest reports indicate only that Metro wants to halt a planned expansion of the Media-Saturn stores, which currently number at seven. But I wouldn't be surprised to see Metro completely scrap the joint venture completely in the next year or two, as it seeks to pare its losses in market.

Bottom line: New setbacks by Yum and Metro underscore the challenges the foreign firms face in the China retail market due to stiff local competition and the potential for food scandals.

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