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Yum! (US) Faces Challenges in China as Growth Slows

06 Oct 2011 - One place where China isn't slowing is in its appetite for fast food.

Amid growing jitters over the health of the world's second-biggest economy, along comes global restaurant giant Yum Brands with its fiscal third-quarter earnings report due after the closing bell Tuesday.

Yum?owner of restaurant chains including KFC, Taco Bell and Pizza Hut?may seem the quintessential American company.

In fact, the biggest chunk of its operating profit now comes from China. Hence, its results offer a timely read on the health of that nation's emerging consumer class.

One thing is certain: The Chinese consumer has more of a pulse than the American one these days. Morgan Stanley estimates sales at Yum locations open a year or more in China will be up 12% year on year during the August quarter.

In the U.S., meanwhile, sales are expected to fall nearly 3%. Of course, fast food is still relatively new to China whereas the U.S. market has long been saturated. Still, the American consumer is broadly in retreat whereas the Chinese one is just beginning to assert himself.

That isn't to say Yum's continued success in China is guaranteed. There are challenges ranging from food and wage inflation to health concerns among the Chinese public.

There is growing worry the country may be headed for a "hard landing," fueled by a correction in its red-hot property sector after a period of rapid, stimulus-induced economic growth.

Despite all this, however, the Chinese consumer seems a much better long-term bet than his beleaguered counterpart in the developed world.

A staff member serves customers at a Yum! Brands Inc. KFC restaurant in Beijing last year.

Currently, Yum has about 4,000 locations in China that generate just over 40% of its total operating profit. By comparison, China generated only 16% of Yum's profit as recently as 2005, according to BofA Merrill Lynch.

Meanwhile, Yum's U.S. profit share has collapsed from 57% to an estimated 26% for fiscal 2011. The international ex-China division, which it is steadily steering towards emerging markets, accounts for the rest.

Yum isn't just the most prolific Western chain in China today, it also plans to expand its restaurant count there fivefold in the years to come.

No wonder investors assign such a high premium to this business?roughly 30 times estimated fiscal 2012 earnings per share, compared with just 10 times for the U.S. segment.

The Chinese consumer just has to deliver.