China challenges persist as Yum spinoff nears

As Yum Brands Inc prepares for the spinoff of its China division later this month, investors want assurances that KFC and Pizza Hut restaurants can overcome challenges after the chain stumbled in its top growth market.

Yum opened its first KFC in China near Beijing's Tiananmen Square in 1987, beating major rivals to the country, where it is the biggest Western restaurant operator with more than 7,300 stores.

The company, which is hosting its annual investor meeting in New York on Tuesday, said an independent China business has the potential to triple the number of restaurants there over the long term. The spinoff is set for Oct. 31.

But Yum China's once-predictable growth has been called into question as it has grappled with internal and external challenges in recent years. Those include marketing blunders, rising competition, bird flu outbreaks, food safety problems and slowing economic growth.

Earlier this month, executives blamed anti-U.S. protests sparked by political tensions in the South China Sea for a surprise 1 percent drop in sales at established China restaurants during the latest quarter.

While the sales were still down "modestly" during the quarter that started Sept. 1, executives said they would return to positive territory.

The company said the protest has not caused lasting harm to the brand, a feeling echoed by Wu Zhenqi, 24, a customer who works in the financial industry in Shanghai.

"I already don't see much anti-U.S. sentiment (toward it) or get that sort of feeling from other people either," he said.

Yum Brands Chief Executive Officer Greg Creed said investors Primavera Capital and Alibaba Group Holding Ltd affiliate Ant Financial, which will buy a $460 million stake in Yum China, would give the company a competitive advantage with local market knowledge and digital expertise. Among other things, Ant's popular Alipay service has been increasing its reach in the country's restaurant industry.

Analysts say KFC, which accounts for roughly 70 percent of Yum's restaurants in China, still has plenty of room to add new units but suggest it may have a limit lower than the company's long-term target.

China has about KFC 4 stores per million people and its level of "Peak KFC," or restaurant penetration, is likely to be equal to Japan's at 9 stores per million people, rather than the 13 stores per million people in the United States, Bernstein Research analyst Sara Senatore said in a recent note.

Yum shares rose 3.1 percent to $90.12 in early trading on Tuesday.

(Reporting by Lisa Baertlein in Los Angeles; Additional reporting by Shanghai newsroom; Editing by Jeffrey Benkoe)