Exclusive -- Yum! Brands Exec: Here's What Happened in China

By Steve SymingtonFool.com

Yum Brands' recovery in China continues, but at a slower-than-expected pace. Source:Yum! Brands.

Yum! Brands just reported third-quarter 2015 results, and the market couldn't spit out shares of the fast-food juggernaut fast enough.

Continue Reading Below

The stock fell more than 17% in Tuesday's after-hours trading, after it revealed that quarterly revenue rose just 2.2% year over year to $3.43 billion, which translated to a 14% increase in adjusted earnings to $1.00 per share. Analysts, on average, were expecting adjusted earnings of $1.07 per share on significantly higher revenue of $3.68 billion.

So what happened? In a word: China.

Specifically, in a prepared statement, Yum! CEO Gregg Creed noted that while the company's "growth fundamentals in China, including new-unit development, remain intact [,] we're experiencing unexpected headwinds, making the second half of the year more challenging than we anticipated."

"We've had a combination of two things ..."To get a better idea of what those headwinds are, I took the opportunity to speak on the phone with Yum! Brands Senior VP Jonathan Blum shortly after the release hit the wires. Blum explained:

On one hand, Blum declined to elaborate on exactly what those marketing missteps were. But he did say the company would delve into more detail in its earnings conference call tomorrow morning.

On the other hand, Yum! is hardly the only U.S.-based business to suffer from widely known macroeconomic headwinds in China. And it's unsurprising that the casual-dining space would be hardest hit by these headwinds. China Division same-store sales grew 2%, including a 1% decline at Pizza Hut Casual Dining locations, and 3% growth from the more fast-food-centric KFC chain in the country. Combined with 7% new restaurant growth, China Division system sales ultimately rose 8%.

It's not all badThat's not to say all of Yum! Brands' report was disappointing. Outside China, the Taco Bell division continued outperforming, with system sales up 7%, helped by 3% unit growth and 4% same-store-sales growth. Taco Bell's operating margin fell 0.1 percentage points to 28% but still achieved the highest margin of any Yum! Brands division.

Source: Wikimedia Commons.

Meanwhile, the KFC Division built on last quarter's momentum, with system sales up 6% on a constant currency basis, including 3% unit growth and 3% same-store-sales growth. KFC operating profit increased 3%, as operating margin fell 0.2 percentage points to 21.7%. All told, Blum says, KFC has enjoyed a solid performance all around the globe, particularly with a 45% increase in same-store sales so far this year in Russia (which comprises 25% of KFC system sales), and a 9% year-to-date same-store-sales increase in Australia, where KFC generates 10% of its sales.

Finally, Yum!'s Pizza Hut division outside China continued to lag, with system sales up 2%, including 2% unit growth and 1% same-store-sales growth. Pizza Hut's operating margin decreased 0.7 percentage points to 25.4%, and operating profit remained roughly flat on a year-over-year basis. According to Blum on our call, the Pizza Hut team "continues to aggressively work to turn the business around," and the key continues to be creating awareness of Pizza Hut's recent brand revamp and menu overhaul, both of which have enjoyed relatively positive consumer reactions in the brand's highly competitive space.

The way forwardBlum elaborated, however, that the China weakness primarily surfaced in the last few weeks of the third quarter and continued into the fourth quarter so far. As a result, and combined with incremental negative effects of foreign exchange, Yum! Brands now expects to 2015 EPS growth to be "well below" its previous target of at least 10%.

To its credit, Yum! attempted to minimize the sting by approving a 12% increase in its quarterly dividend to $0.46 per share and will now target a payout ratio of 45% to 50% of annual net income. I still like Yum! Brands' prospects over the long term, and think investors should be encouraged that the recovery continues, even if at a slower pace. But for now, given this quarterly miss and the market's general impatience, it's no surprise that Yum! Brands stock was being punished today.

The article Exclusive -- Yum! Brands Exec: Here's What Happened in China originally appeared on Fool.com.

Steve Symington has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.