Local firms vie for Yum's slice of the China market

Fri Feb 3, 2012 12:51am EST

* Investors eye China ops as Yum reports Q4 earnings on Mon

* Yum aims to open 600 stores in China in 2012

* China to account for 50 pct of global revs in 2012-Credit Suisse

By Terril Yue Jones

BEIJING, Feb 3 (Reuters) - Four floors up overlooking the bustle of the cavernous Joy City Mall in Beijing, diners take a break from shopping to slurp noodles and nibble on dumplings at an Ajisen restaurant.

It's an increasingly common sight: Chinese consumers turning to local fast-food alternatives to the long-dominant pair in China -- Yum Brands Inc's KFC and McDonalds Corp .

Twenty-five years after Yum introduced China to American-style fast food with its first fried chicken store, the two U.S. giants are facing a plethora of Chinese and Asian eatery chains that are steadily munching away at their market share.

As Yum prepares to announce fourth-quarter earnings on Monday, some investors are eyeing its China operations warily. Last week saw a flurry of put options on Yum after McDonalds reported earnings and said foreign exchange fluctuations and other factors could eat into profits in 2012. [ID: nL2E8CPDU5]

But Yum's China business seems robust. The company said on Dec. 5 that it expects a benefit of $40 million this year from yuan-dollar exchange rates, while operating profit in China is expected to grow 15 percent. It plans to open 600 more locations in China in 2012 at a pace of more than one every day.

China accounted for 36 percent of Yum's global revenue in 2010 and is estimated to be 44 percent in 2011 and 50 percent in 2012, according to Credit Suisse.

Yum's biggest challenge comes from a rising torrent of competition as Chinese consumers increasingly have more money to spend and more places to spend it, which could mean slowing growth rates for Yum in the future.

At the Ajisen outlet, stacked above a Starbucks coffee shop and a Burger King restaurant, shoppers headed in and out all afternoon.

"We were just browsing, and stopped here by chance to eat," said Sun Haihao, 30, an engineer from Sichuan province who was visiting Beijing.

He's been to Ajisen, a Japanese-style restaurant run by Ajisen (China) holdings Ltd and KFC in Mianyang city where he lives. "KFC can be too oily," Sun said. "Ajisen is Asian, so we're used to it."

GROWTH OUTPACES CHINA'S GDP

A recent Reuters poll showed that economists expect China's GDP to grow 8.4 percent this year, down from 9.2 percent in 2011. Meanwhile the quick-service restaurant industry is expected to grow around 15 percent, meaning further revenue growth for Yum and McDonalds, even as their market share declines, according to market research firm Mintel.

"KFC and McDonalds are growing outlet numbers, but so are domestic and foreign chains plus independents," says Paul French, Mintel's chief China analyst. "The pie is bigger, but the number of players wanting and getting a slice of it are bigger too. A rising tide does not necessarily raise all boats."

Ajisen is among the legion of upstarts, which include fellow Japanese entrant Yoshinoya ; Taiwan-owned Dico's restaurants and 85 Degrees Bakery; Burger King, Dairy Queen and Papa John's Pizza from the United States; South Korean-owned Paris Baguette and Tous Les Jours bakeries; and a host of Chinese chains such as Golden Jaguar, Yonghe King and Country Style Cooking.

Many are growing fast, albeit from a smaller base. Ajisen (China) reported a boost in first-half restaurant income last August of 40.8 percent to HK$1.6 billion ($206 million).

Country Style Cooking, a family-style chain offering casual cuisine and focused on western China, increased its locations by 63 percent in 2011, according to China Market Research. Meanwhile, the number of all of Yum brand restaurants in China last year grew 13 percent.

SUCCESS STORY

Louisville, Kentucky-based Yum, whose restaurants in China also include Pizza Hut, East Dawning and a stake in Little Sheep, plus Taco Bell and others in the United States, has had remarkable success in China.

It was the first foreign fast-food restaurant chain to set up business here, opening a fried chicken outlet in Beijing in 1987. Today it is by far the largest with nearly 3,500 KFC locations across China, and more than 4,200 restaurants in all, well ahead of McDonalds' 1,400 locations.

"KFC restaurants are more profitable than any of its competitors and generate about four times as much revenue per restaurant as its U.S. locations," says James Roy, senior analyst at China Market Research, a Shanghai-based consultancy. "No other competitor can come close to adding the number of restaurants per year it can," Roy said.

Yum itself said at the end of the third quarter, "We consider China to be the greatest restaurant opportunity of the 21st century."

Yum executives were not available to comment further because of the regulatory quiet period before the earnings announcement.

Yum's 2011 China revenue to be announced on Monday is expected to rise 23.3 percent, a slower pace from 32.6 percent a year before, according to Credit Suisse.

But China is Yum's growth engine. The company's chief executive, David Novak, said in December that he expects China to lead global profit gains, projected to be up 13 percent for 2011 "despite our disappointing U.S. results" and up 10 percent for 2012, excepting special items.

Rising affluence of the Chinese consumer is behind China's flourishing casual dining market, according to Yuval Atsmon, a Shanghai-based consultant with McKinsey & Co.

"Look at the population of the upper middle class with an income of more than 100,000 RMB ($15,800) a year. It's now 15-20 million households, but it will be over 75 million households in five years," Atsmon says.

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