TEXT - Fitch says China food safety concerns could taint profits
Feb 6 - Fitch Ratings anticipates weak same-store sales (SSS) performance in China for YUM! Brands (YUM) and McDonald's Corp. (McDonald's) in early 2013 due to lingering effects from the antibiotic-related food scare for chicken at the end of 2012. We also believe growing pressure around food safety in China will add to the cost of operating in the country but expect both YUM and McDonald's to manage their supply chains effectively. Due to YUM's extensive presence in China, with 5,275 units versus about 1,720 for McDonald's, and the prominence of chicken on KFC China's menu, the impact of negative publicity surrounding China's poultry supply has been greater for YUM than McDonald's. We rate McDonald's 'A/Stable' and YUM 'BBB/Stable' and continue to view expansion into faster growing emerging markets positively, given the maturity of the U.S. market. We expect modest monetary and public-investment stimulus to support China's GDP growth of about 8% in 2013. Negative rating actions for YUM or McDonald's solely in response to near-term challenges in China are not anticipated as both firms generate significant cash flow and are funding expansion with internally-generated funds. Late Monday, YUM confirmed its anticipated 6% decline in China SSS during the fourth quarter and guided for a 25% decline in China SSS for January and February combined. Based on the firm's internal intelligence, YUM expects SSS to gradually improve through the year and turn positive during the fourth quarter. The firm projects a mid-single digit decline in China SSS for the full 2013 year to result in a corresponding mid-single digit decline in earnings. McDonald's also indicated that heightened consumer sensitivity related to the antibiotic issue negatively affected SSS in January. While not publicly disclosed, we believe the impact to McDonald's was not as great as that of YUM during January. McDonald's SSS in China declined just 0.9% during the fourth quarter of 2012. YUM expects restaurant margins in China to decline to the mid-teens range in 2013, down from 18.1% for 2012. The decline is being attributed to traffic trends and not an increase in food, labor, or other restaurant expenses. YUM continues to expect mid-teen labor and 3% commodity inflation in China during 2013 but is launching a comprehensive quality assurance program with its chicken suppliers following the Chinese New Year in February. For additional information see: "Fitch: YUM's Ratings Not Immediately Impacted by China Weakness," Feb. 5, 2013. "Scenario: China Rebalanced - What a Rebalanced China Would Mean for Corporates," Jan. 24, 2013. "2013 Outlook: U.S. Restaurants - Intensifying Competition, Food Inflation and Legislation to Drive Operating and Financial Strategies," Dec. 19, 2012.