×

Yum's China missteps amplify calls for spinoff, other change

KFC
Getty Images

Yum Brands' disappointing results from restaurants in China including KFC and Pizza Hut add pressure on Chief Executive Greg Creed to make swift changes to the business that is its main driver of sales and profit, analysts said on Wednesday.

Yum shares sank as much as 19.3 percent on Wednesday, a day after the company shocked investors by cutting its forecasts due to weakness in China.

While China's economy is cooling, Yum management also blamed internal missteps at its upscale Pizza Hut Casual Dining chain.

The results come as hedge fund Corvex Management is urging Yum to spin off its 6,900-restaurant China business and prompted new calls for Creed to adopt a fresh strategy. Corvex did not respond to requests for comment.

"The stock is saying people are giving up on Yum. It will not change until management changes its strategy," said Hedgeye Risk Management analyst Howard Penney. At least six brokerages cut their stock price targets on Yum. Notably, Stifel went to $100 from $110 and Nomura to $82 from $106.

Shares in Yum closed at $67.71, slightly above their session low of $67.20.

Penney and other analysts say the China stumble gives proponents of a China spin-off more ammunition. Some also are calling on Yum to slow new restaurant development in China and to start selling existing units there to franchisees.

"Spin off China, sell stores, do something," Penney said.

Creed took the helm of Yum on Jan. 1 after leading a successful revamp of the company's Taco Bell chain. He was charged with turning around the China business, where sales have slumped since news in July 2014 that one of its suppliers used meat that was past its expiration date.

He declined to comment on any strategic changes during a conference call with analysts and investors on Wednesday.

Read MoreEarnings edge: Can the colonel fry up gains?

"We continue to believe in China," Creed said, adding that the country remains the world's fastest-growing major economy.

J.P. Morgan analyst John Ivankoe said now is an ideal time for Yum to adopt a lower-risk strategy for China, which in the last three years has been whipsawed by two food safety scandals and multiple marketing missteps.

Among other things, an independent Yum China would pay a more predictable royalty to the company and allow Yum to take lease obligations off its balance sheet, he said.

"Some spin-offs are done from a position of strength, but this one may be done from a position of weakness," Ivankoe wrote in a client note.

Creed said newly appointed management for the China business would bring fresh ideas and double down on profitable value meals to lure diners shocked by recent financial turmoil in the country.

China's Pizza Hut Casual Dining chain was hit particularly hard during its latest quarter as local businesses cut back on parties and events. Competition from online ordering companies that are operating at a loss also contributed to weak sales.

That business accounts for one-third of profits from the China division, which is dominated by the KFC brand.

Read MoreKFC parent plunges 18% after key China metric miss

Making matters worse, executives said Pizza Hut Casual Dining was promoting a premium-priced steak dish as the China economy softened. Going forward, Creed said the chain will refocus on value offerings such as pizza, pasta and chicken wings.

Yum China contributed 57 percent of the company's overall revenue and 54 percent of its $603 million operating profit in the latest quarter. Yum executives stood by plans to add about 700 new restaurants in China this year.

Nomura analyst Mark Kalinowski called for Yum to spin off its mostly U.S. Taco Bell brand, to divest small brands such as China's Little Sheep hot pot chain and to cut costs meaningfully.

"We believe this disaster of an earnings release could - should! - serve as the crystal-clear call to action Yum Brands needs to shake up the company," Kalinowski wrote in a note to clients.