Food & Beverage

Yum China faces menu, reputation, tech challenges, analysts warn

Yum's challenges in China

Shares of the newly spun-off Yum China rallied on their first day of trade but strategists warn of dark clouds ahead amid a plethora of problems over the company's growth outlook.

Yum China is now a licensee of its parent company, Yum Brands, after activist investors waged a campaign over the latter's direction in the world's number-two economy, prompting Yum Brands to finally agree to spin off its Chinese operations. KFC, McDonald's, Pizza Hut, Little Sheep Mongolian Hot Pot and East Dawning make up Yum China's brand portfolio, with over 7,300 combined locations in more than 1,100 cities.

For the third quarter, the Chinese division of Yum Brands reported a 1 percent drop in same-store sales, against Wall Street's expectations of a 4.5 percent rise. But Micky Pant, CEO of the Chinese unit, told CNBC that the numbers were a blip ahead of the separation.

Shares closed up 8 percent on Monday but reputation, changing consumer preferences and the Yum menu itself were among the key areas of concern for analysts.

A KFC restaurant on Qianmen street, Beijing, China.
Zhang Peng | Light Rocket | Getty Images

"The challenge is to stay in front of the consumer and keep a positive brand image, which has been challenging given supply-chain issues and poultry sourcing scandals in the past," Brian Nelson, president of equity research and ETF analysis at Valuentum Securities, told CNBC's "The Rundown."

In 2012, KFC was supplied with chicken that contained excessive amounts of antibiotics and in 2014, the fried chicken brand and McDonald's were found to be selling tainted meat.

Moreover, fast food had lost some appeal for the increasingly sophisticated Chinese middle class, explained Bob Boyce, founder of Shanghai-based restaurant Blue Frog Bar and Grill.

"Consumers are looking at Yum, KFC, as a quick meal, from a convenience standpoint. I wouldn't say it's very aspirational these days," he said.

Pant, who is now CEO of the spun-off business, has said he planned to compete with home-grown businesses by betting on new food offerings. Analysts noted that tailoring menus to local tasts was a well-known ploy to win over Chinese consumers but with curry rice bowls and Peking duck wraps already available from KFC, some questioned whether there was more Yum could do on that front.

Why this analyst disapproves of Yum Brand's China spin-off

"The menu has been so localized, you already have congee and mooncakes. It's already so localized, I have no idea how he [Pant] can he further localize it," Junheng Li, head of research at JL Warren Capital, told CNBC's "Squawk Box."

In fact, she said the challenges were so great that Yum Brands should have abandoned the spin off. "I think it would make more sense for Yum to sell its China business to a local firm and then buy a stake in that firm."

For now, technological innovation could be the key to Yum China's success.

"When KFC got into delivery, it used to be the only game in town. But now with smartphone apps, it brings to the home any restaurant in the market at any price range," he pointed out. "Now there is hyper-competition, so any one restaurant can compete with the big boys."

Yum China could stay ahead if it focused more on orders from smart devices, including mobile and tablets, as opposed to "walk-ups," Nelson agreed.

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