Looking to Invest in China's Fast Food Industry? Try KFC

Spurred to high growth by changing eating habits, rising consumer incomes and fast-growing cities, China's fast food industry presents a tantalizing opportunity for investors. However, while investing in China has become easier in recent years, Chinese markets remain opaque to most Western investors due to differences in language, accounting and reporting standards, and other factors.

Fortunately for those who want a piece of the Chinese fast food industry, market exposure is available to investors through Yum Brands Inc. (YUM). Yum Brands' subsidiary KFC ranks as the largest fast food brand in China, with more than 4,800 locations in about 1,000 Chinese cities.

Industry Outlook

China is home to more than 1.3 billion people in the midst of a decades-long economic boom that has raised more than 600 million people out of poverty, according to World Bank statistics. Urbanization in the country is expected to continue at breakneck speed, adding 300 million additional people to Chinese cities in the next 15 years to create a total urban population of about one billion people by 2030. As lifestyles change and incomes rise among Chinese urbanites, so too does the demand for fast food.

In the five years ending in 2014, the Chinese fast food industry grew at an average rate of

12.4% per year. In comparison, the mature U.S. fast food industry grew at an annual rate of only 2.5%. While the U.S. industry is more than twice the size of the Chinese industry as of 2015, urbanization and income trends promise continued fast growth in China for the foreseeable future.

KFC in China

KFC is one of America's most iconic fast food restaurants. It has also become an icon in China. The first KFC branch in the country opened its doors in Beijing in 1987, becoming the first international fast food restaurant to operate in China. In the years since, KFC has grown to become the largest fast food chain in the country by far, with more than twice as many locations as any other competitor. During the four years ending in 2014, Yum Brands added nearly 1,600 new KFC locations in China. It expects to maintain the high rate of expansion in 2015, with plans to open a total of 700 new locations between its KFC and Pizza Hut operations.

KFC has experienced and overcome many challenges during its years operating in China. Two recent controversies highlight the challenges KFC currently faces as it works to maintain high quality standards while continuing its rapid expansion. In late 2012, accusations against KFC chicken suppliers in China led to a near-immediate drop in same-store sales across the country as customers looked to avoid chicken tainted by growth hormones, antibiotics and other reported chemicals. Just when it looked like KFC had put that scandal behind it, posting same-store sales growth of 15% in the second quarter of 2014, another food-safety scandal erupted in July of that year linked to the repackaging of expired meat by a KFC supplier. Same-store sales turned negative again, with a 12% decline in the first quarter of 2015 and a 10% decline in the second quarter.

Despite these recent troubles, KFC continues to bring in profits in China. Yum Brands' China division posted a 14.6% restaurant margin and an 8.8% operating margin in the second quarter of 2015, even in the face of a 10% drop in sales. The company remains on pace to meet its expansion target for 2015. To help speed up the return to same-store sales growth, KFC is planning to revamp its menu and refocus on food innovation in China to boost sales across breakfast, lunch, dinner and beverage categories. Further innovations in mobile ordering and customer engagement are expected in 2015 as well.