Yum, Li Ning Take Shine Off Retail

By newsdoug on August 14, 2013

Traditional retailers are taking a hit recently, with fast-food operator KFC and sporting goods seller Li Ning (HKEx: 2331) the latest to report disappointing results due to a complex series of factors. KFC is suffering from a number of company specific issues, combined with residual effects from China’s slowing economy and fallout from a bird flu outbreak earlier in the year. The picture looks more grim for Li Ning and other traditional non-restaurant retailers, which are fighting a losing battle against fast-rising e-commerce firms.

The bigger story is that traditional Chinese retailers may never return to their heady growth days of years past, as competition remains fierce and e-commerce poses a growing challenge. If I were a betting man, I would strongly advise investors to stay away from any traditional retailers without a strong e-commerce strategy. Even retailers with a strong e-commerce component, such as Suning (Shenzhen: 002024) or Walmart (NYSE: WMT), could face a difficult time as they battle for share with pure e-commerce plays like Alibaba and Jingdong.

The difficulty in traditional retailing was on display over the last week when British giant Tesco (London: TSCO) announced it was pulling back from China by rolling its local stores into a joint venture with partner China Resources Enterprise (HKEx: 291). (previous post) Now KFC’s parent Yum (NYSE: YUM) is adding more downbeat news to the mix with its announcement that same-store KFC sales in China slid 13 percent in July, bigger than an estimated 10 percent drop in June and well ahead of market expectation for a 7.1 percent decline. (English article)

The size of the drop surprised industry watchers who were expecting KFC’s same-store sales to slowly improve after tanking earlier this year during a bird flu outbreak. At the height of the outbreak in April, KFC’s same store sales tumbled 36 percent. (previous post) KFC has also been suffering some image problems dating back to a food safety scandal late last year, when media reported that some of the chain’s chickens contained excessive levels of antibiotics.

While it’s easy to blame one-time factors like food scandals and bird flu for Yum’s woes, I’ve been forecasting this kind of a slowdown for the company for more than a year now. The reasons are simple, namely that the market is becoming saturated with KFC and new rivals with better food choices are also expanding aggressively. While Yum’s same-store sales growth should probably return to positive territory by the end of this year, I wouldn’t expect it to re-enter double digit growth anytime soon.

Next let’s quickly look at Li Ning, which is trying to put a positive face on its latest earnings that show it lost a 184 million yuan ($30 million) in the first half of this year. (English article) Investors didn’t seem too excited by the fact that the loss was less than expected or the company’s proclamation that its recent restructuring was yielding positive results, with Li Ning shares slumping nearly 6 percent after the latest earnings came out.

Private equity firm TPG paid nearly $100 million last year for Li Ning convertible bonds that could ultimately give it a 12 percent stake in the company, and is now trying to help turn around the company. That buy-in looks similar to Bain Capital’s purchase through another convertible bond of about 10 percent of Gome (HKEx: 493), a similar fast-fading retailer, back in 2009. If I were a gambling man, I would bet that TPG will never convert its debt to Li Ning shares, and that Li Ning’s downward slide will continue. At the end of the day, Chinese consumers are just becoming too fond of e-commerce to give these mass-scale traditional retailers the room they need to survive and thrive over the long term.

Bottom line: KFC is unlikely to return to double-digit same store sales growth in China over the next 18 months, while Li Ning will continue to struggle due to competition from e-commerce.