Food Supplier Scandal Rocks U.S. Fast Food Chains in China

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Images Of McDonald's Corp. And Yum! Brands Inc. Restaurants As Supply Chain Scare Hurts Results
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Like many other business sectors, big fast food is -- or at least was -- thriving in China. China is a tough market, with stiff competition from Western rivals and local chains and several recent food supply scandals.

The latest controversy erupted this past July, but its effects are lingering. A TV report showed workers at Shanghai Husi, a supplier owned by privately held American concern OSI Group, using meat past its expiration date as well as scraps that had fallen to the factory floor.

Shanghai Husi clients Yum! Brands' (YUM) KFC, McDonald's (MCD), Burger King International (BKW) and Papa John's International (PZZA) were quick to distance themselves.

The scandal even touched Starbucks (SBUX). The coffee giant said that although it's not directly a Shanghai Husi client, some chicken used in one of its sandwiches was purchased from a different supplier but originated from the offending company.

Yum? Yuck!

Yum! Brands says it sourced only a small percentage of its meat from the company; nevertheless, it halted all of its orders from Shanghai Husi and issued a formal apology to its customers.

But that doesn't seem to have been enough. At the end of July the company warned that the ugly news was having a "significant, negative impact to its China operations." Indeed, its China division same-store sales cratered by 14 percent on a year-over-year basis in its most recent quarter, a fall the company attributed directly to the controversy. This was in sharp contrast to the 15 percent increase in the previous quarter.

Investors aren't encouraged. At the moment, Yum! Brands' stock trades at just over $69 per share, or roughly $10 below the year-to-date peak it hit before the scandal broke.

Let's Stick to the Local Cuisine

The impact to McDonald's reverberated since Shanghai Husi supplied around 20 percent of the Chicken McNuggets in Japan.

As with Yum! Brands, controversy is very bad for business for McDonald's. The company just reported its third-quarter results, in which global same-store sales dropped by 3.3 percent on a year-over-year basis. The Asia-Pacific, Middle East, and Africa region saw a queasy 9.9 percent fall during the month. The company attributed this to what it termed the "supplier issue."

McDonald's stock stumbled in the wake of the Shanghai Husi scandal, and it's yet to recover. At the beginning of July, it traded comfortably above $100 per share; these days it's floating barely above $90.

Food Fatalities

Shanghai Husi is far from the first food supply scandal that has rocked China. In 2008, a horrifying series of incidents saw tainted baby formula supplied by a company called Sanlu cause the deaths of six infants. Around 300,000 others were made ill by the products.

Giant American retailer Walmart (WMT) has besmirched its name in China more than once over the past half-decade due to its food misadventures. In 2011, it made headlines for the wrong reasons for keeping duck meat on its shelves past the date of expiration. This past January, it recalled donkey meat -- eaten as a snack by Chinese consumers -- sold at several stores following revelations that some of it was made from other animals like fox.

Great Wall

China, with its massive population and seemingly ever-growing economy, is a valuable market for any business. But it presents obstacles and challenges not present in more mature, developed markets. In spite of government efforts to police the nation's food producers more thoroughly, bad stuff continues to make its way into the market, and companies act dishonestly about their wares. If the situation doesn't change, both China's mass of consumers and the American restaurant chains helping to feed them will keep suffering the ill effects of that misconduct.

Eric Volkman has no position in any stocks mentioned. The Motley Fool recommends McDonald's and Starbucks. The Motley Fool owns shares of Papa John's International and Starbucks. Try any of our Foolish newsletter services free for 30 days. To read about our favorite high-yielding dividend stocks for any investor, check out our free report.
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