China Food Safety and Poor Earnings Put These Consumer ETFs in Focus - ETF News And Commentary

It seems that the food safety issue will not leave

and

so easily as the duo would hope. These chains, especially Yum! Brands, have been slammed with serious allegations over food safety in China in recent days.

Just as Yum's China business started to gain strength after suffering negative publicity regarding the quality of chicken supplied to KFC China in December 2012, the chain again got trapped in a food-safety scandal in China on July 21. Another restaurant bellwether McDonald's, also faced the same allegation.

The latest charge was related to supplier Shanghai Husi Food Co Ltd, a unit of U.S.-based OSI Group LLC, which sold expired meat to the two quick-food chains, as per

. McDonald's Holdings Co (Japan) acknowledged sourcing almost one fifth of its Chicken McNuggets from the supplier and confirmed that it had stopped the sale of this product on Monday.

The agency also noted that, on July 22, Starbucks confirmed selling Shanghai Husi-supplied chicken items at some of its outlets earlier. Shanghai Husi was closed by local controllers as its staff was shown using expired meat and mixing fresh meat with that which had fallen on the floor in a TV report. 

China plays a pivotal role in Yum!'s growth story. After contributing immensely to Yum! Brands' growth in the recent years, the China business ─ accounting for more than double its U.S. revenues ─ started faltering since fourth-quarter 2012 – on food safety concerns.

In December 2012, China's state television, CCTV had reported that two poultry farms in the Shandong province of China had supplied chicken fed with unapproved levels of antibiotics to KFC and McDonald's (read:

).

Although Yum! reiterated its commitment toward ensuring food safety and assisted the government in the investigations, the shaken consumer confidence over the brand due to the whole incident continues to mar the company's performance in China. It was only in the first quarter of 2014, when Yum! was finally able to post an 11% increase in comps at KFC China after a prolonged struggle.

McDonald's and Yum!'s Pizza Hut have cut off ties with Husi and stopped selling

that were made with meat supplied by the company. The chains have also agreed to help in investigation and strictly comply with consumer safety regulations. However, we feel that the damage has already been done, especially considering this isn't the first such incident.

If the food safety scare was not threatening enough, McDonald's missed the Q2 Zacks Consensus Estimates on both lines back-to-back this year. Though its adjusted earnings of $1.40 per share in the second quarter of 2014 (reported on July 22) nudged up 1.4% year over year, it fell short of the Zacks Consensus Estimate of $1.43 by 2.1% (read:

).

Revenues too missed the Zacks Consensus Estimate of $7.29 billion by 1.5%, probably to reflect a decline in comps in the U.S. and Europe. However, revenues saw just 1.4% growth from the year-ago level. Global comps were flat in the quarter thanks to lower footfall. The company expects to post negative comps for the month of July.

Yum! too put up a boring show in 2Q. Its adjusted earnings of $0.73 per share and revenues of $3.20 billion merely matched the Zacks Consensus Estimate. Though the numbers leaped year over year, this was the result of easy comparisons, in our view.

U.S. remained the weak spot for both eateries as evident by a decline in comps. In any case, despite showing signs of recovery, Yum!'s China business was still not out of the woods, given the economic slowdown in the nation.

On the other hand, McDonald's appears to have fallen from its previous grace as this burger behemoth has been dragging its feet for quite some time now thanks to heightened competition in the U.S. and deceleration in key markets. Amid such a situation, a food safety issue in this key market is likely to create a great deal of trouble for these restaurant companies.

As expected, the market reacted harshly to these issues. Yum! fell 4.95% on July 21 following the food scandal while McDonald's shed 1.45%. Not only are these eateries under investigation, the entire restaurant industry took a hit on July 21.

retreated 1.58%,

was off 0.42% and

was down 0.81%.

Notably, Yum! has fallen out of favor since it reported Q2 earnings on July 16. Since then, the stock fell about 10% (as of July 22). McDonald's dropped 1.31% following its earnings miss. Amid such a situation, while stock pick will not definitely be an option, investors could also avoid the ETFs having considerable weight in the afore-mentioned stocks.

McDonald's takes up the fifth spot with 4.69% allocation in

(

) while SBUX gets a 2.82% allotment. Yum! too has little presence in XLY.

(

) assigns a respective of 3.6% and 2.1% of assets in MCD and SBUX (read:

).

Each fund has about 10% share in the restaurant industry. XLY and VCR lost 0.46% and 0.55% following the China news but added about 0.42% and 0.52% on July 22 probably to reflect easing tension in global markets. Notably, both have a Zacks ETF Rank #4 (Sell) so we may continue to see pain in these products in the months ahead (read:

).

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