Yum! Buyback Levitates Shares, But Chicken Is Off The Menu In China

Yum! (YUM) stock should be falling through the floor. For a company whose brand (KFC) is synonymous with "chicken" in China, the H7N9 bird flu scare is nothing short of disastrous. With 4,000 locations in the country, China is now KFC's most profitable market, accounting for over 40% of KFC's global revenue.

KFC's brand on the mainland was just beginning to recover from the 2012 tainted chicken supplier scandal that shaved a third off its Chinese sales when H7N9 struck in Shanghai and Anhui, although data provided by Flutrackers shows a massive influx of number of atypical pneumonia and other "influenza-like" cases going all the way back to January, including a school cluster in Macao.

Pictures of empty KFC stores are appearing all over China-based microblogging service Weibo, some taken even during lunch hours when store counters are usually packed.

(Source: iFeng)

Chicken Is Off The Menu

Reports indicate that airline flights both in and to China are taking chicken off their in-flight menu as many passengers have refused to eat it. Xiamen Airlines, for example, plans to offer passengers a choice of pork or seafood instead.

Google Trends: The Recent Spike In "禽流感" [Bird Flu] Searches Suggests The Chinese Are Beginning To Panic

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In short, the Chinese are ignoring the reassurances of their own government and are swearing off chicken, raw, cooked or otherwise.

So why isn't the stock falling? One reason is that the company appears to be furiously buying back its own shares in an attempt to forestall a route. Unless Warren Buffett has suddenly fallen in love with KFC, the surge in YUM trading volume on the 11th and the smaller buying spree the following day in the chart would appear to confirm tha! t suspicion.

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However, if that's all there was to it, there would be no need for any reasonably large company to ever be penalized by the market for declining revenues. To levitate the stock, Yum has to make massive, market distorting, imminently front-runnable buys in the open market every time the share price falls below $67. Once the war chest is used up, Yum's board will either have to authorize another buyback, or the stock will correct to reflect real market conditions.

The Effects of Avian Flu Virus On Consumer Spending Behavior

According to a study conducted by the U.S. Department of Agriculture (PDF), which examined the response Italian consumers to news about the bird flu information in Italy as news about highly pathogenic H5N1 avian influenza (HPAI H5N1) from October 2004-October 2006, aversion to poultry should increase in line with the number of news reports with the words "bird flu" in them and recede within 5 weeks, with a 20.8% drop in sales over the course of the outbreak, on average.

(Source: USDA)

However, the Italian experience may be both too specific and overly conservative to be applied as liberally as the USDA would like. Whatever Italy is, it's definitely not China. Italians can afford to be complacent. They aren't surrounded by 71 million pet chickens. The chicken-to-people ratio in China at any given time is 3:1.

Conclusion

April is likely to be a decisive turning point in the progression of H7N9.There are now 43 "unofficial official" cases of the H7N9 Shanghai Flu. That number has yet to be officially corroborated, but Flutrackers has proven itself to be the most credible source on the subject to date, so I expect it will find its way into the mainstream media shortly, along with the first repor! ted case ! in Beijing.

While the USDA's conclusion of 5 weeks maximum reduced consumption will certainly be a relief to investors with exposure to the Asian poultry market -- namely, Yum, Tyson (TSN), and McDonald's (MCD) investors -- I think that relying too closely on the Italian consumers' experience with H5N1 to interpret the reaction of Chinese consumers to H7N9 might potentially be a disastrous assumption.

My own research indicates that If the virus reaches the college campuses in Hong Kong, it's almost a statistical certainty that it will leave the island. According to a study (PDF) on the 2009 swine flu pandemic by the National Center for Biotechnology Information:

By separating the geocoded cases into students and non-students, we further determined that student infections tended to be more clustered. If all student cases were excluded, the connectivity among swine flu cases in the community became very loose and might not have led to the subsequent epidemic. Students were therefore likely to be the main virus disseminators across Hong Kong, as has been reported in other countries for swine flu.

Demonstration of temporo-spatial clusters of all cases, student cases and non-student cases using SaTScan™, with analyses made separately in the three regions of Hong Kong Island, Kowloon Peninsula and the New Territories)

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(Source: NCBI)

If that is indeed what happens, it will trigger a number of automatic health emergency protocols, including a level 1 EOC response by the CDC. When that happens -- even by the USDA estimate -- Yum, Tyson and McDonald's aren't just going to have a problem selling chicken in mainland China, they're going to have a global problem that's staggered in waves. After all, when a novel avian influenza breaks out in China, it's something that's happening "over there." When it breaks out! in Rome,! Berlin, Moscow, Mexico City, New York and Omaha, the reaction is quite different.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)