Taco Bell Still Hurting from Beef Quality Lawsuit

By Lisa Baertlein | July 15, 2011

Yum Brands Inc expects damage from a dropped lawsuit over the quality of Taco Bell’s ground beef to linger in the third quarter, but to ease during the remainder of the year, and laid out plans to turn the business around.

Taco Bell is Yum’s most profitable U.S. brand. A sharp decline in closely watched same-restaurant sales, along with higher-than-normal commodity inflation, resulted in a 28 percent decline in U.S. operating profit for the second quarter.

A California woman in January sued Taco Bell over the contents of its seasoned beef. Taco Bell responded by saying it planned to take legal action against the “false statements” being made about its food. In April, the woman voluntarily dismissed her lawsuit.

But the damage was done. Taco Bell sales at established restaurants, which were up 2 percent in the fourth quarter of last year, were flat in the first quarter and tumbled 5 percent in the second quarter ended June 11.

“The negative sales that resulted from the lawsuit have lasted longer than any one of us thought,” Chief Executive David Novak said on a conference call with analysts.

Novak said Taco Bell’s light users, who stopped visiting after the lawsuit made headlines, have been surprisingly difficult to bring back.

“We expect slow improvement from the low point in the second quarter,” said Novak, who added that it usually takes about six months to fully recover from food quality-related issues.

To that end, Chief Financial Officer Rick Carucci told analysts to expect another decline in same-restaurant sales for the current quarter.

“Taco Bell will be negative in the third quarter but not as bad as the 5 percent” in the second quarter, Carucci said.

The executives said Taco Bell would announce new products this year and roll out “more compelling” advertising in a bid to improve results.

We “are determined to turn around these unacceptable results. Believe me, all hands are on deck,” Novak said.


Yum, which also owns the KFC and Pizza Hut brands, is one of the biggest fast-food restaurant operators in the United States.

But its U.S. business has been a persistent laggard compared with Yum’s operations in China and other international markets — which combined generate 75 percent of Yum’s operating profit.

On Wednesday, Yum raised its full-year earnings forecast and posted better-than-expected second-quarter results on strength in China and its other international markets.

While same-restaurant sales for China were up 18 percent in the quarter and rose 2 percent in its other international markets, they fell 4 percent overall in the United States on declines at Taco Bell, Pizza Hut and KFC.

The company said it expects U.S. profit performance to improve by the fourth quarter.

While the second-quarter should mark a bottom for Taco Bell, “Yum’s U.S. business takes the ‘prize’ for the worst performing restaurant business we know of,” JP Morgan analyst John Ivankoe said in a client note.

Nevertheless, Janney Capital Markets analyst Mark Kalinowski said Yum’s U.S. results are not a bellwether for the rest of the fast-food industry.

“While these numbers are poor, we do not believe they are indicative of a worsening U.S. quick-service sector overall,” Kalinowski said.

Michael Yoshikami, chief executive and founder of YCMNET Advisors, said Yum rival McDonald’s Corp was once in Yum’s shoes, with strong emerging market growth and same-restaurant sales problems in the United States.

McDonald’s turned it around by moves including expansion of its low-price Dollar Menu and the introduction of coffee and other beverages, he said.

“They’re going to have to figure out a way to revitalize their domestic menu,” said Yoshikami, who owns McDonald’s shares and closely monitors Yum results.

Yum shares were up 1.5 percent at $56.39 on Thursday afternoon, while the broad S&P 500 Index was down 0.4 percent.

(Reporting by Lisa Baertlein, editing by Matthew Lewis)

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