Yum Brands Inc posted a quarterly profit that topped Wall Street's estimate, boosted by sales growth in China, its largest market, though labor and food costs there surged.

The rising costs reduced margins slightly in China for the company, owner of the KFC, Pizza Hut and Taco Bell chains. Margins improved in the United states and other markets.

Yum's shares rose 2.3 percent to $48.85 in extended trading after it also surprised Wall Street with China and U.S. sales at established restaurants that outpaced those posted by key rival McDonald's Corp.

Yum gets about one-third of its earnings from China, the world's fastest growing major economy, and same-restaurant sales in that market jumped 8 percent in the fourth quarter, surpassing analysts' expectations and accelerating from the prior quarter's 6 percent rise.

Yum's U.S. same-restaurant sales were up 5 percent overall for the latest quarter, improving from a 1 percent gain in the prior quarter and exceeding analysts' expectations.

Yum's domestic business funds its international expansion and takes a back seat to operations in China, where the company established a foothold before other Western rivals.

McDonald's reported 4.4 percent same-restaurant sales growth in the fourth quarter.

Yum's shares have surged 36.5 percent since Jan. 1, 2010, largely on the back of its growth in China. It is widely regarded as one of the biggest China plays for investors in the U.S. stock market.

ALL EYES ON CHINA

Yum has more than 3,700 restaurants -- mostly KFC outlets -- in China and has a big lead over Western rivals there. [ID:nN08114643]

McDonald's operates almost 1,300 restaurants in China and plans to have 2,000 restaurants there by the end of 2013.

Investors are concerned about spiking food and labor costs in China.

Payroll and benefits expenses rose 33.5 percent in China from the year earlier quarter, while paper and food expenses rose 19.5 percent.

The Bank of Communications last week said China's annual inflation will probably top 6 percent around the middle of 2011 before losing steam in the second half of the year. It cited soaring food prices, rising production and labor costs and abundant banking liquidity as key drivers.

Yum said its China restaurant margin was 18.2 percent in the fourth quarter, down from 18.3 percent a year ago.

When you see same-store sales up 8 percent, you expect to see margins perform better than that ... it shows that you're seeing some food and labor pressure, said Edward Jones analyst Jack Russo, who added that analysts would likely focus on that data point from the company's better-than-expected results.

The stock trades on what happens in China. We'll have to see what their tone is tomorrow when executives host their conference call with analysts and investors, Russo said.

A Yum spokesman told Reuters that the company recently raised some prices in China, where McDonald's Corp and Starbucks Corp already have raised prices.

Stifel Nicolaus analyst Steve West said he wants to know how China same-restaurant sales are trending so far this quarter and what kind of reception the menu price increases are receiving there.

That's what we'll need clarity on tomorrow, he said.

HOME-GROWN SURPRISE

Yum's U.S. results also stood out.

By brand, Pizza Hut posted a jump of 10 percent, Taco Bell was up 4 percent and KFC -- which has struggled in Yum's home market -- was up 1 percent.

Yum International's 1 percent rise in fourth-quarter same-restaurant sales was flat from the prior quarter and fell short of analysts' call for a 2 percent to 3 percent gain.

Fourth-quarter net income at Yum, based in Louisville, Kentucky, was $274 million, or 56 cents per share, compared with $216 million, or 45 cents per share, a year earlier.

Excluding special items, Yum earned 63 cents per share, beating analysts' average view by 3 cents, according to Thomson Reuters I/B/E/S.

Analyst West said Yum had a lower tax rate to thank for its earnings beat in the fourth quarter.

Total revenue was $3.56 billion compared with $3.37 billion a year earlier -- topping analysts target of $3.5 billion.