Yum Brands Inc , parent of the KFC, Taco Bell and Pizza Hut chains, issued a disappointing full-year earnings outlook and said it expects labor costs to rise in its key China market, sending its shares down 3.2 percent.

I think they're downplaying guidance a little bit to be conservative, said Keith Goddard, president of Capital Advisors, which holds Yum shares.

In the second half of 2010, Yum expects labor and commodity inflation in its China division, which contributes 35 percent of company profit.

KFC China workers won a pay raise in June amid mounting unrest that is pushing up labor costs in the world's third-largest economy.

While higher costs could put pressure on China margins, Goddard said the company should benefit when China allows its currency to appreciate. Higher wages should also bolster consumer spending.

You are finally seeing a greater share of the economic pie going to labor in China and that's good for Yum, Goddard said. For every nickel that they might lose in labor cost I would venture that they are going to get three back from customers who can afford their product.

Yum raised on Tuesday its full-year earnings per share forecast to $2.43 from $2.39, based on results from the first half of the year. Analysts' average forecast had called for 2010 earnings of $2.48 per share, according to Thomson Reuters I/B/E/S.


Net income for the quarter ended June 12 fell to $286 million, or 59 cents per share, from $303 million, or 63 cents per share, a year earlier when it booked a $68 million gain related to increasing its stake in the operator of the KFC business in Shanghai.

Excluding items, Yum earned 58 cents per share in the latest quarter, topping analysts' average call for per-share earnings of 55 cents, according to Thomson Reuters I/B/E/S.

Total revenue was $2.57 billion compared with $2.48 billion a year earlier.

Overall, we are encouraged with our strong performance in a difficult macro-economic environment, Yum Chief Executive David Novak said in a statement.

Closely watched sales at established restaurants in China rose 4 percent during the quarter, in line with analysts' expectations. Yum's China division includes mainland China, Thailand and Taiwan.

Yum has more than 3,500 outlets in mainland China and is its largest foreign restaurant operator. The China division contributed operating profit of $139 million during the second quarter compared with the $184 million contributed by the United States.

The company's international unit, which saw same-store sales rise 1 percent, includes more than 100 countries as varied as France, Russia and India.

Overall sales at U.S. restaurants open at least one year were flat. That result included an 8 percent same-store sales rise at Pizza Hut and a 1 percent gain at Taco Bell, offset by a 7 percent decline at KFC.

Yum shares fell to $40.36 in extended trading, after closing up 2.1 percent at $41.71 on the New York Stock Exchange. At the close of regular trading on Tuesday, Yum shares were up 19 percent year-to-date, a slightly better gain than the 14 percent increase in the Dow Jones U.S. Restaurant and Bars index <.DJUSRU>.

(Reporting by Lisa Baertlein; editing by Leslie Gevirtz and Andre Grenon)