A food-safety scare is one of the fastest ways to shake a restaurant stock, and Yum! Brands (YUM) just lived through one.Its most important brand, Taco Bell, spent much of July tied to a widening cyclospora outbreak. Sales fell, foot traffic dropped, and the stock slid as investors braced for a long recovery.Then the company reported second-quarter results, and the mood changed.For anyone holding Yum! Brands stock, or thinking about buying the dip, the important question is whether the damage runs deep or clears quickly. The earnings call gave the first real answer.How the cyclospora outbreak put pressure on Taco Bell salesThe trouble started in mid-July, when federal health officials linked a cyclospora outbreak to shredded iceberg lettuce served at Taco Bell.Cyclospora is a waterborne parasite often carried on fresh produce, and it causes a gastrointestinal illness that can last for weeks.The response from diners was immediate. Daily traffic to Taco Bell locations fell over 18%byJuly 15 and dropped nearly 31%onJuly 17, Nation’s Restaurant News reported.That kind of drop matters more for Yum! than for most rivals, because Taco Bell is the company’s main growth driver and earns a large share of its U.S. profit.The Cyclospora outbreak that spooked Yum! Brands investorsThe outbreak was serious enough to justify the caution.The Centers for Disease Controland Prevention has tied at least 1,947 illnesses across nine states to people who ate at Taco Bell.There were at least 98 hospitalizations and no deaths, according to the CDC outbreak investigation.The U.S. Food and Drug Administration traced the contaminated lettuce to Taylor Farms de Mexico, which recalled the affected product.Taco Bell pulled the lettuce from its restaurants nationwide by July 17.Investors had seen this kind of scare before. In 2015, an E. coli outbreak at Chipotle Mexican Grill (CMG) hurt its sales and its stock for years. That history shaped how investors first reacted to the Taco Bell news.Why Yum! Brands stock rose despite the Taco Bell hitHere is the part that surprised the market.Yum! Brands stock climbed more than 3% on July 30, the day the company reported earnings, even afterfalling about 5% to 8% since the outbreak first surfaced.The turnaround came down to two things: a strong quarter, and clear signals that the worst of the sales damage had already passed.Related: National beer and wine leader files Chapter 11 bankruptcyYum! posted adjusted earnings of $1.62 per share for the second quarter, beating expectations of $1.58, CNBC reported. Revenue rose 12% to $2.17 billion, just short of the $2.2 billion analysts expected.The second-quarter numbers covered the period till June 30, so they came in before the outbreak began. That means the report captured a healthy Taco Bell heading into the crisis, not the July slump.
A cyclospora outbreak hit Taco Bell sales hard in July, but a strong second quarter and early signs of recovery pushed Yum! Brands stock higher.Mario Tama / Getty Images
What Yum! executives revealed about the Taco Bell recoveryThe bigger relief came from management’s comments on current sales.Chief Executive Chris Turner said the outbreak caused a meaningful short-term sales decline but described it as temporary.By July 27, Taco Bell’s U.S. sales at established locations had fallen 2% for the third quarter so far. That’s a sharp reversal from the second quarter, when sales grew 7%.Chief Financial Officer Ranjith Roy said the worst hit landed over the weekend of July 18, and trends improved from there. More Restaurant Coverage:After closing 250 restaurants, pizza chain drops nostalgic offeringStarbucks CEO silently repeats Chipotle’s playbookMajor burger dining chain closes more locationsHe noted on the earnings call that recent sales had recovered about halfway back to prior-year levels.Management also gave investors a number to watch. Third-quarter store-level margins at Taco Bell are expected to land between 19% and 21%, down from 26.2% in the second quarter, CNBC reported.The industry-wide problem that limited the damage to Taco BellOne detail helped Taco Bell’s case: it was not alone in the outbreak.Consumers came to see the outbreak as a farm-level supply problem rather than a Taco Bell kitchen problem, which softened the blow to the brand.Chipotle confirmed the point on its own earnings call, saying the outbreak cut about 2 percentage points from its sales in the second half of July, CNBC reported.When several lettuce-heavy chains feel the same pinch at once, the market reads it as a shared agricultural failure. That framing matters, because a brand-specific safety scandal tends to linger far longer than an industry-wide one.How Taco Bell is trying to win customers backTaco Bell moved fast to bring diners back through value.The chain leaned on low-price promotions, including its Tuesday drops, which stayed popular through the outbreak, CNN reported.A few things need to hold for the recovery to stick:Traffic keeps climbing back toward pre-outbreak levels rather than stalling.Value promotions bring diners in without permanently shrinking the average order size.No new safety headlines emerge to reset consumer fear.Yum! is also reshaping its portfolio. The company agreed in June to sell Pizza Hutfor$2.7 billion, CNBC reported. LongRange Capital is paying $1.5 billion for the international business outside mainland China, while Yum China is buying the mainland piece for $1.2 billion.That leaves KFC and Taco Bell as the core of the company.What Yum! Brands investors should watch nextThe full financial cost of the July drop will show up in the third-quarter report, not the second-quarter numbers investors just celebrated.Watch whether heavy discounting starts to eat into Taco Bell’s average numbers, since prolonged $1 promotions can pull down the very margins its management is trying to protect.Also keep an eye on regulations. Rising federal scrutiny of food-safety practices could raise compliance costs across the fast-food industry over time.The outbreak clearly hurt Taco Bell, but Yum! showed investors a strong underlying business and early proof that sales are climbing back. That combination is why the stock rose on a week that started with bad news, though the third-quarter report will be the real test of how complete the recovery is.Related: 44-year-old mall retailer quietly closes 40 stores