Yum China Holdings - Group investor call takeaways
- We hosted Yum China for a group investor call, regarding its 2024 outlook, competition landscape, and strategy ahead
- With emphasis on 2Q lapping a high comparable base, as well as competition and value offerings, we trim our earnings by 6% in 2024E/2025E
- Trim TP to HKD388/sh, retain BUY on long-term outlook to ride through cyclical periods with stable shareholder returns
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Industry catering sales recorded a moderation in April 24. How does the company view the current outlook in 2024? 2Q23 was the strong quarter, where system sales rose 32% y/y and operating profit stood at the highest across all 2Qs since listing. The company also benefited from strong demand during the Labour Day and Children’s Day holidays. Besides this, the company also recorded USD12mn in temporary relief and a VAT deduction benefit, which is not expected to recur this year. As such, this would form a high base for comparison from 2Q24 onwards. The company intends to drive incremental traffic with focus on value. Consumers are more rational in spending in general but do respond to value offerings and campaigns.
Across different tier cities, the company does recognise there are pessimistic headlines upon softer consumption spending across 1st tier cities. However, Yum China continues to see vibrancy across tier 2 cities such as Changsha and Chengdu in central China. In addition, tier 3-6 cities continue to see benefits of a consumption upgrade. To date, Yum China has identified at least 1,000 unpenetrated cities, out of c.3,000 cities across China for the KFC brand, with Pizza Hut posing even more opportunities. In terms of ticket average, lower and higher tier cities are trending similarly (~Rmb42), while higher tier cities would have higher store traffic due to differences in city density.
KFC, as the company’s primary growth engine, has seen a solid reception for high-ticket items. What is the sales breakdown in terms of offering? Core options account for 80% of total sales, while premium offerings (beef burger, whole chicken) accounted for 12%, with the remainder being value offerings (8%).
What is the company’s delivery strategy for both brands, as we have seen delivery sales recording an improvement in 1Q24? KFC is trying to capture the entry price option for delivery orders under Rmb40. As such, the company has lowered the delivery cost from Rmb9 to Rmb8 to allow more affordable meals to be delivered to consumers, such as breakfast, tea sets, etc. As for Pizza Hut, delivery continues to be an important option, with the offerings of sub-Rmb50 one-person sets. The company will unlikely offer pure delivery models and hopes to capture a wider customer space instead. The smallest shop size would be the satellite model, where 100sqm offers 10-20 seats.
It is difficult for investors to pinpoint how much of an impact competition has had on Yum China’s sales. One of your peers have been expanding aggressively with value offerings. Would the company be able to share any industry insight into the competition landscape? One of its competitors that is expanding rapidly is an unlisted domestic player targeted in the lower tier cities. According to industry experts, the player’s payback period stood roughly between one to two years and it operates under a franchise model. With the cancellation of area protections, the franchisees are beginning to feel the competition as well as the impact of value offerings from Yum China. Yum China has faced significant competition since its entry to China, with strong focus on product upgrades (500 SKUs annually), where KFC records roughly more than 100 upgrades/ new launches annually alone. Another strategy of concern would be the focus on the third-party online channel across Douyin and other social media platforms, where the competitors may opt for coupon offerings to drive sales traffic. Yum China relies mainly on its direct channel through its Super mini apps where it has encompassed over 485mn members. As for other direct competition, an international player has also been rapidly expanding, mainly focused on the higher tier cities, while Yum China would be more evenly distributed across all tiers.
Yum China has reported solid increases in shareholder returns up to USD1.5bn in 2024. Would the company consider raising dividends instead of conducting share repurchases? In 1Q24, Yum China’s quarterly DPS has risen to USD0.16/sh (+23% y/y). The company hopes to manage investors’ expectations as they do not hope to reduce dividends if the company runs into any issues. Share buyback offers more flexibility in the medium term. In addition, Yum China is a dual-listed company where the dividend payout would be subjected to US taxes that the management would have to take into consideration.
Can the company share with us its expectations for the margin trend given concerns over consumers trade down and competition? The company has maintained the cost of sales at around 31% (+/-1ppt) through the management of the supply chain and control on raw material costs for the KFC brand. Pizza Hut holds a higher cost of sales despite the higher ticket average due to a larger variety of product offerings. Besides this, the company has been managing labour costs through smaller store layouts. Between KFC and Pizza Hut, KFC operates on a more automated model with less workers needed through mobile ordering and automated kitchen models, while Pizza Hut has a more traditional sit-down setting.
As noted during Investor’s Day, the company plans to introduce more franchise models to capture unpenetrated areas. Can you give us an update on the arrangement with franchisees recording the cost and profit-sharing model? Franchise stores account for a small but growing portion of the company’s sales. International players mainly operate on franchise models to grow rapidly, hence Yum China also hopes to keep its growth pace. 15%-20% of new store openings are under franchise models. Typically, franchisees would pay for raw material procurement, marketing, and IT expenses. To roughly gauge, around 40%-45% of the sales made would be paid to Yum China. Of which, Yum China would pay 2%-3% of net sales to the Yum Brand, its parent company.
During 1Q24, Yum China emphasised on the importance of coffee. What is the strategy for coffee under K-Coffee and Lavazza? Lavazza aims to offer quality coffee beans with around 120 stores across 10-11 cities. The company hopes to improve its brand awareness and continue to scale once stores break even overall. As for K-Coffee, over 10,000 KFC stores currently sell this product. In 1H23, KFC sold 119mn cups of coffee (+35% y/y), while 1Q24 recorded a 30% y/y increase in volume. The company plans to open more pop-up stores as it requires very low capex and cost to operate.
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