Yum China Holdings, Inc. (NYSE:YUMC) Q1 2024 Earnings Call Transcript

Yum China Holdings, Inc. (NYSE:YUMC) Q1 2024 Earnings Call Transcript April 30, 2024

Yum China Holdings, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by, and welcome to the Yum China First Quarter 2024 Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to Florence Lip, Investor Relations Senior Director. Please go ahead.

Florence Lip: Thank you, Operator. Hello, everyone. Thank you for joining Yum China’s first quarter 2024 earnings conference call. On today’s call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung. I would like to remind everyone that our earnings call and investor materials contain forward-looking statements, which are subject to future events and uncertainties. Actual results may differ materially from these forward-looking statements. All forward-looking statements should be considered in conjunction with the cautionary statements in our earnings release and the risk factors included in our filings with the SEC. This call also includes certain non-GAAP financial measures and should carefully consider the comparable GAAP measures.

Reconciliation of non-GAAP and the GAAP measures is included in our earnings release. You can find the webcast of this call and the PowerPoint presentation on our IR website. Please note that during today’s call, all year-over-year growth results exclude the impact of foreign currency unless otherwise noted. Now I would like to turn the call over to Joey Wat, CEO of Yum China. Joey?

Joey Wat: Hello, everyone, and thank you for joining us today. I’m proud to share that we turn in a solid performance in the first quarter. System sales grew 6% year-over-year on top of 17% growth last year. Our revenue reached US$3 billion in the quarter, an all-time high. Core operating profit improved to US$396 million from a high base of US$392 million last year. Adjusted operating profit in quarter one of last year was the highest in the 30 quarter since our spin off. This quarter was the second highest. We achieved these results in a challenging and competitive environment, thanks to our resilient business model and our team’s agility and hard work. We’ve demonstrated once again our ability to adjust to changing conditions and deliver solid results.

We continued to invest to accelerate growth, adding a record number of stores. We reached and surpassed the milestone of 15,000 stores. At the same time, we returned a record amount of cash to our shareholders through share repurchases and cash dividends totaling US$745 million. Let me start with our store opening strategy. We remain bullish on China. We see the China market as offering us white space for years to come. We intend to fill in by expanding our store portfolio. In quarter one, we passed the 15,000 store milestone, opening 378 net new stores. I am proud of how we have been able to accelerate. It took us 25 years to build the first 5,000 store in China, 8 years to build the next 5,000 stores. And just 4 years for the last 5,000 stores.

We are well on our way to another 5,000 stores by 2026. Contrary to select [indiscernible] reason reports, China continues to develop rapidly with hundreds of new shopping malls, residential complexes and commercial developments opening every year. Urbanization and long-term consumption upgrades in Tier 2 cities and below, present a particularly attractive opportunity for us. Housing and living costs are more affordable there. Tremendous consumption potential has yet to be unleashed. We expect roughly 30% of our new stores this year to be in new cities or strategic locations, such as transportation and tourist locations. Our flexible store models and franchise partnerships give us the tools to capitalize on every opportunity. Taking a closer look at each of these.

Our flexible store models enable us to expand across city tiers and penetrate further. In quarter one, two-thirds of new store openings were in smaller store format. On average, our new store now take just RMB1.2 million to RMB1.5 million CapEx to build. And we are always pushing for even lower CapEx and innovating new format. KFC has recently developed a small time mini model for lower tier cities. With the simplified menu and optimized equipment per store CapEx can get as low as RMB0.5 million. Pizza Hut has just 3,400 stores and holds significant potential for further expansion. We have developed a compact model. It is smaller than our standard stores, but features more dining space and menu choices than our satellite model. These promising new models enable us to add store density and enter smaller cities more flexibly and profitably.

Transportation and tourist locations represent just single-digit of our store mix right now. But they are key to capturing the spike in travel volume during holiday period. Same-store sales as these locations grew around 20% during Chinese New Year. We are opening more stores at highway service centers in over 20 provinces, capitalizing on the opportunity presented by the rising car ownership. Some of our stores will be open through franchising. In fact, partnering with franchisees is key to unlocking opportunities in lower tiers, remote areas and other strategic locations. At our Investor Day last year, we estimate about 15% to 20% of our net new stores in the next 3 years will come from franchising. In quarter one, this mix has reached 19% at KFC, a disciplined approach [indiscernible] accelerated expansion.

Payback periods have remained consistent at 2 years for KFC and improved from 3 years to — 2 to 3 years for Pizza Hut. We track these KPIs very closely to help ensure we open high quality new stores. Let’s now spend some time on our brand strategy. We have devised robust strategies to meet diverse demands in China. We satisfy our customers taste buds with delicious, innovative food and we built an emotional bond with them. Through a combination of premium and affordable options, we make sure there’s something for everyone. We recorded over 460 million transactions in the first quarter alone, representing a 15% increase year-over-year. It was not easy. While our restaurants remained open this year and last year, there were a lot more other restaurants opening during the holidays this year.

But our customers respond well to our offerings. The strong transaction growth also reflects our successful strategy to spread our price point expanding into low-ticket orders, and that will allow us to capture more market shares. Now let me spend some time on each brand. Beginning with KFC, our primary growth engine. Delicious, innovative food and amazing value have been the keys to our success. Our high-ticket average product sold very well in quarter one. KFC’s beef burger and whole chicken sales grew double-digit. We take a holistic approach to drive traffic, while protecting our ticket average. We launched the super juicy pineapple Beefburger, [indiscernible]. The combination of pineapple and beef taste is exotic, and customers liked it.

At the same time, we add entry price beef burgers into our weekday value combo. So we have both value and premium options to meet diverse consumer needs. Our 6 years old signature Crazy Thursday’s continue to drive major traffic to KFC. Thursdays now even outperform weekends. Leveraging full chicken utilization, we offer great value to customers at sustainable cost. Our delivery business remains strong. Delivery sales have grown double digits every year for the past decade. We identify smaller orders as an area of opportunity. To tap it. KFC reduced its delivery fee and expand one person meal options in late February. The initiatives attract strong incremental traffic, capturing more market share, especially in lower tier cities. To offset the lower delivery fee, we have taken actions to reduce our overall operating costs for riders.

This includes introducing platform riders at selected locations where their quality actually matches our dedicated riders. We can serve more customers while maintaining service quality and sustainable margins. We are constantly searching for new growth pillars. KCOFFEE continues to grow nicely achieving a 30% increase in cup sold in quarter one. We are excited about further penetrating this segment of the growing coffee market. To this end, we have developed a side-by-side KCOFFEE mode. We call it [indiscernible] storefront and dining area [indiscernible] [] and beyond surrounded by coffee aroma. These shops are connected to KFC stores, so that we can share a kitchen to keep the investment and operating costs down. Using KFC equipment, we can serve unique products like Coffee flows [ph], shedding coffee and sparkling coffee [indiscernible] without additional investment in equipment.

Summer is coming, so we really encourage our friends to try this very refreshing sparkling coffee. Its indeed one of our bestselling coffee already. We see initial success of 100 side by side stores across 80 cities already and we intend to this model out aggressively. Next is Pizza Hut, which now has over 3,400 stores only and is ready for accelerated growth. In the past 12 months, Pizza Hut adds over 400 stores and increased city coverage by 10% to over 750 cities. We aim to broaden its addressable market with a strong value proposition for mass market appeal. Our strategy emphasize widening price points, expanding into new categories and delivering emotional value to consumers. First, we are widening price points. We enriched our entry price Pizza offerings.

Sales from below RMB50 pizzas grew double-digit in quarter one. Our [indiscernible] [] roll jam pizza priced at RMB39 has quickly become one of our top five bestselling pizzas. It’s a familiar taste inspired by our spaghetti, well actually our signature dish for the past 30 years. It has become a customer favorite. These results give us confidence that we are on the right track. Our higher ticket offerings also offer abundant value. We brought back our popular all-you-can-eat deal at RMB178 for 5 days with Beef Wellington, Durian pizza, Crayfish and other very delicious options to choose from. This campaign generated a lot of social buzz and became a strong sales driver, particularly for those people who love to indulge themselves with the — or you-can-eat deal.

We are also expanding offerings to capture our share of growing one person meal occasions. Just last week, we launched the pizza [indiscernible] [] burger cheese [indiscernible] in around 2,000 stores with existing ingredients. This made to all the burger features Pizza dough buns, freshly baked in store on daily basis. The inspiration actually comes from Chinese bun. So our pizza dough bun is chewy and fluffy, it’s very unique and it’s very different. It perfectly complements our juicy beef and chicken patties. The result is good and we are confident that will unlock incremental sales. We aim to offer emotional value to our customers beyond delicious foods. In quarter one, we more than doubled the number of IP collaborations with top animation and games.

These campaigns attract a wave of young customers eager to join the fun. Let’s turn to Lavazza. Lavazza’s [indiscernible] growth engines, coffee shop and retail are making good progress and thriving synergies. We further reduced the CapEx of our latest small store format. Improved store economics. Our retail business expanded to premium outlets such as five star hotels and Michelin star restaurants. By growing the two businesses, we are building the Lavazza brand in China. Looking forward, Lavazza group and we are planning to partner with a local [technical difficulty] for fresher beans, more competitive costs and smoother operations. Now let’s briefly touch on our Chinese dining brands. Little Sheep and Huang Ji Huang had a strong recovery last year.

Huang Ji Huang remains a very resilient model with strong growth potential. Little Sheep has made good progress with their new one person hop module. We achieved initial tests with the pilot stores in Shanghai, resulting a robust pipeline with our franchisees. We are also expanding internationally, such as the entering the U.S., we’ve a new Little Sheep store in New Jersey. As we expand to serve more customers and capture incremental traffic, we are pursuing greater operational efficiency to make our business even more resilient. In the spirit of our Restaurant General Manager number one, or our GM number one philosophy, we launched Project Fresh Eye to assess our operational processes through the fresh eyes of our RGM. Our goal is to empower our RGM supporting them better and faster.

The scope covers all aspects from our restaurant to supply chain and back office. We aim to improve efficiency, enhance agility and drive cost effectiveness. We are streamlining processes and integrating resources to promote synergies across regions and functions. Technology will continue to play a big role in driving efficiency. We’re starting to use generated AI to develop creative marketing and facilitate our recruiting processes. In addition, we benchmark against the industry to identify areas of opportunities and develop targeted strategies. We aim to be best-in-class and best-in-cost, passing on any cost savings to our customers and other stakeholders. Our ability to address our consumers ever evolving needs, allows us to connect with them emotionally and continually.

Our pioneer digital capabilities, proprietary Supply Chain Management and unmatched operational efficiency enable us to do this on a massive scale. These qualities set us apart from our competition and help us drive sustainable growth in this dynamic market. With that, I will turn the call over to Andy. Andy?

Andy Yeung: Thank you, Joey, and hello, everyone. We delivered solid results in the first quarter, driving sales, core operating profit and EPS growth despite a higher base. During the action packed first quarter, we launched exciting offerings and took both specific actions to expand our addressable market. At the same time, we’re pressing on with our cost structure rebasing, driving operational efficiency to support long-term sustainable growth. Let’s now look at our first quarter performance in more detail. System sales increased 6% year-over-year, led by 8% net new unit contribution. Same-store sales were at 97% of prior year levels against a very strong performance last year. By brand, KFC system sales increased 7% year-over-year, driven by net new store contribution.

KFC’s portfolio reached 10,603 stores adding 307 net new stores in the quarter. Same-store sales were at 98% of prior year levels, with 4% same-store traffic growth and a 6% low ticket average. Putting this into perspective, our ticket average in the quarter was RMB42. This is sequentially higher than RMB39 in the fourth quarter last year due to holiday impact. And it is also higher than RMB39 in the first quarter 2019. Now in line with our strategy to drive incremental traffic, we offer higher-ticket average products like whole chicken and beef burger, while enriching entry-level combo. We also lowered our [indiscernible] fees to capture smaller ticket orders. And we had a nice rebound in breakfast, coffee and ice cream sales, which have a lower-ticket average.

Pizza Hut’s system sales increased 4% year-over-year driven by net new unit contribution. Pizza Hut’s portfolio reached 3,425 stores with record first quarter net new stores of 113. Same-store sales were at 95% of the prior year level, led by strong traffic growth of 8% and a 12% lower-ticket average. As Joey mentioned, we are particularly enriching our entry price pizza, take smaller party size options and one person meals at Pizza Hut. This helps Pizza Hut tap into underserved customer segments and roll out to more locations, capturing incremental traffic [ph]. Operating profit was $374 million. Our operating margin as a percentage of revenue was 12.6%. We are delighted that our core offering profit was not only stable, but also grew by 1% on top of the very strong performance last year.

As a reminder, core operating profit excludes foreign exchange intact, special items and other items affecting comparability. Our proactive savings in G&A expenses partially offset the year-over-year low restaurant margin. As Joey mentioned, we have challenged ourselves to strive for high efficiency so that we can drive sustainable growth. Now let’s go through our restaurant margins and key cost items. Our restaurant margins was 17.6%, 230 basis points lower than last year or 130 basis points lower on a comparable basis. The year-over-year difference was mainly due to higher cost of sales and cost of flavor while our occupancy and other costs continue to improve. Total sales was 32.1%, 200 basis points higher year-over-year, or 170 basis points higher on a comparable basis.

We increased value for money offerings, favorable commodity costs, procurement and efficiency gains from Project Fresh Eye allow us to pass the savings back to customers. Cost of labor was 25.4%, 80 basis points higher year-over-year or 60 basis points higher on a comparable basis. This was mainly due to last year’s wage increases for frontline staff and higher rider costs as the delivery mix went up. We improved our labor productivity, which more than offset the sales leveraging impact. Occupancy and other was 24.9%, 10 basis points lower year-over-year or 60 basis points lower on a comparable basis. This improvement came from lower rent expenses as well as lower marketing and advertising expenses. Our G&A expenses decreased 10% year-over-year because of operational efficiency gains across organization and lower performance-based compensation this year.

G&A expenses as a percentage of revenue was 4.7% in the quarter, improving from 5.6% a year ago. Obviously, the ratio would fluctuate with seasonality in sales. But for the full year, we aim to keep G&A ratio to be around 5%. Our effective tax rate was 26.9% in the first quarter. The lower tax rate on a year-over-year basis was due mainly to less non-tax deductible expenses. We expect the full year effective tax rate to be in the high 20s. Diluted EPS was $0.71, growing 10% year-over-year. Moving on to our second quarter outlook. As a reminder, the second quarter of last year was a phenomenal quarter. System sales increased 32% year-on-year in the second quarter last year. Operating profit last year was the highest among all second quarters.

We also benefited from strong demand around Labor Day and [indiscernible] day holidays last year. We recorded around $12 million in temporary relief and VAT deduction benefit, which is not expected to recur this year. So all this would again from a high base comparison. Looking ahead to the second quarter of this year, we expect the tide to remain choppy. This will test our ability to adopt, we’ll continue to execute on our strategy to drive incremental traffic with great value for money offerings. Consumers are indeed more rational in the spending in the new normal, but they do respond well to our exciting offerings and campaigns. On the operational side, we will continue to work hard to improve the efficiency across the organization and pass along the savings to customers.

For the full year, with a strong store pipeline, we are expecting to open 1,500 to 1,700 net new stores. In addition to investing for growth, we also returned a record US$745 million to shareholders in the first quarter, including buying back 16.6 million shares, which is equivalent to more than 4% of our share outstanding. Our strong cash flow generation and a healthy cash position are what made this possible. At the end of the quarter, we had US$3.1 billion in net cash. We are committed to return US$1.5 billion to shareholders in 2024 and continue to drive our long-term sustainable growth. With that, I will pass it back to Florence. Florence?

Florence Lip: Thanks, Andy. Now we will open the call for questions. In order to give more people the chance to ask questions, please limit your questions to one at a time. Operator, please start the Q&A.

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Q&A Session

Operator: Thank you. [Operator Instructions] The first question today comes from Michelle Cheng from Goldman Sachs. Please go ahead.

Michelle Cheng: Hi, Joey, Andy. Congrats for the still very resilient results, a very tough comp. My question is about the same-store sales and consumption trend. Given we know the offline traffic has been very bad year-to-date, but on same-store sales, especially KFC is still pretty healthy. And you share the higher-ticket size items going by like a double-digit and transportation hub growth during Chinese New Year [ph] are pretty strong at 20%. I’m wondering whether you can share more color about the different performance including like TLCDs [ph], daypart, consumer cohorts or holiday versus post-holiday sales? And is there any color on month-to-date trend and how we should expect into second quarter and Labor Day, given? Andy you just mentioned that we had — we also had a tough comp last year. So wondering how we should look at the second quarter same-store sales. Thank you.

Joey Wat: Thank you, Michelle. I would recap a little bit of the Chinese New Year and then go to the quarter to what we are seeing right now. So as mentioned on the quarter four earnings release call last time, we anticipate a tough Chinese New Year because it was very high base. The situation was unique last year with the reopening and then there’s pent-up demand on traveling and then also, we are a bit more well prepared with the new store — with the store openings than our peers. And yet, we delivered 6% system sales growth on top of 17% growth last year’s quarter one. And mainly leading — led by the robust transaction growth and that’s very encouraging. And with — from the growth of the total 15% transaction growth, we see [indiscernible].

For the 2024 Chinese New Year, we see the return to normal trading with more so available for consumer. Trading was robust and the transportation hub, et cetera, the business was booming. And then we also see diverse demand, which I mentioned in my prepared remarks. On the one hand, customer like the value for money for the high-tech items, but at the same time, the functional needs with lower-ticket average is equally appreciated and that’s a very strong recovery of the smaller ticket items from delivery all the way to coffee, breakfast, ice cream, et cetera. So all these are good. And then we also see the trend — continue to see the trend of consumer behavior during holidays. So during holidays, they stretch [ph] and then after the holidays, they tie them up the belt a little bit.

But the trading in [indiscernible] sequentially improved. And then if we move to the next trend, it’s about the region, city tier location, et cetera. We see the regional recovery from the North recovered the best because that was lapping on lower base the year before. In Eastern China, Eastern part of China continue to be very resilient, which is brilliant. And then, of course, all regions across China grew system sales. By city tier, as we have mentioned a few times before, the Tier 2 still performed the best and lower tier city lapping strong. Tier 1 last year and the Tier 2 cities with regional hubs such as [indiscernible], et cetera, continue to do really well because, as I mentioned again, in the prepared remarks, the living costs and housing price there are lower.

So the trading is very robust, which is good. By location, sales at shopping mall where we have more so have surpassed the 2019 level and the trading is robust, and that’s also very encouraging because it’s not report value, but China last year actually at about 400 shopping mall to the base of about 6,000 shopping mall that we are tracking. And I don’t think that many countries are still building that many shopping malls. And for 2024, that trend will continue. We estimate to have more hundred shopping mall coming to China. And — so — and one other trend, delivery continues to do very well. And as you can see, KFC delivery sales actually increased by 14%, which is massive 14% that is a consistent growth for a decade in this delivery business.

And it’s driven by the smaller order delivery, which is something that we again mentioned in the previous quarter earnings release, that was our — part of our strategy and work really well. And going to the quarter two, I think Andy can make a few comments about the quarter two, yes.

Andy Yeung: Thanks, Michelle, for the questions. So I think for quarter two, as we mentioned, we are committed to delivering compelling value to consumers. And again, we share work really well. We will introduce more products and then try to execute some more engaging marketing campaign to drive sales. As in our prepared remarks, we have mentioned we continue to see consumers to be more rational in spending, but they do respond positively to our new product instructions, value propositions and also some of their fund marketing campaign as well. So that’s what we’re going to do more. And in terms of like a quarter for this year, just remind everyone, we have a very high base last year. Last year, we actually have seen a 32% increase in our system sales and then also record profit last year in the second quarter which is helped by some very strong performance during the Labor Day and [indiscernible] holiday sales, as well as last year, we also had some one-time about US$12 million which we are not expecting that to occur this year.

So all in all, we will have a high base. But despite these challenges we mentioned, we focus on our strategy, values, new port introduction campaigns, the [indiscernible] consumers. And then we also have mentioned in the prepared remarks, we have a project Fresh Eye and to further boast our efficiency. And again, as we mentioned, we will try to find more savings so that we can pass on to the customer. And we do plan to continue to improve our G&A expenses. Obviously, that will fluctuate quarter-by-quarter the ratio. But for the full year, we intend to attribute around 5%. So yes, so this is sort of the plan there. But a couple of things I want to mention is that is worth keeping in mind. One is that our new store contribution, the revenue structure is changing as we increase the mix of store and also franchise store, right, which would change the mix between franchise fees versus company sales.

And also foreign exchange. Our operating currency is RMB, and our foreign currency is U.S. dollar. So we will continue to be impacted by the currency exchange fluctuation. Thanks.

Michelle Cheng: Thank you, Joey. Thank you, Andy for the detailed explanation.

Operator: Thank you. The next question comes from Brian Bittner from Oppenheimer. Please go ahead.