Yum China (YUMC) Q2 2023 Earnings Call Transcript

Yum China (YUMC 1.56%)
Q2 2023 Earnings Call
Jul 31, 2023, 8:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Thank you for standing by and welcome to the Yum China second quarter 2023 earnings conference call. [Operator instructions] I would now like to hand the conference over to Ms. Michelle Shen, IR director. Please go ahead.

Michelle Shen -- Director, Investor Relations

Thank you, Ashley. Hello, everyone. Thank you for joining Yum China's second quarter 2023 earnings conference call. On today's call are our CEO, Ms.

Joey Wat; and our CFO, Mr. Andy Yeung. Before we get started, I'd like to remind you that the 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. You should carefully consider the comparable GAAP measures. Reconciliation of non-GAAP and GAAP measures is included in our earnings release.

You can find a webcast of this call and a PowerPoint presentation on our IR website. Now, I would like to turn the call over to Joey Wat, CEO of Yum China. Joey.

Joey Wat -- Chief Executive Officer

Hello, everyone, and thank you for joining us today. I'm delighted to report outstanding performance in the second quarter, both top line and bottom line. Our result is a testament to our resilient and anti-fragile business, which allows us to capture upside in good times and protect downside in bad times. From the back office to the front lines, our teams are doing a great job.

During the quarter, we reached new heights on multiple fronts. First, sales performance. Total revenue of 2.65 billion set a new record for second quarter, especially given the exchange rate. System sales grew 32%, and same-store sales grew 15% year over year.

We observed strong demand around holidays. Trading for the May 1st Labor Day holiday was vibrant. However, demand actually softened afterwards, with a dip in customer traffic. We adjust nimbly with attractive campaigns and regained sales momentum in June.

On June 1st Children's Day, we hit a record 8.5 million transactions. That's equivalent to a transaction every minute in every location across our 13,000-plus store portfolio in a single day. Thanks to our amazing operation team, robust end-to-end digitalization, and agile supply chain, we flexibly handled the spike in demand during campaigns without compromising quality and customer service. The result demonstrates our brand equity and ability to connect with customers with delicious, innovative food and compelling value for money.

Second, store expansion. In the first six months this year, we opened 655 net new stores, setting a new record. We continue to see vast opportunities across all regions and city tiers in China. KFC continued its aggressive expansion, hitting 9,500 stores in over 1,900 cities.

Notably, Shanghai became our first city to reach 500 KFC stone -- stores. Our 500th store is in the Shanghai Library, Shanghai Tushuguan, as part of our Book Kingdom Program for Kids. It features a dedicated reading area to promote the love of reading to children. It's also one of our 36 Angel Restaurants of KFC China.

The restaurant offers a warm, inclusive space for employees and customers with special needs. This showcases our commitment to positive social impact in the communities we serve. Pizza Hut opened a record 169 net new stores in the first half of the year, supported by strengthened fundamentals through the revitalization program. Healthy new store payback give us confidence for accelerated growth.

In addition, Pizza Hut reached 3,000 stores in China, a milestone that few casual dining restaurant chains can claim. Our 3000th store is in Qinhuangdao, a popular holiday destination in northern China. This resort-themed store boasts a beautiful patio with stunning sea view. In addition, it was built with eco-friendly materials and an intelligent energy management system.

Third is profitability. Our operating profit for the first half of 2023 has already exceeded the entire year of 2022. This achievement reflects our ability to capture sales and rebase our cost structure. Our [Technical difficulty] first half was below 9%.

This is the best ratio in the past decade. Now, let's talk about KFC. Our value platforms generate amazing sales results. First, Crazy Thursday.

The famous Crazy Thursday, Feng Kuang Xing Qi Si, continued to be a tremendous draw, driving 50% more sales than other weekdays. Second, Sunday Buy More Save More, Zhou Ri Feng Kuang Ping, energized Sunday sales. We captured a home consumption with our juicy whole chicken, [Foreign language] Quan Ji. We sold 22 million of this product in the first half and more than doubled itself year over year.

Third, our Weekday Value Combos, OK San Jian Tao, are gaining popularity. We add a new sizzling roasted chicken side burger [Foreign language] to enrich our entry price point offering for just U.S. $3. Customers love the new Weekday Value Combos.

Delicious and innovative food continues to delight our customers at KFC. In the second quarter, we introduced the K-zza, a creative twist on pizza that utilized our existing ingredients. We used the wrap from our Dragon Twister [Foreign language] to make the thin crust and popcorn chicken [Foreign language] as the topping. This fun, innovative, limited-time offer generated strong sales.

We see great potential for more K-zza variations in the future. K-Coffee sales grew 50%, with 47 million cups sold in the second quarter. Our iced sparkling Americano with zesty lemon [Foreign language] is the perfect drink to beat the summer heat. We use our soda fountain machine to make this sparkling drink without additional investment in the store.

It has become K-Coffee's best-ever limited-time offering. Now, let's talk about our marketing campaigns. Connecting with families and children is an important part of strengthening our brand affinity. Around Children's Day, we partnered with Sanrio [Foreign language] and sold nearly 3 million meal sets with adorable toys such as Hello Kitty.

This campaign contributed to our overwhelming success on Children's Day. Of course, these popular toys also work very well for adults as well. Pizza Hut. Let's move to Pizza Hut.

We continuously innovate to offer better products at great value. Our new [Technical difficulty] in May has been a big success and strong sales driver. Over half of the menu items are either new or upgrade from a year ago. Pizza is our biggest category, accounting for over one-third of sales.

We continue to fortify our pizza expert image by upgrading existing products and introducing new toppings. Apart from our signature Super Supreme [Foreign language] and durian [Foreign language] pizzas, we introduced a new -- new pizzas like Bolognese Pizza with beef [Foreign language] pizza. It's a familiar taste [Technical difficulty] because of spaghetti, and it has become a customer favorite, especially among children. Of course, we use quite a bit existing ingredients to simplify the store operation and to keep the ingredients fresh as well.

In addition, many customers are trading up to stuffed crust pizza [Foreign language] pizza, which accounts for nearly 40% pizza sales. Most recently, we launched Pineapple and Cream Stuffed Crust [Foreign language] to complement our other stuffed crust choices of cheese and sausage. Pizza Hut has been sharpening its value proposition and customer engagement. Our value platform Scream Wednesday successfully drove sales and traffic growth.

Every Wednesday, we offer different meal choices, from pizza, steak, rice, and pasta to appetizer at attractive price of $3 to $5 U.S. dollars. There are choices for one-person meals and for social gatherings. We continue our collaboration with Genshin Impact [Foreign language] for the second year.

This campaign significantly boosts sales and attracts many young customers. We saw more than 2 million meal sets with themed accessories, tripling last year's numbers. This wildly popular campaign helped us recruit over 1 million new members. Lavazza.

Let's switch gears to Lavazza. Lavazza continues to make good strides forward. In July, we crossed the 100-store milestone. In addition to the coffee shop business, we sell Lavazza coffee beans and capsules to premium hotels, restaurants, and other channels.

Recently, Lavazza also started supplying coffee beans to Pizza Hut to upgrade the coffee at Pizza Hut. I'm happy with the progress we have made and excited about the growth opportunity. Digital. Onto digital.

Our digital ecosystem plays a crucial role in recruiting and engaging members, driving their activities, and unlocking sales performance and potential for us. Our loyalty programs now exceed 445 million members. Member sales increased to 66%, setting a new record. Our Super App had a major update earlier this year, offering our customers a better digital experience.

We introduced interesting member-exclusive perks to tickle our customers, such as app-exclusive new products, pre-sales, and lucky draws utilizing member points. In addition, we have been working with third-party online platform to expand our reach. For example, prepaid discount vouchers [Foreign language] have been gaining popularity on short video platforms. By offering geographically specific deals, we effectively attract new members and increase spending of existing customers.

Our end-to-end digitization unleashed great potential of our restaurant general manager, RGM. Our store management team sharing initiative is progressing well at KFC and Pizza Hut. Select RGM, for the first time in our history, can now manage multiple stores. Our AI-enabled systems have streamlined administrative work to help relieve our RGMs of repetitive tasks.

By further integrating our store management system, we enhanced the visibility of store operations and cross data -- cross store data analytics. These digital tools empower our RGMs to manage multiple stores more effectively while upholding operating standards. This will be a driver for future store cost management and also address our bottleneck of new store opening. So, we are looking for more progress going forward.

Summer peak season. As we speak, we have entered our summer peak trading season. We are ready to capture summer holiday traffic with eye-catching menu items backed up by rock-solid operations. At KFC, we have brought back our crowd-pleasing fried chicken taco with a new ingredient [Foreign language].

It does not translate well, but trust us, it's a delicacy for our customer in China. At Pizza Hut, we have expanded our popular durian pizzas with a new product, Durian Coconut Lava Pizza, [Foreign language] pizza. To handle increased demand in the summer peak season, we are ramping up crew resources, securing supplies, and staying vigilant with multiple scenario planning. With that, I'll turn the call over to Andy.

Andy Yeung -- Chief Financial Officer

Thank you, Joey, and hello, everyone. Let me now share with you our second quarter performance. I'm delighted to report our robust performance in the second quarter. We achieved record revenues of $2.65 billion, representing 25% year-over-year growth.

Operating profit of $257 million also reached a record level, more than tripling that of the prior year. We accelerated new store openings. We opened 542 new stores, resulting in net new store growth of 422, setting a new second quarter record. Even though same-store sales remained below 2019 levels, we saw 25% growth in revenues and 26% growth in operating profit in the second quarter compared to the pre-pandemic levels in 2019.

We accomplished all this while operating in a challenging and volatile environment: an uptick of COVID infections started in late April, consumers continue to be value-conscious, sales materially weakened after the May 1st holiday. But leveraging our multiple scenario planning, we swiftly -- we responded by launching attractive offers to drive sales. Our sales subsequently improved in June. To provide more context, in the second quarter last year, multiple cities were under lockdown.

We are lapping last year's austerity measures and temporary relief. Now, with that, let's go through the financials. Foreign exchange had a negative impact of approximately 6% in the quarter. Second quarter total revenue were $2.65 billion in reported currency, a 25% year-over-year increase.

In constant currency, total revenue grew 32%. System sales increased 32% year over year in constant currency. The strong growth was mainly from same-store sales growth of 15%. The remaining growth can be roughly split equally between new unit contribution and the lapping of last year's temporary closures.

Dine-in sales rebounded significantly year over year while delivery continued to grow. By brand, KFC same-store sales grew 15% year over year, same-store traffic grew 21%, and ticket average decreased 5%. It was driven by successful traffic-driving promotions, the lapping of large community purchasing orders, and the decrease in delivery mix. Delivery has higher ticket average than dine in.

Pizza Hut same-store sales grew 13% year over year, same-store traffic grew 27%, and ticket average decreased 11%. It was driven by successful promotional activities and the lapping of community purchasing orders. Lower mix of delivery, which has a lower ticket average than dine in at Pizza Hut, partially offset the ticket average decrease. Restaurant margin was 16.1%, 400 basis points higher than the prior year.

Occupancy and other improved significantly year over year. This was primarily due to operating leverage derived from higher sales and ongoing benefit of cost structure rebasing efforts. These were partially offset by lapping last year's austerity measures, increased promotional activities, and wage inflation. Let me now go through the key items.

Cost of sales was 30.7%, 20 basis points lower than the prior year. We kept our cost sales -- cost of sales low despite increased promotional activities to drive traffic. Our supply chain team's hard work and innovative use of affordable ingredients contributed to the favorable commodity pricing. Cost of labor was 26.4%, 70 basis points lower than the prior year.

This was driven by operating leverage from sales growth, lower rider costs due to lower delivery sales mix, and benefit from store management sharing initiatives. This more than offset wage inflation, the lapping of austerity measures, and temporary relief last year. Occupancy and other was 26.8%, 310 basis points lower than the prior year. Rental expense and depreciation improved year over year.

Operating leverage from higher sales, store portfolio optimization, and more favorable new store rental terms all contributed to the improvement. This was offset by lapping austerity measures and higher rental relief last year. G&A expenses increased 15% year over year in constant currency, mainly from high-performing base incentive accruals and merit increases. Operating profit was $257 million, more than tripled year over year.

Our effective tax rate was 24.7%. We continue to expect our full year effective tax rate to be around 30%. Net income was $197 million, increasing 138% in reported currency. Diluted EPS was $0.47, increasing 135% in reported currency.

We generated $417 million in operating cash flow and $264 million in free cash flow. We returned $116 million to shareholders in cash dividends and share repurchases. At the end of the second quarter, we had around $3 billion in cash and short-term investments and another $1.2 billion in long-term bank deposits and notes to benefit from better interest rates. Now, let's turn to our outlook for the third quarter.

Driving sales remain our top priority. As Joey mentioned earlier, we are stepping up promotional activities and have planned attractive offers with great food at compelling values. We are also lining up exciting marketing campaigns and resources to support those initiatives to capture peak summer holiday sales. In terms of store opening, with healthy store economics and a robust store pipeline, we are confident to achieve 1,100 to 1,300 net new stores in the full year.

Our team has put tremendous effort into developing multiple store formats, lowering capex, and securing more favorable lease terms. We opened 655 net new stores in the first half of 2023. Our new stores have maintained a healthy payback of two years for KFC and three years for Pizza Hut. This gives us confidence to expand across different city tiers and regions.

Regarding margins, our store network expansion and our cost structure rebasing efforts, over the past few years, positioned us well to capture both sales and drive operational leverage since the reopening. With 40% of our current store opened after 2019, we are opening an average of one new store every five hours. Our store portfolio is well suited to operating efficiently in the evolving market condition. We expect our efforts on efficiency improvement and cost structure rebasing to continue to benefit profitability in the long term.

So, we looked at last year's record third quarter restaurant margins set a relatively high benchmark due to austerity measure and $30 million of temporary relief in the prior year. We also expect some more hiring to normalize and wage inflation of low to mid-single digits in the second half. Now, despite macro uncertainty and volatilities in the near term, our multiple scenario planning capabilities and agility position us well to capture opportunities in good times and manage the downside in bad times. We continue to focus on driving sales, improving operational efficiency, and investing in digital and supply chain for long-term growth.

Before I conclude, I would like to highlight our upcoming Yum China Investor Day to be held in September in Xi'an, China. Joey, myself, along with our leadership team, including KFC and Pizza Hut brand manager, will share updates on our strategic priorities. We have also planned food tasting during visit to our restaurants, logistic centers, and digital center. Now, through this event, investors and analysts can gain firsthand insight into the market and our business.

So, we look forward to hosting you in Xi'an. With that, I will pass you back to Michelle. Michelle.

Michelle Shen -- Director, Investor Relations

Thank you, Andy. If you are interested in attending our Investor Day in person, please reach out to the investor relations team. 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.

Ashley, please start the Q&A.

Questions & Answers:

Operator

Thank you. [Operator instructions] Your first question comes from Michelle Cheng with Goldman Sachs. Please go ahead.

Michelle Cheng -- Goldman Sachs -- Analyst

Hi, Joey, Andy. Congrats again for the very strong results. My question is about the promotion and the competition. So, as you mentioned, the market is still very promotional.

And also, we hear some smaller players are actually coming back. So, on the one side, can you discuss or share with us your observation on the competition side? And more specifically, on the margin, we still see the food cost margin manage pretty well. And particularly, can you talk about Pizza Hut? Since we have been working on this value reposition for many years, but it looks like, in this quarter, the food cost control is pretty decent. So, can you also share with us how should we think about this pricing strategy and also further savings on the food cost? Thank you.

Joey Wat -- Chief Executive Officer

Michelle, thank you. I'll talk about the promotion competition, and Andy will handle the margin question. Customers are very value cautious, for sure, but at the same time, it's not enough if we just focus on promotion. It has to be promotion -- fun promotion and good food.

And our focus is to focus on few very effective promotion platform. So, what are the famous ones? Crazy Thursday is very, very fun. It's user-generated content these days. And of course, the food there is good.

So, we have some new food like spring roll, not only normal spring roll but skinny spring roll. When the spring roll is smaller, they actually taste better. You can try it with our KFC spring roll on Crazy Thursday. And then Pizza Hut is focusing on Screaming Wednesday.

Again, you know, very powerful message, very simple message, but with great food and great offer, from steak to pizza. And Taco Bell, focused on Taco Tuesday. So, not only just random promotion but very focused promotion. And we keep doing it again and again and again.

It takes time to build to have the effect because little do people remember Crazy Thursday start from back to 2018. So, by now, it's a very familiar mechanism, and that worked beautifully. And of course, we continue to build new promotional platform. KFC, the new one will be Buy More Save More on Sunday, and that has a clear product focus called the whole chicken.

During normal times, the chicken sell for 39, but on Sunday weekend, it sell for 29. So, it's not only promotion but great food. And I think what people don't also necessarily correlate how we differentiate from our competitors in driving this promotion. We have the unique advantage of having our own very effective, powerful, agile, and nimble supply chain because without the supply chain capability to source, to innovate, and to deliver all these very affordable ingredients is almost impossible to support this kind of promotion on a sustainable basis.

Last but not least, operation team. June 1st Children's Day, we achieved 8.5 million transactions a day. That's a huge number of transactions. And the fact that our operations team can handle that is amazing.

Well, for people who are running the -- well, running the restaurant in operation, you would be able to appreciate how difficult it is to be able to handle the peak and the spike. And the IT system, it did not go down. We can continue to push our system in terms of the stability and efficiency. So, that all come together.

It's not just marketing promotion, it's supply chain, it's the digital, it's the operation. And while many competitors can probably replicate the marketing campaign, but the operation, the supply chain, digital, these are the real top core capability, very difficult to replicate. So, I'll pause here, move on to margin question.

Andy Yeung -- Chief Financial Officer

OK. Thanks, Joey. So, in the second quarter improvement in terms of margins, I think, obviously, the main driver is the operational leverage from higher sales. And also, if you look at the overall margin improvement, we continue to benefit from our portfolio optimization over the past few years.

As I mentioned earlier, you know, if you look at our portfolio, currently, you know, 40% of our store opened after 2019, and they're very much geared to, you know, working efficiently in our current operating environment. Also, we continue to benefit from the cost structure rebasing that we initiated over the past couple of years. And so, those are the key driver for margin improvement. And I think, you know, it positioned us well for the long term to operating efficiently.

Certainly, if you look at particularly on cost of sales, I think, overall, you know, commodity price -- pricing in the second quarter was slightly favorable with overall commodity inflation being favorable. But the chicken price in the second quarter, actually, we continue to experience an upward trend. And given the spot price and also our contract, we expect that to probably extend into the third quarter. So, I think for both brands, you know, they manage their [Audio gap] very well over the past few years.

Generally, we'll be balancing to expand the pricing range so that we can continue to expand our addressable customer base and balancing, you know, commodity price and also the value proposition to consumer. And we generally try to return some of the savings to our consumer. So, if you look at cost of labor, you know, it also improved 70 basis points in the quarter. And again, it's driven by the cost structure rebasing that we have.

And then also, as Joey mentioned, we have the store management sharing initiative that continue [Inaudible] our store efficiently. And that's more than offset the low single-digit labor inflation in the second quarter we experienced. And then if you look at O&O, as we mentioned, you know, biggest improvement over the past few years, we continue to structurally change our rental contract. Not only we have more variable components of that rental term, but also overall lease rent as a percentage of revenue at decade levels, right, best in the decade.

And so, I think those structurally change will continue to benefit us. And also, in terms of depreciation and also as we work down our capital investment per store, that's also very sustainable, I think. And then, you know, look at our initiative in energy savings, and also we benefit from our investment in technology. So, that A&P also, we're seeing some leverage.

And so, all that contributed to our O&O improvement. So, I think that's how we look at it. In terms of like the outlook, I think, as we mentioned, commodity prices generally are favorable, with the exception, perhaps, with chicken price in the next quarter. In terms of labor cost inflation, I think we're looking at low to mid-single digit in the second half of this year.

Again, you know -- but one thing I wanted to again emphasize a little bit is that last year, it was a special situation. Obviously, we received about $30 million of one-time relief due to COVID situation last year. And then we also have some austerity program. So, that's it.

Thanks.

Operator

Thank you. Your next question comes from Brian Bittner with Oppenheimer and Company. Please go ahead.

Brian Bittner -- Oppenheimer and Company -- Analyst

Thank you. I just want to ask about the sales trends, Andy. You mentioned that May saw a step back in demand trends, but then you regained momentum in June. Can you just add some context here? Could you perhaps talk about where your underlying trends are versus '19 or anything else regarding perhaps the consumer environment in China that you're witnessing right now just to help us all get on the same page with modeling sales moving forward?

Andy Yeung -- Chief Financial Officer

OK. Brian, thanks for the questions. I think -- as we mentioned, you know, we're pretty early for in the reopening. This is the second quarter since the reopening.

So, we're going to -- probably going to continue to see some volatilities and whatnot. Obviously, in the decline -- or like the softening in demand in May had to do with a couple of things. One, we've seen an uptick in COVID at the end of April -- starting end of April. And then the other one is, obviously, you have seen the -- some of the economic data and indicated that, you know, the macroeconomic situation is still markedly challenging.

So, continue -- so consumer, you know, obviously have experienced three-year COVID and would likely going to take some time to regain some of the confidence. And so, that's what we're seeing right now. But, you know, as we mentioned, we have multiple scenario planning, as always. So, we take quick actions as we see the change in consumer behavior.

We have very strong product offering and successful campaign. And that, as we mentioned, revitalized the sales momentum in June. And I think -- again, I think in the near term, there's going to be some volatility and uncertainty. But I think we are well positioned to capture, you know, the opportunity when it reemerge and then able to respond quickly should the situation become a little bit more challenging.

Joey Wat -- Chief Executive Officer

Brian, thank you. Let me give an overall picture of the business that might help understand the sales trend right now as well. Overall, our investors and analysts who really look at the business with a fresh pair of eyes because the business is a rather different business now compared to pre-pandemic. We might not be too obvious enough.

The 40% of our current store did not exist before pandemic. So, the same-store sales really only applied to a bit more than half of our business now because 40% of the stores are new. And even for the portfolio that existed before 2019, the business is very different, too, because the management team has taken the opportunity in the last few years of the pandemic to prune the portfolio, particularly those stores with less desirable economics. So, overall, the portfolio is better.

But even for the stores that have survived the pruning process, you bet the economics are much better with lower rent, etc., etc. And the big historical problem that we have, we used the pandemic time to sort them out as much as possible. On top of that, we have rebased the cost structure. We have completed the end-to-end digitization and also digitization of the entire supply chain process.

So, the business is more resilient, more nimble, and with better cost structure for the entire company, but also for the store economics for each store. So, it's very different. Therefore, the system sales growth is quite good and same as the profitability, and that's what we wanted. Going forward, in terms of outlook, Andy talked about Q2 -- Q3.

Obviously, we're going to focus on sales. We are going to focus on growth. We're going to focus on opening more stores and then continue to focus on delicious and innovative food that really work for our customers. But in the longer term, the macro in the short term, you know, it's hard to predict from month-to-month basis.

But, you know, China GDP has slowed down to growing probably twice as fast as other developed countries. It's not too bad, isn't it? And then it's an amazing big market. And we still serve 2 billion customers a year. And certain regional growth like in the middle of China is very nice.

The growth is very good. And therefore, we are able to open stores very fast, particularly in these, what we call, new bread basket. So, what does that mean to KFC and Pizza Hut? KFC, you can see from our speed of store openings in the last few years, we are opening a lot of stores, and we are reaching 9,500 stores in China alone for KFC. And Shanghai alone is 530.

And we're not only just opening store in lower-tier city, we are actually opening stores in all tier city. We are utilizing franchising. We are utilizing different channels such as -- some channels and newly found opportunities such as university and hospital and high-speed rail service station, and it works. And then Pizza Hut is really ready to accelerate growth after a few years of turnaround.

The margin is good, and it surpassed 3,000 mark for casual dining, which is quite difficult to get to in terms of scale in terms of casual dining. So, the smaller brands are also developing. And, you know, Lavazza just reached the 100-store milestone and also start to sell coffee beans in retail. So, going forward, we are committed, we are optimistic, and therefore, you can see our net new store opening this year is still at the rate that is record for our business in the last 36 years.

Thank you, Brian.

Operator

Thank you. Your next question comes from Chen Luo with Bank of America. Please go ahead.

Chen Luo -- Bank of America Merrill Lynch -- Analyst

Thank you, Joey and Andy. My question is on margin as well. So, if we combine first half this year with second half last year, and actually that would imply a four-quarter margin of close to 17% at the restaurant level. So, I remember many years ago, we talked about the long-term normalized restaurant margin of 17%.

I know we no longer talk about long-term market, but -- long-term target. The market, usually, will still look at the 17% as a reference. But now, we are almost there. How much upside are we going to see from here? In particular, as Andy mentioned previously, starting from Q3, we are going to see pretty high-lapping full margins.

Is it fair to say that from now on the low-hanging fruit from cost rebasing is no longer that strong and the majority of the margin expansion will come from the same-store sales or sales leveraging in the future? Thank you.

Andy Yeung -- Chief Financial Officer

Thanks, Luo Chen, and thank you for the questions. It's a wonderful question, and then it's also wonderful questions -- as you mentioned, an issue to deal with, right? Because after the reopening, after all this restructuring -- cost structure rebasing that we have performed over the past few years, after -- as Joey mentioned, our portfolio changed entirely different -- almost entirely different store portfolio. We are now, you know, obviously at multiyear, right? You know, I think at least five years, if not all-time high, in terms of margins. And we're operating very efficiently at this point.

And, you know, as mentioned, even despite the near-term volatility and challenges in the market, we are operating very efficiently. And so, I think, you know, a couple of things that I want to mention. You know, if you look at the cost structure rebasing, as we mentioned, those are very fundamental change in terms of how we operate our restaurant and also the cost structure itself. Now, in terms of 17% and margins, I'm glad that you mentioned, you know, over the past four quarter, your average hour is more there.

We don't give guidance on margins, but we just do it sometimes, right? So, we mentioned it over the past year or two, but I think we continue to focus on doing that. We're pretty confident in terms of, you know, our cost structure rebasing math. We're pretty confident that our new store performance, our new store economics at multiyear, I guess, the offering in the past in multiyear level. And so, that gives us confidence in terms of our portfolio moving forward as we open more store.

So, we look forward to that improvement continuing. However, as we always mentioned, you know, we generally look at cost of sales. We try to maintain that stability there. The reason why we do that is because we obviously have a very innovative team that can help us to mitigate some of the volatilities in commodity prices.

We also use efficiently our product that we have over the year. So, fully utilizing the resources like pork, chicken, and beef. And then also our supply chain's tremendous ability to actually lock in long-term contracts, for example, coffee bean over the last couple of years. [Foreign language] we were able to lock them lockdown three-year contracts.

However, we always have been very cautious about pricing and price increase and because the reason is that we want to make sure that our consumers continue to benefit from cost saving and also enjoy great value from our food. So, we generally try to keep things as stable. And then still sell out. You know, I think we have initiatives to continue to improve labor productivity improvements.

As we mentioned, we have the store management sharing initiative. We continue to invest in technologies and enable our team member to work more efficiently in the restaurant. But we have to also look at the ongoing labor inflation. It's a fight in our industry, right? We always have to deal with labor cost inflation over time.

So, we generally also try to keep that stable. Now, as we mentioned, O&O have improved over the years and not only in the last couple of years, but even over the past five years, 10 years. And so, as we mentioned, we are at a pretty efficient level, but we see continued room for improvement. So, that's generally how we look at the overall margin.

Obviously, the next quarter or so will be -- there'll be some anomaly on a year-over-year basis because of last year temporary relief and austerity program. But overall, I think our trajectory is the right trajectory. Thanks, Luo Chen.

Operator

Thank you. Your next question comes from Anne Ling with Jefferies. Please go ahead.

Anne Ling -- Jefferies -- Analyst

Hey. Hi. Thank you very much for taking my call. I have -- first of all, the question also on the restaurant margins.

With, you know, Pizza Hut, you know, improving and success in the restructuring, what would be the normalized restaurant margin would be over time? Can it be like, you know -- it was like -- you know, I mean, like figure, can it be as high as like, you know, KFC's like, you know, 18%-plus? And if that's the case, you know, what are the drivers? Is it more on the scale of the whole network or is it more on like, you know, driving the sales per store for further normalization? And Joey, last time, you mentioned that -- in the previous call that you would love to see further increase in the delivery or takeaway business for the Pizza Hut side. Any strategy that we can facilitate this? Thank you.

Andy Yeung -- Chief Financial Officer

Yeah. Hi, Anne. Thank you for the questions. Regarding Pizza Hut, we're very happy to see that, you know, the revitalization program have achieved very strong result over the past last two quarter already.

We continue to see very strong traffic growth, continue to see strong sales growth. And as Joey mentioned, that's fantastic product that coming out from Pizza Hut. And also, Pizza Hut, over the past few years, as we have kept pricing stable, have continued to improve its value propositions to consumers. Value is great.

And then when you look at the brand, we -- resonating really well with consumer as well and especially with some of the campaign, Genshin and other, that really connect with our new customers. So, I think it's wonderful that they make this transformation because I think, you know, expand the pricing range, improve their value propositions, you know, continue to drive their addressable market. So, now we're at 3,000 store level. You know, obviously, it has great opportunity to grow into even more store.

And in fact, if you look at their store opening, so opening right now is at record level. And if you look at, you know, in the quarter alone, we probably opened more restaurant than, you know, last couple of years combined. And so, I think that's tremendous progress. And I think we continue to hope to see KFC more network expansions, especially driven by satellite store and smaller store format, and then continue to build that value propositions.

And then also, as they have done in the last couple quarter, to improve their margins over time. So -- but when you say normalized, I think, you know, normalize, you know, I think, right now, margins are even higher than 2019. I don't know when will you consider being normalized, but I think they are in the right trajectory, for sure.

Joey Wat -- Chief Executive Officer

I think, Anne, the ultimate question for Pizza Hut is not necessarily only about margin. Our goal for Pizza Hut going forward after turnaround is to continue to work on its resiliency and growth because after turning around, that's what we want, the growth. The growth without resiliency is not too comfortable, isn't it? So, growth -- resiliency and growth. And then, of course, next up is the more strategic mode, right? We are very consistent with our thinking, RGM.

So, the question is how to get there. What's the key to unlock to get to resiliency, to get more sales, to manage the investment, and to get profits in the short term, long term? Well, our view of the key, which we have been working on, is the satellite store model. It's -- overall, we look at the result of the new store payback Pizza Hut moved from four years to three years in which satellite stores really delivered. These are the smaller stores, focused on takeaway and delivery, which is your second question.

The satellite store do the trick, and satellite store require less investment. It requires a different menu because they are mainly delivery and takeaway driven. And the profit is very good. And the payback is two years.

So, when we put the satellite store and the other store together, the overall payback is three years. So, we have found the key, which is satellite store. We just need the time to build more and more and more and more from top Tier 3 all the way to lower-tier city. And the growth story of Pizza Hut is not difficult to understand.

KFC only are in 1,900 cities in China, with 9,500 stores. And Pizza Hut, we only have 3,000 stores in 700, 800 cities in China. So, that's more than a thousand cities in China that have Pizza Hut does not -- have KFC, does not have Pizza Hut. So, you can see why we are quite confident about the growth potential of Pizza Hut in terms of sales, profit, resiliency.

Thank you, Anne.

Operator

Thank you. Your next question comes from Lin Sijie with CICC. Please go ahead.

Sijie Lin -- CICC -- Analyst

Thank you, Joey and Andy. I have a follow-up question on promotion and competition. So, we've seen that our insistence on value for money leads to a very resilient sales recovery. But we've also seen increasing promotion and more value combos like OK San Jian Tao.

So, do we think this is only because people are value-conscious under this dynamic environment or this also has a relationship with more intense competition from McDonald's, from [Inaudible] and all other competitors? And how will this impact our ticket average and sales per store? Thank you.

Joey Wat -- Chief Executive Officer

Thank you. So, OK San Jian Tao is new. Right now, it's delivering about low single digit in terms of sales mix. The key thing here is, well, of course, customers are very cautious.

It's -- it doesn't hurt to open up the price range. What does that mean? In the past, we did not have that price at 19.9 yen as a combo. When we introduced it, the most critical thing that we are looking for is incremental sales, in particular, incremental same-store sales. What's not to like? It's fantastic.

New business for us. And then in terms of its performance across the city tier, well, people might think that it works very well in low-tier cities. Actually, not really. It works better in top-tier cities because this is more for what we call [Foreign language] the functional consumption for the lunch.

So, it was better for the top-tier city. But for lower-tier cities, it actually gives us insight. We might -- we still can open more stores. We can more -- open more in lower-tier city to capture that functional consumption.

So, we are happy with that. And the -- again, the key to unlock this OK San Jian Tao, the retail is ability in supply chain, whether we can source such affordable ingredient to deliver that price point and still at reasonable profit. And our team did it.

Sijie Lin -- CICC -- Analyst

Thank you.

Operator

Your next question comes from Lillian Lou with Morgan Stanley. Please go ahead.

Lillian Lou -- Morgan Stanley -- Analyst

Thanks, Joey and Andy, for all the answers I have follow-up questions on same-store sales growth. So -- because, Joey, you just mentioned that our store network right now is very different from pre-COVID. So, when we look at the same-store sales growth compared to pre-COVID i.e., 2019 level, in the second quarter, it was still 10% below. But if we look at more on the holistic basis, because we're adding more and more smaller stores, does that mean that actually our same-store sales growth will be below 2019 level for a longer period of time, even though our underlying operation is already kind of close to back to normal? That's more like mathematics problem -- question.

And also, in the operation perspective, what has been dragging our same-store sales growth below normal level, in particular? Is it still the traffic hub stores or in certain area or in certain tier of cities or store format? Thanks a lot.

Andy Yeung -- Chief Financial Officer

Lillian, so let me try to clarify this. Our system sales was 25% year over year. Our same-store growth was 15% year over year. And then if you adjust for the impact of temporary store closure last year, our system same-store sales growth, a lot of time people use that in the industry, would be about 24%.

And, you know -- and then sorry, our system growth is 32%. So, if you look at that, our adjusted, you know, like same-store sales growth would be close to 24% year over year. So, I think even -- you know, we mentioned some of the slowing down in the -- in May period. In fact, you know, our same-store sales growth were very robust and very strong.

And, you know -- and obviously, you know, the driver for the different tiers, different -- slightly different. You know, Joey mentioned, the lower-tier cities generally, you know, grow a little bit faster. And then you mentioned about the TMT space. TMT space are very important for us, and we continue to see the robust recovery over there.

You know, and if you look at tourist locations, I think, you know, it's doing quite well, a couple quite well. Even at the major transportation hub for domestic travel, for high-speed rail road, and for domestic flight, they continue to improve. I think, at that trajectory [Inaudible] Obviously, international travel, flight travel will be softer and will probably take a longer time until the flight schedule got sorted out. And so, I think in terms of our same-store sales growth, it's pretty robust.

So, I don't know if Joey have anything to mention.

Joey Wat -- Chief Executive Officer

For the existing store that opened before 2019, as Andy mentioned, the transportation hub actually coming back during the May and particularly during the holidays. And by the way, that's sort of another consumer behavior right now. There's consumption during the holiday and festival amazingly well. It's just in between, it's a bit more depressed, but we have programmed to manage that.

But for tourist locations, actually, they have recovered really, really well and particularly in the Tier 2 cities, you know, like Xi'an and whatever. So, these sort of tourist destination Tier 2 cities are doing very well, back to 2019 level already. But to answer your other question about the holistic same-store sale, well, here the ultimate question is how to continue to grow our same-store sales, particularly when our stores are getting smaller and smaller and smaller, particularly the newly opened one, because the smaller stores require less capex and the payback is good. Well, it sounds silly, but why not growing the same-store sales outside the store then? Therefore, it's rather important to continue to drive the delivery, takeaway, and that goes for both KFC and Pizza Hut.

And therefore, I've been emphasizing on how important it is to grow the off-premises and the new retail. New retail is still low single digit compared to the entire Yum China sales, but the absolute number is not small and it provides very nice, resilient sales driver, particularly during the tough times. And let me be a bit more specific about KFC. How do we do it outside the store? So, if you come to China, have opportunity, particularly during our Investor Day, you will see more and more and more of our KFC store will have a window opened up so that you don't even need -- customers don't even need to go inside the store to get your coffee or ice cream or whatever snack or meal.

And that improved convenience helped. And you bet, we are doing it at scale at -- whenever we could. And then you will see more coffee trucks or stand-alone coffee. Well, the systems sales growth is nicely, but if we look at our KFC coffee compared to last year, it only increased by 50%, which is not too bad, isn't it? And the coffee investment is low.

It's lovely. It's so cute, in any tourist location or anywhere without a fixed location. It's OK. So, we only have about 200 right now, but you bet, we're going to have more.

And then during the holiday and festival, there's the pop-up stores. Well, actually, it's not something new. We just don't talk enough about it. We do a lot of the pop-up store during Chinese New Year.

And right now, it works for holiday and festival, too. So. It doesn't matter -- well, to a certain, it matters, but we don't want the size of the store to limit our same-store growth because we can go outside. You will see more and more and more breakfast kiosks around the store these days.

It works both for KFC and Pizza Hut. You know, even though it's already very convenient to pick up breakfast from our store, we further improved the convenience by bringing the breakfast to the subway station, etc., etc. So, I hope that gives you a sense about how do we drive the holistic same-store sales despite our stores are getting smaller. Thank you.

Operator

Your next question comes from Christine Peng with UBS. Please. Please go ahead.

Christine Peng -- UBS -- Analyst

Thank you, management, for the presentation, as well as answering most of the questions I think investors care about. So, I have a very quick question regarding the capital allocation. So, if you look at the first half 2023 cash -- free cash flow, etc., so basically all the margins suggest that the cash accumulation for the company has been very strong. But as we look at the cash dividends and share repurchases, it was not really suggesting a big pickup compared with the pandemic period.

So, I was just trying to understand what's the logic behind this and what's the future thought in terms of distributing more cash toward investors. Thank you.

Andy Yeung -- Chief Financial Officer

Thank you, Christine. I think, you know, a couple of things. One is that our capital allocation, as always, is focusing on driving organic growth, and so it's on store opening. It's on store remodeling.

That generally capture more than 60% of our capex spending. And then we also look into investing, obviously, you know, new brand and also digital and supply chain to make sure that we continue to run our operations effectively, efficiently, and also accurately so that we can deal with different uncertainty. The other one is, you know, for cash allocations, obviously, we want to have a strong balance sheet to make sure that we can deal with any contingency that may come up. Occasionally, opportunistically, we look at investment, especially investment that will boost our capabilities, both in the technologies, in our store operations, and our supply chain.

We are very committed to returning capital to shareholder. You know, if you look at -- in the quarter, we have returned more than $110 million to shareholder. The pace of share repurchase obviously will vary depending on a number of factors, but I think we hold very strong commitment to return excessive cash to shareholder. Dividends, as we have done so in the first quarter this year, we have raised dividends, you know, at the early part of this year by almost 8%, 9%.

And so, we will revisit, obviously, dividend policy with our board every quarter and every year. And so -- but again, we're very glad, our strong operating performance generate good operating cash flow and free cash flow in the second quarter in the first half this year. And so, we will continue to return that excess cash to shareholders for sure. Thanks, Christine.

Operator

Thank you. That is all the time we have for questions today. I'll now hand back to Ms. Michelle Shen for closing remarks.

Michelle Shen -- Director, Investor Relations

Thank you for joining the call today. If you have further questions, please reach out through the contact information in our earnings release and our website. 

Joey Wat -- Chief Executive Officer

Thank you.

Andy Yeung -- Chief Financial Officer

Thank you.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Michelle Shen -- Director, Investor Relations

Joey Wat -- Chief Executive Officer

Andy Yeung -- Chief Financial Officer

Michelle Cheng -- Goldman Sachs -- Analyst

Brian Bittner -- Oppenheimer and Company -- Analyst

Chen Luo -- Bank of America Merrill Lynch -- Analyst

Anne Ling -- Jefferies -- Analyst

Sijie Lin -- CICC -- Analyst

Lillian Lou -- Morgan Stanley -- Analyst

Christine Peng -- UBS -- Analyst

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