In its first full year since separating from Yum Brands, Yum China (YUMC 0.62%) stock climbed 53% in 2017, making it one of the top performing restaurant stocks of the year. The exclusive operator of Kentucky Fried Chicken ("KFC"), Pizza Hut, and Taco Bell chains in China reported steadily improving quarterly results last year, and another rally could be in store as the company continues to expand its footprint across a huge Chinese market.
Overcoming a difficult period
Yum China's restaurant chains have spent the last three years rebuilding their brand image after dealing with food safety issues in 2013 and 2014. These problems caused same-store sales growth to plunge from 4% in 2012 to a negative 15% in 2013. Take a look at Yum China's yearly same-store sales trend below.
| Metric | *2017 | 2016 | 2015 | 2014 | 2013 | 2012 |
|---|---|---|---|---|---|---|
| Same-store sales growth | 4% | 3% | (4%) | (4%) | (15%) | 4% |
Data source: Yum China Holdings. *2017 data is year to date through Q3 2017.
A combination of various factors led to Yum China's recovery, including a focus on running more efficient restaurants, introducing innovative menu items, and investing in digital ordering and marketing. The result has been dramatically improved traffic leading to 6% growth in same-store sales in the third quarter of 2017.
Better restaurant-level efficiency led to growth in operating profit of 23% year over year over the first nine months of 2017. However, a higher share count and a negative impact from currency fluctuation knocked earnings-per-share growth down to 9%. Excluding currency changes and other one-time expense items, earnings per share increased 15% year over year for the same period.
The strong year led management to initiate the first quarterly dividend of $0.10 per share, which represents an annual dividend yield of 0.87% as of this writing. Management intends to gradually increase the dividend over the long term, which reflects their confidence in Yum China's future growth.
Image source: Yum China.
China is a huge market
Yum China has a lot of momentum entering 2018. The growth of its loyalty program is a good sign of how well KFC and Pizza Hut are resonating with Chinese consumers. Total members have grown from 93 million in the first quarter to 120 million as of the third.
Management has also been very clever in leveraging the growth of the loyalty program with the power of social media to attract young customers. For example, earlier in 2017, KFC ran a promotion by digitally delivering coupons to loyalty members that offered Original Recipe Chicken and mashed potatoes at the same prices these items were launched in 1987. This promotion drove more than 80 million views on social media and kick-started a strong year.
In addition, Yum China has built out a strong digital ordering business, with mobile payments generating 45% of Yum China's total sales in the third quarter. Digital is a must-have for any restaurant chain in China, which is seen as the most cashless society in the world. The company has maintained a lead in digital compared to its competitors, and management sees digital ordering and delivery as a growth opportunity and a valuable tool to sign up more loyalty members.
Looking beyond 2018, Yum China has plenty of room to grow. Big picture, management believes they can triple the number of restaurants over the next two to three decades. And the company just opened its first Taco Bell in Dec. 2016, giving the company another major brand to generate growth going forward.
