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Yum China Turns in Mixed Numbers on Possibly Its Last Earnings Call

By Nicholas Rossolillo - Aug 2, 2018 at 10:00PM

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China’s largest restaurant chain had a difficult but not terrible second quarter.

It's been a news-heavy week for Yum China (YUMC 4.11%), the exclusive licensee of KFC, Pizza Hut, and Taco Bell in the world's most populous country. Less than two years after splitting from former parent Yum! Brands, Chinese investment firm Hillhouse Capital is apparently interested in acquiring the fast food chain.

A few days after that headline broke, Yum China reported a mixed bag of results from its second quarter 2018. If Hillhouse pulls the trigger, this could be the last quarterly report investors get.

The quarter's numbers

Metric

Q2 2018

Q2 2017

YOY Increase

Revenue

$2.07 billion

$1.84 billion

12%

Operating expenses

$1.88 billion

$1.67 billion

12%

Earnings per share

$0.36

$0.31

16%

KFC same-store sales increase (decrease)

0%

4%

N/A

Pizza Hut same-store sales increase (decrease)

(4%)

0%

N/A

Chart by author. Data source: Yum China quarterly earnings.

Yum China's top and bottom-line numbers looked pretty good, but same-store sales weakness weighed down results. Because of flat performance at KFC's existing stores and another drop at Pizza Hut, average restaurant profit margins fell to 15.1% compared with 16.6% in 2017. Management said consumer spending in China has softened as of late, so increased promotional activity was necessary. Paired with aggressive deals from competitors, foot traffic in stores suffered.

To be fair, Yum China was firing on all cylinders last year, so lapping those strong numbers was going to be difficult. CEO Joey Wat also reminded investors that while same-store sales is an important driver of profit margins, the primary goal is growing the total number of restaurant locations in the developing Chinese market.

A close-up shot of a plate of fried chicken strips.

Image source: Getty Images.

On that front, Yum China has now opened 365 new locations in 2018 through the end of the second quarter, bringing its total store count to 8,198. That's a better than 6% increase from the year prior, and don't expect that expansion to slow down. The chain thinks that the country can eventually support 20,000 KFC and Pizza Hut stores. Plus, Yum recoups its investment into a new build on a pretax basis in as few as two to three years. Thus, even though same-store sales were a drag, Yum still grew at a decent clip thanks to its aggressive push for more restaurants.

What happens next?

As for other goings-on at the company, expanding digital and delivery initiatives are still priorities. Investing in technological capabilities is an important way Yum is managing the high single-digit growth in wages in China.

Those investments continue to yield results, with delivery across the company growing by double digits again. KFC rewards members are up 50% year over year to 135 million, and KFC deliveries are up 33%. Pizza Hut rewards members are up 20% year over year to 45 million, and delivery is up 18%.

Part of the original reason Yum China gained independence from Yum! Brands was to have more flexibility in tailoring its menus to its unique market. That is also an ongoing project, especially at Pizza Hut, where rekindling consumer interest remains elusive. A new store concept recently opened in Shanghai to elevate the brand's image -- because Pizza Hut is upscale in China. At KFC, breakfast, coffee, and dessert have been targeted as key growth drivers. KFC launched a sparkling coffee in the second quarter and expanded its ice cream menu.

The interior of the new Shanghai Pizza Hut. Chairs and walls are in neutral white with soft neutral brown accents and modern lighting.

The interior of the new Shanghai Pizza Hut. Image source: Yum China.

Yum China's second quarter was mixed, but that's okay. The company continues to make progress on its most important initiatives and is maintaining its status as China's largest restaurant chain. Details regarding a potential buyout are still forthcoming, but for now, investors can chalk up this report as a win for the company as it tries to best last year's blowout numbers.

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