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KFC and Pizza Hut Stores Shuttered by Coronavirus Take a Bite Out of Yum China's Forecast

By Nicholas Rossolillo - Feb 9, 2020 at 12:43PM

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The news is terrible, but should be temporary.

Yum China (YUMC 0.27%) -- sole licensee of KFC, Pizza Hut, and Taco Bell in China from former parent Yum! Brands (YUM 0.06%) -- finished 2019 with solid results. The quarterly update was partially eclipsed by the now infamous, and as of yet vaccineless, novel coronavirus. The disease is becoming a disruptive force for any business that has operations in China, let alone a business that is almost completely reliant on the nation.

As could be expected, management said it has shuttered stores in compliance with Chinese regulations trying to control the spread of coronavirus, leading to a removal of most financial guidance for 2020. It's an unnerving situation, but likely a very temporary one.

The good news first

In the fourth quarter of 2019, Yum China's revenue increased 6% from a year ago, boosted by new stores (the company ended the year with 9,200 compared with 8,484 at the end of 2018), a 3% increase in comparable sales at existing KFC locations, and flat comparables at the work-in-progress Pizza Hut. Between better restaurant profit margins from a year ago, share repurchases, and a big equity gain in the company's investment in Chinese delivery and group buying website Meituan Dianping, adjusted earnings per share doubled in Q4. Added to the rest of the year's results, Yum China did pretty well -- given a sluggish Chinese economy exacerbated by the U.S.-China trade war.

Metric

2019

2018

Change

Revenue

$8.78 billion

$8.42 billion

4%

Operating expenses

$7.88 billion

$7.47 billion

5%

Earnings per share (EPS)

$1.84

$1.79

3%

Adjusted EPS

$1.88

$1.53

23%

KFC restaurant margin

17.8%

17.9%

(0.1 pp)

Pizza Hut restaurant margin

11.1%

10.3%

0.8 pp

Pp = percentage point. Data source: Yum China.

Also helping was Yum China's new wholly owned "COFFii & JOI" brand, aimed at the burgeoning coffee culture in China, being led by the expansion of Starbucks and Luckin Coffee. Management said it now has 53 COFFii & JOI locations in 10 cities. Other organic restaurant chains received support in the last year, like the Little Sheep hot-pot restaurant chain which now has 300 locations in 11 countries -- including its first-ever stores in New Zealand and Myanmar. Yum China also started opening new fast-food stores inside China's gas stations, as outlined during the investor conference last year. And Taco Bell continues to be experimented with, and now has seven stores open in Shanghai.

On the digital front, Yum China is impressive. KFC and Pizza Hut have massive followings across the Pacific; KFC has over 215 million loyalty rewards members and Pizza Hut over 70 million. Growth in these digital tools likely isn't over, either, as the huge loyalty-customer base increased 35% year over year at KFC and 33% at Pizza Hut. Digital orders accounted for 61% of the total in Q4, providing a template for digital and delivery efforts for U.S. restaurant brands battling over evolving consumer preferences.

Yum China currently trades for 23.3 times 2019 adjusted earnings per share, a reasonable valuation given the company's growth and massive potential for further expansion.

A KFC store in China

Image source: Yum China.

And now the bad news

Some of that growth is going to get put on pause, though. Coronavirus is currently wreaking some havoc on Yum China. According to its chief financial officer Andy Yeung, on the Q4 2019 conference call, about a third of all stores have been shuttered due to travel restrictions and other government work to contain the spread of the disease. It remains to be seen whether more closures will be needed, and how long the closures will last. Traffic at the stores still open has dropped drastically.

Granted, this time of year is always quiet for businesses in China. The Chinese New Year celebration -- which was on Jan. 25 in 2020 -- always leads to store closings and reduced hours in observance of the holiday. However, after adjusting for New Year's, Yeung said traffic is down 40% to 50% at the Yum China restaurants still in operation.

Management said it could incur operating losses in the first quarter of 2020, and for the full year, if the coronavirus disruption continues. Specific numbers weren't provided as the situation is still rapidly changing. Shares are down 14% from all-time highs reached in mid-January, just before the outbreak of coronavirus in China was officially acknowledged.

Providing a backstop against further declines, though, was management (correctly) maintaining its long-term focus. While the 2020 plan could get altered if containment efforts persist, Yum China still expects to spend $500 million to $550 million this year to open another 800 to 850 stores (excluding any permanent closures). That's up from the $435 million in capital expenditures shelled out in 2019.

Things could get rough for the stock over the next few weeks or months, but the long-term outlook still looks rosy for Yum China. I'm holding off making any new purchases for now, but may change my mind once there's more clarity on the specific financial impact on the business from coronavirus.

Nicholas Rossolillo and his clients own shares of Starbucks and Yum China Holdings. The Motley Fool owns shares of and recommends Starbucks. The Motley Fool owns shares of Luckin Coffee. The Motley Fool has a disclosure policy.

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