Yum China (YUMC, Financial), the $14.2 billion fast food restaurant chain, registered (-)0.4% year-to-date revenue growth to $2.88 billion and 27% profit growth to $282 million in the second quarter (9.8% margin vs. 7.7% in the year-prior period).
Total costs and expenses declined by 4.4% resulting in better margins compared to a year earlier despite having little decline in revenue.
"I am pleased with our overall performance during the quarter with same-store sales up 3% and system sales up 7% on the back of continued strength at KFC. Operating profit, restaurant margin and net income all showed robust improvement.
"We are committed to building one of the world's leading restaurant companies and are executing against a plan that we have developed towards this goal. We are making progress in the key themes we are investing in – loyalty programs, digital and delivery capabilities and continued upgrade of restaurant assets and optimization of store formats. We are pleased to report some encouraging results: Loyalty members for KFC and Pizza Hut have surpassed 100 million in total, and mobile payment exceeded 40% of our company sales in the second quarter. Over 4,900 of our restaurants offered delivery service. Delivery sales accounted for 13% of company sales in the second quarter.
"We also completed the acquisition of an 80% stake, on a fully diluted basis, in Daojia, an online aggregator platform with two brands focusing on higher-end delivery market segment, for a cash consideration of $36.7 million to the selling shareholders and a capital contribution of $25 million to Daojia. We see this acquisition as complementary to our existing delivery business, and it provides valuable operational and technological expertise." – Micky Pant, CEO
Valuations
Yum China is overvalued compared to its peers. According to GuruFocus data, the company had a trailing price-earnings (P/E) ratio of 27.3 times vs. 24.8 times, a price-book (P/B) ratio of 6 times vs. 2.9 times and a price-sales (P/S) ratio of 2 times vs. 1.1 times.
The company has not paid dividends while average 2017 revenue and earnings-per-share estimates indicated forward multiples 2.06 times and 25.6 times.
Total returns
Yum China outperformed the broader Standard & Poor's 500 index having generated 41.9% total gains vs. the index’s 11.05%.
Yum China
According to filings, Yum China Holdings' U.S. office is located at Plano, Texas, which carries on the key bookkeeping, record-keeping and day to-day management functions of the holding company. The company’s operational headquarters, meanwhile, is located at Hong Qiao Road, Shanghai, People’s Republic of China.
Yum China separated from Yum! Brands Inc. (YUM, Financial) in October 2016, becoming an independent, publicly traded company (1).
In exchange for its separation from its parent company, Yum China pays a license fee to Yum equal to 3% of net system sales from both its own and franchise restaurants. In contrast, Yum China owns the East Dawning and Little Sheep intellectual property and pay no license fee related to these concepts (2).
Yum China is the largest restaurant company in China with more than 7,500 restaurants as of year-end 2016.
The company has a growing restaurant base that consists of China’s leading restaurant concepts, including KFC, Pizza Hut Casual Dining, Pizza Hut Home Service, East Dawning, Little Sheep and Taco Bell.
In addition, the company has the exclusive right to operate and sublicense the KFC, Pizza Hut and Taco Bell brands in China and owns the East Dawning and Little Sheep concepts outright.
Yum China was the first major global restaurant brand to enter China in 1987 and has developed deep experience operating in the market, according to filings.
As of December 2016, Yum China owned and operated approximately 90% of its restaurants while franchisees contribute to its revenues on an ongoing basis through the payment of royalties based on a percentage of sales.
KFC is the leading quick-service restaurant brand in China in terms of system sales and number of restaurants. As of December 2016, KFC operated over 5,200 restaurants in over 1,100 cities across China (3).
Yum China has two reportable segments: KFC and Pizza Hut Casual Dining.
In 2016, Yum China owned 74.9% (3,913) of all KFCs in China and 98.6% (1,690) of all Pizza Huts. Meanwhile, the company registered 3% and 1% same-store sales growth year to date in its KFC and Pizza Hut restaurants.
KFC
Revenue in the KFC segment fell (-)0.8% year over year to $2 billion (70% of all Yum China sales year to date). The operating margin was 17.9% (most profitable) vs. 14.8% in the same period last year.
Pizza Hut Casual Dining
Revenue in this segment grew 1.7% year over year to $847 million (29.4% of all sales), and the segment had a margin of 11.5% vs. 6% in the same period last year.
Sales and profits
In the past three years, Yum China registered revenue growth decline average of (-)0.74%, profit growth of 58.5% and profit margin average of 4.09%.
Cash, debt and book value
As of May, Yum China had $892 million in cash and cash equivalents and $27 million in capital leases with debt-equity ratio 0.01 times (vs. 0.012 times in December). Shareholder equity climbed by $292 million while no debt was incurred in the five-month period.
Of Yum China’s $4 billion assets 5.2%Â were goodwill and intangibles while book value has increased by 11.8% year over year to $2.7 billion.
Cash flow
From January to May, Yum China increased its cash flow from operations by 11.8% year over year to $473 million. Capital expenditures were $177 million leaving the restaurant chain with $296 million in free cash flow (vs. $251 million in the same period last year). The company also allocated 10% ($30 million) of its free cash flow in share repurchases while $17 million in capital obligations and others.
Yum China authorized a $300 million share repurchase program in February. The company repurchased about 1.1 million of its shares on average price of $36.27 each (vs. $37.07 at the time of writing).
In the past three years, the restaurant chain generated $1.08 billion in free cash flow, repaid $904 million in debt (net any issuances) and raised $460 million in share issuance.
Conclusion
Yum China exhibited steady business growth so far this year albeit weaker (slight decline) in its biggest business generator –Â KFC –Â in China. Brought by better operational costs management, the company was able to eke out more profitability for its shareholders in recent times.
Meanwhile, the restaurant chain did show a strong balance sheet and steady cash flow generation –Â having required no debt intake in recent years.
Eight analysts have an average price target of $40.8 per share vs. $37.07 at the time of writing. Using three-year revenue growth average multiplied by 1.5 times sales and a 20% margin resulted in a $21 per share figure.
In summary, Yum China is a pass.
Notes
(1) Company filings
In connection with the separation of the company from YUM, Yum! Restaurants Asia Pte. Ltd. (“YRAPL”), a wholly owned indirect subsidiary of YUM, and Yum Restaurants Consulting (Shanghai) Company Ltd. (“YCCL”), a wholly owned indirect subsidiary of Yum China, entered into a 50-year master license agreement with automatic renewals for additional consecutive renewal terms of 50 years each, subject only to YCCL being in “good standing” and unless YCCL gives notice of its intent not to renew, for the exclusive right to use and sublicense the use of intellectual property owned by YUM and its subsidiaries for the development, promotion and operation of the KFC, Pizza Hut and, subject to achieving certain agreed upon milestones, Taco Bell brands and their related marks and other intellectual property rights for restaurant services in the PRC, excluding Hong Kong, Taiwan and Macau.
(2) Company filings
The KFC, Pizza Hut, East Dawning, Little Sheep and Taco Bell brands are collectively referred to as the “brands.” The KFC, Pizza Hut Casual Dining, Pizza Hut Home Service, East Dawning, Little Sheep and Taco Bell concepts are collectively referred to as the “concepts.”
(3) Company filings
Measured by number of restaurants, we believe KFC has a 2-1 lead over the nearest Western QSR competitor in China and KFC continues to grow in both large and small cities. Similarly, Pizza Hut Casual Dining is the leading casual dining restaurant (“CDR”) concept in China as measured by system sales and number of restaurants. We believe Pizza Hut Casual Dining, with over 1,700 restaurants in over 400 cities as of Dec. 31, 2016, has an approximately 6-1 lead in terms of restaurants over its nearest Western CDR competitor in China.
Disclosure: I have no shares in any of the companies mentioned.
