Yum China (9987.HK) 3Q23 trails behind expectation
- Yum China 3Q23 trails behind expectation on slowdown in same-store sales, and currency impact
- Net store expansion of 500 in 3Q23, with 1,155 net new store openings YTD
- 4Q23 is a seasonally soft quarter, typically accounting for c.10-11% of estimates.
- Our last rating stood as a BUY with TP under review.
A tempered quarter. Yum China (9987.HK) adjusted net earnings rise of 19% to US$248m, came in trailing behind expectations on the back of currency exchange impact of roughly 6%. Separately, same-store sales slowed to 4% in Yum China (KFC: +4%; Pizza Hut: +2%) versus 9M23 of 8% (KFC: +9%; Pizza Hut: +7%) in 3Q23. Adjusted operating profit rose 3% to US$327m, slowed by normalisation of labour costs, and a mid-single digit raise for frontline staff. Quarterly DPS of US$0.13/sh was declared, while 2.9m shares was repurchased in 3Q23.
Enrichment in menu offering and store expansion priority to address rise in competition. Pressure on ticket average and competition remain key concerns of the market. To address this, Yum China continues to enrich its core menu offering. Beef burger, and whole chicken categories combined made up more than 6% of KFC sales mix. With rising cost-consciousness behaviour from consumers, Yum China has been expanding their price ranges across brands. At Pizza Hut, Yum China has expanded their pizza selection priced below Rmb50. At KFC, the Company has extended to Rmb19.9 3-item value combos to address customer needs. In 3Q23, the Company recorded a net store opening of 500 stores, with a combined total of 1,155 net new stores in 9M23 and remains on track to meet 1,400-1,600 stores. Looking ahead, 4Q is a seasonally soft quarter, accounting for c.10-11% of full-year adjusted earnings historically. The Company no change in store expansion guidance to open 1,400-1,600 stores as updated during Investor Day in Sept’23, with capex unchanged between US$700-900m. Yum China remains fundamentally strong, with a net cash position at US$4.2bn (Sept’22: US$3.8bn) We will review our earnings subsequently. Our last rating stood as a BUY rating, with TP under review.
Key Summary
3Q23 revenue increased by 9% y-o-y to US$2.91bn, or c.15% y-o-y increase in constant currency. Same-store sales growth slowed to 4% y-o-y in 3Q23, where KFC recorded 4% increase y-o-y and Pizza Hut at 2% y-o-y. The Company had opened 500 net new stores in 3Q23, with total store count reaching 14,102 as of 30th of Sept. By sales mix, delivery as % of Company sales contracted by 3ppt to 35% of sales, in-line with the normalisation in dine-in store traffic. Operating profit rose 2% to US$323m. The slowdown in operating profit increase is primarily on a 1.8ppt increase to 25.3% of sales in payroll and employee benefits, on the back of normalising frontline staff members, a mid-single digit increases in salaries for frontline staff. Food and paper as % of sales contracted 0.4ppt to 31.1%, while occupancy and other operating expenses increased by 0.4ppt to 26.6%. Overall OP margin contracted 0.6ppt to 11.7%. Excluding temporary reliefs, adjusted operating profit rose 21% y-o-y in constant currency.
In 3Q23, Yum China repurchased 2.9m shares for US$157m. As of Sept’23, c.US$870m remained available for future share repurchases. The Company declared a quarterly DPS of US$0.13 in 3Q23.
How does the Company view the rise in competition in the restaurant industry? The Company views rising competition as a positive sign with greater investments by domestic and international players, particularly for the chain-store business model. The Company noted vibrant competition in the lower tier cities, where Yum China has been investing heavily into. The Company has launched Chinese-style burgers in Tier 2 cities, with price point competitive. Their strategy tries to adapt to lower tier cities’ demand.
The Company’s operating profit growth has slowed relative to sales growth in 3Q23, which is a different trend to 1Q/2Q, why? Labour costs has been increasing steadily, where historically the Company has been reducing the pressure from occupancy costs, through store portfolio organisation. Same-store sales levels remain 10% below 2019 levels.
How should we view the ticket average pressure, with the ongoing value campaign to broaden price ranges and to sell more coupons on tiktok? For example, KFC ticket average is still higher than 2019 levels, thanks to higher delivery sales mix, where ticket average is higher generally. Second, breakfast daypart saw a solid recovery in 3Q23 which command a lower ticket average in general.
With the normalising of labour costs, and absence of subsidies, how should we view the operating profit margin, especially with a hike in store expansion going forward? The Company will continue to focus on how the new store opening performance with KFC rough payback of around 2 years, and Pizza Hut at 3-years. As long as store economic remain steady, they will remain focused on store expansion.
Was there a fall-off in festivities, or would there be any further details regarding the softness in sales trend? July-August was pretty firm with school holidays and with a residual of pent-up spending. However, Mid-Autumn-National Day saw softer sales than expected.