The operator of KFC and Pizza Hut restaurants in China reported its same-store sales rose 8% year- over-year in the first quarter

Key Takeaways:

  • Yum China recorded strong sales growth and its highest quarterly restaurant margin since 2017 on sales leveraging, improved efficiencies, cost controls and temporary relief
  • The restaurant operator said its recovery from three years of Covid controls will be ‘gradual and uncertain,’ noting same-store sales remain below pre-pandemic levels


By Doug Young

After serving up some cautiously optimistic financials three months ago, Yum China Holdings Inc. (YUMC.US; 9987.HK), operator of KFC and Pizza Hut restaurants in China, has just followed with a second helping of financials showing strong signs of recovery after three years of pandemic indigestion.

Topping the menu in the company’s latest results was a restaurant margin that reached a six-year high as China’s largest restaurant operator benefited from steps it took over the last three years to improve its operation efficiency. Not far down the menu, the company also reported same-store sales growth in the first three months of the year.

“Our performance was enabled by the execution of our RGM (Resilience-Growth-Moat) strategy over the past few years. Today, we are more agile and responsive to the dynamic operating environment with enhanced supply chain infrastructures and digital capabilities,” Yum China CEO Joey Wat said in comments accompanying the company’s first-quarter results released on Tuesday.

In many ways, Yum China came to represent the huge challenges that confronted China’s many consumer-facing retailers during the pandemic. Its same-store sales both fell and rose during the last three years, reflecting a volatile operating environment as it was frequently forced to temporarily close or reduce service at its thousands of restaurants, and as consumers often avoided in-store dining to reduce their risk of infection.

Despite stepping up its delivery and takeout services, the company’s revenue also fell in two of the last three years, even as it maintained an aggressive expansion initiative that saw it boost its footprint by 40% during the three years of the pandemic. That campaign continues, with Yum China planning to open between 1,100 and 1,300 net new stores this year, up about 10% from its 12,947 stores at the end of last year.

Yum China said it opened 233 net new stores during the first quarter, and reiterated its 1,100 to 1,300 net new store opening target for the full year.

But Yum China also cautioned that it isn’t out of the woods just yet, as the company still faces a number of headwinds such as challenging global macroeconomic conditions and lingering impact from the Covid-19 pandemic. It added such conditions will likely make its recovery “gradual and uncertain.” 

The company’s shares rose 4% in Hong Kong after the results came out, and are now up 16% over the last 52 weeks. Its stock trades at a lofty price-to-earnings (P/E) ratio of 57, though the figure comes down to 30 based on analyst expectations for the company’s profit to roughly double this year, according to forecasts on Yahoo Finance. Even on that reduced basis, the company still trades at a premium to former parent Yum Brands’ (YUM.US) forward P/E of 26, and McDonald’s (MCD.US) similar forward ratio of 27. It trails the forward ratio of 35 for Jiumaojiu International (9922.HK), one of China’s hottest local restaurant operators of a traditional sit-down dining chain best known for its “sauerkraut fish.”

The relatively high valuation could owe partly to Yum China’s growing use of technology, which was a major focus during the lean years of the pandemic. The company said 89% of its orders were placed digitally in the latest quarter, similar to levels from a year ago. In operational terms, the company also is using artificial intelligence (AI) to improve its demand forecasting, inventory management, crew scheduling and production monitoring.

Healthy restaurant margin

The greater automation was just one of several factors that helped Yum China to record a restaurant margin of 20.3% during the first quarter, a big gain over the 13.8% figure a year earlier and its best showing since 2017.

The company attributed the strong showing to its planning for a range of scenarios and ongoing introduction of new efficiency-boosting measures, including more efficient labor use and inventory deployment that enabled it to seize on pent-up demand, especially during the Chinese New Year holiday in January. Yum China also said it made adjustments based on actual operating environments in different regions as a result of lessons learned during the pandemic.

“Margins improved substantially, benefitting from sales leveraging, cost structure rebasing, and temporary relief from the government and landlords,” CFO Andy Yeung said in the company’s results announcement. “However, we are still in the early stages of recovery,” he added.

For now, at least, the company certainly seems to deserve a pat on the back for its relatively strong bounce-back after a dismal fourth quarter when, at one point, it had to temporarily close or reduce operations at about a third of its stores during some of China’s strictest Covid controls. The company’s revenue rose 9% year-on-year in the latest quarter to $2.92 billion, and was up by an even stronger 18% excluding the effects of foreign currency translation, outpacing the industry average of 14% and contrasting sharply with the 9% revenue decline in the fourth quarter of 2022.

Same-store sales for the quarter rose 8%, again contrasting with three straight years of annual sales declines during the pandemic. The same-store sales figure for restaurants in travel hubs and tourist destinations was up by an even higher amount of more than 40% in the quarter, though the company pointed out that even at that level, sales for those restaurants were still 20% to 30% below pre-pandemic levels of 2019. Management also pointed out that even after the jump in business with the end of pandemic restrictions, same-store sales were still below pre-pandemic levels by a teens percentage amount in the post-Lunar New Year period.

While the recovery is clearly still a work-in-progress, the company’s broader efficiencies, combined with cost controls, carried through to its bottom line. Yum China’s net income nearly tripled to $289 million in the first quarter from $100 million a year earlier.

Despite the report’s overall positive tone, Yeung cautioned that the road back to full recovery could be bumpy, with inflation and cooling consumer sentiment both possible risk factors as an early burst of post-pandemic “revenge spending” subsides.

“The pace and the trajectory of the recovery remain uncertain, given the challenging macroeconomic conditions and the lingering effects of the pandemic,” Yeung said. “Nevertheless, we are confident that with vigorous scenario planning, more flexible cost structures and operational agilities, we can seize opportunities in good times and stay resilient in challenging times.”

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