A KFC store operated by Yum China in Shanghai

The latest results for the operator of KFC and Pizza Hut restaurants in China included signs of consumer caution and ‘challenging macro conditions’ post-pandemic

Key Takeaways:

  • Yum China posted record revenue and operating profit in the second quarter, lifting them above pre-pandemic levels, even as same-store sales remained below 2019 levels
  • The company opened 655 net new stores in the first half of the year, putting it on track to meet its target of 1,100 to 1,300 new stores for the full year


By Doug Young

The latest quarterly report from Yum China Holdings Inc. (YUMC.US; 9987.HK) could well be titled “Surviving and thriving in uncertain times.”

China’s largest restaurant operator delivered record revenue and an operating profit that exceeded pre-pandemic levels in the second quarter, even as it also noted that same-store sales remained below pre-pandemic levels. At the same time, signs of an uncertain recovery from three years of Covid-induced challenges, which the company first flagged in May, were peppered throughout its latest financial report issued on Monday.

In the face of such uncertainties, Yum China continued its campaign of becoming more efficient through use of technology and cost structure adjustments to maintain its margins at relatively strong levels. It also ramped up its new store openings, seizing on a business model that stresses greater flexibility in store formats in different parts of China.

“Our results are a testament to our resilient and anti-fragile business, which allows us to capture upsides in good times and protect against downsides in bad times,” Yum China CEO Joey Wat said on the company’s earnings call following the release of its second-quarter results.

Yum China’s post-Covid rebound has not been easy due to the many challenges facing the broader Chinese economy. The company and most consumer-facing businesses in China suffered a major blow for much of last year as China’s strict Covid-control measures forced them to implement massive closures and face other restrictions on their operations.

Things improved with the lifting of most restrictions at the end of last year, leading many of those same businesses to briefly enjoy a sharp jump early this year, though business still remained below pre-Covid levels of 2019. But many began to stumble again not long after the Labor Day holiday at the start of May amid growing signs of a longer-term economic slowdown in China after more than two decades of explosive growth.

The resulting drop in consumer confidence has hit sellers of big-ticket items like cars, property and even smartphones most acutely, with sales from such categories all falling sharply in recent months following a wave of “revenge spending” to start the year. As purveyors of the smaller, more affordable “luxury” of dining out, restaurant operators like Yum China have fared better.

Promotions aimed at budget-conscious consumers helped to drive Yum China’s revenue to a record $2.65 billion in the second quarter, up 25% year-on-year and 32% higher in constant-currency terms. Same-store sales also rose 15% during the quarter, accelerating from an 8% rise in the first quarter.

The big gains were more than enough to reclaim setbacks from 13% revenue and 16% same-store sales declines in the second quarter of 2022, when Yum China and other major chains suffered a huge blow as the entire city of Shanghai was locked down for two months.

Shanghai was back in Yum China’s headlines in the latest quarter, but this time for more positive reasons, as the city became the first in China – and probably worldwide – to host over 500 KFC restaurants, showing demand continues to grow in China’s largest cities. Yum China also opened its 3,000th Pizza Hut during the quarter, bringing its total store count of KFC, Pizza Hut and several smaller brands to 13,602 by the end of June.

Challenging’ business environment

Yum China’s Hong Kong-listed shares fell 0.3% after the release of its latest report, but are up nearly 25% over the last 52 weeks. The company currently leads the pack of major global fast food chains with a price-to-earnings (P/E) ratios of 41. McDonald’s (MCD.US) trades lower at 31, former parent Yum Brands (YUM.US) at 32 and Starbucks (SBUX.US) at 33, though domestic rival Haidilao (6862.HK) trades at a higher 67.

Despite the strong top-line revenue growth, Yum China CFO Andy Yeung cautioned of a current business environment that was “challenging.”

“We delivered record second quarter revenues and profits, despite challenging macro conditions and a surge of Covid infections,” Yeung said on the company’s earnings call. “When customer traffic slowed in the quarter, we adjusted nimbly to address consumer needs, capture holiday demand and successfully regained sales momentum.”

Signs of the growing consumer caution were present in subtle ways throughout Yum China’s latest report. The average order size for KFC restaurants shrank 5% year-on-year, and was down by an even larger 11% at Pizza Huts during the period, partly due to the lack of large community purchasing orders that happened during the Covid-19 lockdown a year earlier. Management also noted that sales were 50% higher than other weekdays during the company’s value-focused weekly “Crazy Thursday” promotions.

Additionally, the company said that sales for K-coffee, an affordable coffee brand offered in all of its KFC restaurants, jumped 50% during the quarter year-on-year. And with over 445 million members, its KFC and Pizza Hut loyalty clubs now account for about two-thirds of sales for the two chains.

Amid the company’s acceleration of new store openings, Yum China pointed out that its rent ratio came in below 9% in the first half as a result of its increased efforts with rent negotiations – its best performance in the last decade. The company opened 422 net stores during the latest quarter, accelerating from just 233 the previous quarter, and on track to meet the company’s target of 1,100 to 1,300 new store openings this year.

The new openings, combined with inflationary pressures and higher sales, drove Yum China’s total costs and expenses up 17% during the quarter, accelerating from just a 1% rise the previous quarter. But those were offset somewhat by greater efficiencies, including its growing use of a model that controls labor costs by grouping stores into clusters, with single management teams overseeing each cluster.

As a result, the company’s second-quarter restaurant margin came in at 16.1%, up four percentage points from the year-ago quarter. The company’s operating profits more than tripled year-on-year. And more notably, its operating profit for the first half of 2023 exceeded that for all of last year, largely the result of its ability to capture more sales and a more efficient cost structure. The company’s net income rose 138% to $197 million.

The road ahead is likely to remain bumpy for the rest of the year, and quite possibly into 2024 for Yum China and its peers as China’s economy tries to regain its footing. But the company seems to have found a recipe for weathering the many types of business climates coming its way, which could serve it well in such choppy economic waters.

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