Yum China ‘rediscovers’ its fast-food roots in budget-conscious times

The operator of KFC and Pizza Hut restaurants in China has been expanding its price range to tap underserved consumers

Key Takeaways:

• Yum China reported record third-quarter revenue and adjusted operating profit, which rose 15% and 10% year-on-year, respectively, in constant currency
• The company is widening its food prices to capture an underserved segment at the value end of China’s pizza market and expand the lower range of its KFC offerings

By Doug Young

Times may be getting leaner in China these days, but people still enjoy eating out.

That’s one of the key messages coming through in the latest quarterly results from Yum China Holdings Inc. (YUMC.US; 9987.HK), which managed to report record third-quarter revenue and strong profit growth even as China’s own breakneck growth of earlier times showed signs of entering a new phase. The growing consumer caution on spending actually favors fast food outlets like KFC and Pizza Hut, which have a wide range of offerings for value-conscious customers.

China’s slowing economy is showing up in a wide range of indicators lately, from sagging exports to record youth unemployment, falling real estate prices and signs of deflation. As that happens, consumers are growing increasingly careful with their spending. Sellers of big-ticket items like cars, homes and even smartphones were the first to feel the pinch, as the caution slowly creeps down the food chain. Some signs have emerged that a recovery may be underway, such as improvements in exports, even as calls continue for the government to provide more supportive measures.

“It’s important to remember that consumers have continued to be cautious in their spending,” said Yum China CEO Joey Watt on the company’s earnings call following the release of its third-quarter results on Tuesday. “Our formula to capture sales growth has always been simple: good food, good fun, and exceptional value,” she added.

CFO Andy Yeung elaborated on the current sentiment, noting that demand began to soften in September and continued into October, following a relatively strong summer season in China’s first post-pandemic year.

“The overall trend towards recovery is evident this year, and many of our performance metrics are setting new records,” he said. “The post-pandemic economic recovery is shaping up to be a wave-like and non-linear process. So, we will maintain our focus on driving sales and cost efficiency.

Yum China also announced an expansion of its current share-buyback program by $1 billion, bringing the plan’s total authorized value to $3.4 billion. The company added it has repurchased $1.6 billion through the plan to date.

Yum China was the first major global restaurant brand to enter China in the Reform era, opening its first KFC restaurant on the periphery of Tiananmen Square in 1987. While its cornerstone KFC and Pizza Hut chains are relatively low-end in the U.S. and other Western markets, those stores were much pricier affairs for average Chinese earning the equivalent of just $20 per month or less at that time. Some Chinese during that era even held wedding receptions at KFC, seeking to impress their guests with the relatively high-priced fare with an exotic foreign flavor.

KFC and Pizza Hut have become more common in China these days as living standards have improved dramatically over the last 30 years. KFC and Pizza Hut are now far more mainstream, reflected by Yum China’s total of 14,102 stores throughout the Mainland at the end of September, according to its latest results. Still, KFC and Pizza Hut are relatively more upscale in terms of image in China when compared with the West.

Affordable options

The company detailed quite a few of its recent affordable offerings in its latest results. At Pizza Hut, the company is rolling out more pizzas costing 50 yuan or less to capture underserved markets, and around a fifth of the pizzas offered at the chain are now priced below that level.

Value items are also a hot ticket, with the company saying that KFC’s weekly “Crazy Thursday” marketing campaigns have become a “cultural phenomenon” that outperformed other weekday sales by 40% in the third quarter.

That focus on value, despite the consumer caution, helped boost Yum China’s revenue by 9% year-on-year in the quarter to a record $2.91 billion. The growth was an even stronger 15% on a constant currency basis, reflecting recent depreciation of China’s currency, the yuan, against the dollar, which is Yum China’s reporting currency.

Same-store sales rose 4% year-on-year in constant currency and are at about 90% of pre-pandemic levels from 2019.

Yum China opened a record 500 net new stores during the quarter, and a total of 1,155 net new stores for the first nine months this year, putting the company squarely on track to reach its target of 1,400 to 1,600 new stores for all 2023. Yum China said at its investor day in mid-September that it aims to bring its store count to 20,000 by 2026, an aggressive target as the company expands to more cities to achieve that number.

The company has been working to improve its efficiencies through a wide range of measures, including the use of centralized management teams that can cover several stores, greater digitalization and automation to reduce labor costs and growing use of franchised restaurants that require less spending than self-operated ones.

As those measures take effect, the company’s adjusted operating profit, after excluding the effects of temporary government relief last year during the pandemic, rose 21% in constant currency for the quarter. In the first nine months, adjusted operating profit exceeded $1 billion.

Yum China’s shares fell 15% in New York the day of the report’s release, but regained some of that back the next day. The stock is down about 20% this year, but still commands a premium to its peers with a price-to-earnings (P/E) ratio of 26. That’s ahead of the 24 for both its former parent, Yum Brands (YUM.US), as well as McDonald’s (MCD.US). It’s also quite a bit higher than the 20 for Restaurant Brands International (QSR.US), which is also active in China with its core Burger King, Tim Hortons and Popeyes brands.

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