Yum China expands footprint in lower-tier cities to drive growth amid growing consumer caution

The operator of KFC and Pizza Hut restaurants in China posted 21% revenue growth last year, led by aggressive new store opening and price widening campaigns to capture new customers

Key Takeaways:

• Yum China’s revenue grew 21% in both the fourth quarter and for all of 2023, as it opened a record of nearly 1,700 new stores last year
• The master franchisee for KFC and Pizza Hut restaurants in China had 14,644 stores at the end of last year, and reiterated its plan to raise that to 20,000 by 2026

By Doug Young

Yum China Holdings Inc. (YUMC.US; 9987.HK) has seen the future of fast food in China, and that future lies in the nation’s thousands of smaller cities that currently have few or none of the slick fast-food eateries that have become common in major centers like Shanghai and Beijing.

Such smaller cities accounted for over half of the nearly 1,700 new stores opened last year by the master franchisee for KFC and Pizza Hut restaurants in China, according to its fourth quarter report released on Tuesday. The new openings marked a record for Yum China, beating its previous target of 1,400 to 1,600 stores for the year. The company ended 2023 with 14,644, stores, and said it is aiming for double-digit growth this year as it marches towards its goal of 20,000 total stores by 2026.

Though KFC is often considered a higher-end dining option in smaller cities, the company is rolling out a growing stable of made-for-China products to woo customers. While that list is topped by best-sellers like whole chickens, it also includes a growing number of local-taste items you won’t see anywhere else, like beef wraps with spicy duck blood and chicken and bullfrog tacos.

The broader theme is that Yum China is taking advantage of its first-comer status to China, with more than three decades in the market since arriving in 1987. In addition to localizing its menu, the company is becoming comfortable outsourcing more of its functions that it once kept in-house to control quality in an earlier era when Western-style restaurants were still an exotic dining option in China.

That has the company moving more aggressively into franchising that is a staple for major fast food operators in the West. Yum China’s partnerships with major e-commerce and social media platforms also helped to extend its reach beyond its physical stores. It is also working closely with popular Chinese third-party delivery services like Meituan and Ele.me that can help it cater to consumers’ growing fondness for convenience.

“In this developing market, we see a long runway of growth for our brands. KFC still only serves one-third of China’s population. Our next ambitious target is to extend our reach to half of the population by 2026,” said Yum China CEO Joey Wat.

Yum China and many of its peers are turning to growth through expansion as China’s economy slows after years of breakneck growth. The country’s GDP grew just 5.2% last year, its slowest rate in more than 30 years, excluding the pandemic. According to data from China’s National Bureau of Statistics, annual food and beverages sales in 2023 reached 5.2 trillion yuan ($723 billion), up 20.4% year-on-year, outpacing the recovery in other sectors.

The company’s shares rose 4.2% in New York on Tuesday after the results came out, and soared as much as 28% in the Wednesday trading day in Hong Kong. Concerns over China’s economy have taken a toll on the stock, which is down about 12% so far this year. At its latest price, the stock now trades at a lower price-to-earnings (P/E) multiple than major global fast food operators like the company’s former parent Yum Brands (YUM.US), as well as McDonald’s (MCD.US) and Restaurant Brands International (QSR.US).

Growth through expansion

Yum China’s latest results were broadly upbeat, though much of its strong gains owed to its rapid expansion. Its revenue rose 19% to $2.49 billion in the final three months of the year, and the figure would have been 21% excluding impact from weakness of China’s local currency, the yuan. That lifted the company’s full-year revenue to about $11 billion, also up 21% excluding foreign currency translation.

But same-store sales were up by a far more modest 4% in the fourth quarter from a year earlier, with the figure up 7% for all of 2023, fueled by a 12% increase in transactions for the full year.

To drive incremental traffic and grab new consumers, Yum China has been broadening the overall price band for its products with a focus on appealing to more value-oriented customers at the lower end of its range. Its branded apps are contributing one-third of online sales in 2023, up 35% to more than $9.2 billion last year.

The company also continued to boost its loyalty program. Its KFC and Pizza Hut loyalty clubs had a sizable 470 million members at the end of last year, up 14% from a year earlier, with such members accounting for about two-thirds of all sales.

In another bid to broaden its appeal at the lower end of the market, the company also began piloting a program to reduce its delivery fees by working more with the previously mentioned third-party delivery services rather than relying exclusively on its own dedicated drivers.

At the same time, the company has also been trying to operate more efficiently through greater digitization and automation, more flexible store formats, and expanding its model where individual management teams oversee clusters of stores rather than needing a dedicated team for each store.

As it keeps down costs and wrings greater efficiencies from its operations, the company boosted its restaurant margin to 10.7% in the fourth quarter, up 1.7 percentage points from a year earlier excluding temporary government relief during the pandemic. Its annual restaurant margin also rose 2.7 percentage points on the same basis to 16.3%, even higher than pre-pandemic levels in 2019.

The bottom line was that Yum China’s profit rose 81% in the fourth quarter and 87% for all last year to $97 million and $827 million, respectively. Operating profit was even up 170% while core operating profit quadrupled. The company has returned $3 billion to shareholders through share buybacks and dividends since its New York listing in 2016, and said it aims to accelerate that effort by returning another $3 billion over the next three years.

We’ll close with a look at some of the company’s smaller brands, led by its two homegrown Chinese chains that posted significant milestones last year. Its Huang Ji Huang chain has been one of its strongest performers since it acquired the brand in 2020, and last year opened 40 new stores and tripled its profit. Meantime, its Little Sheep chain using a popular hotpot format returned to profitability last year. Both Chinese dining brands have plans to expand locally in China and overseas markets this year.

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