Yum China : 2Q 2021 Earnings Conference Call Transcript

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EDITED TRANSCRIPT

Q2 2021 Yum China Holdings Inc Earnings Call

EVENT DATE/TIME: JULY 29, 2021 / 12:00AM GMT

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JULY 29, 2021 / 12:00AM GMT, Q2 2021 Yum China Holdings Inc Earnings Call

CORPORATE PARTICIPANTS

Joey Wat Yum China Holdings, Inc. - CEO & Director

Ka Wai Yeung Yum China Holdings, Inc. - CFO

Michelle Shen Yum China Holdings, Inc. - Director of IR

CONFERENCE CALL PARTICIPANTS

Chen Luo BofA Securities, Research Division - MD

Kin Shun Ling Jefferies LLC, Research Division - Equity Analyst Lillian Lou Morgan Stanley, Research Division - Executive Director

Michelle Cheng Goldman Sachs Group, Inc., Research Division - Executive Director

Xiaopo Wei Citigroup Inc., Research Division - Director & Head of Asia-Pacific Consumer Research

Yan Peng UBS Investment Bank, Research Division - Executive Director and China Consumer Staples Sector Analyst

PRESENTATION

Operator

Good day, and thank you for standing by. Welcome to Yum China's Second Quarter 2021 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions) I would now like to hand the conference over to our first speaker today, Ms. Michelle Shen. Thank you. Please go ahead.

Michelle Shen Yum China Holdings, Inc. - Director of IR

Thank you, Divina. Hello, everyone, and thank you for joining Yum China's Second Quarter 2021 Earnings Conference Call. Joining us on today's call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung.

Before we get started, I'd like to remind you that our earnings call and investor presentation contain forward-looking statements, which are subject to future events and uncertainties. Our actual results may differ materially from these forward-looking statements. All forward-looking statements should be considered in conjunction with the cautionary statement in our earnings release and the risk factors included in our filings with the SEC.

This call also includes certain non-GAAP financial measures. You should carefully consider the comparable GAAP measures. Reconciliation of non-GAAP and GAAP measures is included in our earnings release.

Today's call includes 3 sections. Joey will provide an update regarding recent developments and our second quarter 2021 results. Andy will then cover the financial performance in greater detail. Finally, we will open the call to questions. You can find the webcast of this call and the PowerPoint presentation, which contains operational and financial information for the quarter, on our IR website.

Now I would like to turn the call over to Ms. Joey Wat, CEO of Yum China. Joey?

Joey Wat Yum China Holdings, Inc. - CEO & Director

Thank you, Michelle. Hello, everyone, and thank you for joining us today. Our business has recovered remarkably well, although the pandemic is still impacting our business and will continue to do so. We have learned to live with it, and we are focusing on the future. We focus on our core: good food, great value and customer experience. We penetrated further into lower-tier cities. We increased our store network density to suit the shift to off-premise dining post pandemic.

KFC remains resilient and continues to grow at a very fast pace. Pizza Hut achieved stellar performance and is expected to become another growth engine of Yum China. COFFii & JOY and Lavazza are making good progress.

We delivered a solid second quarter. System sales grew 14%. Operating profit grew 83%. We expanded the store footprint at an accelerated pace opening 404 new stores in the quarter. In less than 1 year, we added more than 1,000 net new stores and increased total store count to over 11,000.

Our team is laser-focused on driving sales. Our powerful digital platform enabled us to swiftly adjust our marketing campaigns. We can

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JULY 29, 2021 / 12:00AM GMT, Q2 2021 Yum China Holdings Inc Earnings Call

reach members directly with targeted offers. In the quarter, we recruited over 10 million new members, ending the quarter with over 330 million members.

Notably, off-premise and home consumption are becoming more popular in the post-pandemic era. Our delivery sales grew over 60% compared to 2019. We also launched retail products across our brands, leveraging our online and off-line assets, we intend to learn and innovate to address evolving consumer needs.

Let me update you on our core brands. First, let's start with KFC. KFC led our new store openings. We increased store density in existing cities and entered over 100 new cities in the last 12 months. With 280 new stores opened in the quarter, we now have over 7,600 stores across China. More impressively, new store cash payback and profitability remains very healthy across city tiers.

System sales grew 14%, led by same-store sales growth and accelerated new store openings. KFC successfully navigated this tough operating environment with reduced volume at transportation and tourist locations. Our operating profit grew by 50% to $240 million. It goes without saying the crucial role good food plays in our business.

In the second quarter, KFC added the wagyu and angus beef burgers to the permanent menu. KFC also launched Double Down a meaty chicken sandwich as a limited time offer. These innovations generated strong social buzz and are well received by consumers.

We know our consumers well and cater to local taste buds. KFC has introduced regional menu items such as hot and dry noodles, Wuhan Re Gan Mian and steamed dumplings, Xiao Long Bao in Hangzhou. We also launched a Sichuan spicy plant-based beef wrap and an oatmilk latte to provide choices to consumers.

With our good food, we also offer great value. Throughout the quarter, we launched attractive promotions to drive traffic. Our May Labor Day holiday bucket are the first ever mix and match buckets for dine-in locations.

On the digital front, we focused on growing our member base and driving their spending. We launched a new Privilege subscription plan, giving our members the choice of perks from a range of offerings. This provides flexibility for our members and drives incremental sales. We sold 8 million Privilege membership in the quarter. The average spending of our Privilege members doubled that of regular members.

Now let's move on to Pizza Hut. Our transformative initiatives in the last 4 years have yielded great results. Compared to pre-COVID levels in the back to 2019, same-store sales continued to recover, system sales growth turned positive. Operating profit more than doubled from the same period last year. We accelerated our new openings and add 70 net new builds in the first half of this year. This is the highest total net new units we added in the first half since 2016. It shows our confidence in the business model now.

Hub and spoke and other small store formats have proven to be successful and now account for most of our new stores. Store economics continue to improve. New store payback remains healthy and particularly for the hub and spoke and small stores. We will continue to increase density and penetrate into more new cities.

In the March new menu, we changed 40% of the menu items compared to the previous year. In the second quarter, we continued to improve our product offerings for better customer experience. In June, we upgraded our hand-tossed dough with more premium flavor and low-temperature long fermentation. This makes the pizza dough crispy outside and soft inside. It tastes particularly good and very, very suitable for delivery.

We also launched sirloin steak with parmesan cheese and knife-sliced noodle, not a very proper translation, but the Chinese name is called Dao Xiao Mian, it's a traditional specialty noodle of Shanxi province. This is a great fusion product combining elements of East and West.

To enable value proposition and enhance our value proposition, Pizza Hut has expanded the price range of its pizza offerings. In June, we launched 13 new pizza flavors at more affordable price points, mainly for the new upgraded hand-tossed dough. We also launched

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JULY 29, 2021 / 12:00AM GMT, Q2 2021 Yum China Holdings Inc Earnings Call

another successful All You Can Eat campaign offering abundant value. The Pizza Hut membership reached a significant milestone of 100 million members. Member sales now account for over half of system sales.

Digital and technology continue to play an important role in driving sales. Digital ordering increased to 84% of sales from just 29% 2 years ago. Delivery and table-side mobile ordering became more popular.

Coffee. Our coffee business making good progress. Lavazza tripled its store count, although the base is a bit small, in the second quarter. Initial results of our new store openings are encouraging. We now have 14 Lavazza stores in Shanghai, and we are opening our first beautiful store in Hangzhou, which is the first store outside China in about 1 hour, today.

We are confident in the potential of this 126-years-old Italian coffee brand.

COFFii & JOY doubled its per unit sales compared to 2019 and had a meaningful number of stores breaking even at the end of the quarter. We are reinforcing a specialty coffee brand positioning, expanding dayparts with more food choices, broadening the customer base and have better value for money.

To conclude my session, we are well positioned to capture the market opportunities in China. Our store network is growing at an unprecedented pace. We are investing ahead to fortify and future-proof our infrastructure and digitization. At Yum China, we are committed and confident to achieving sustainable growth in many years to come.

With that, I will turn the call over to Andy. Andy?

Ka Wai Yeung Yum China Holdings, Inc. - CFO

Thank you, Joey, and hello, everyone. Let me now provide additional details on our second quarter financials and then share our perspective on this year's outlook. Unless noted otherwise, all percentage changes are before the effects of foreign exchange.

Let me first cover our second quarter financial results. Total revenue grew 17% year-over-year and reached $2.45 billion. System sales increased 14% led by same-store sales growth of 5% and accelerated new unit development. Similar to last quarter, we are providing pro forma measures here for convenient comparison with 2019.

Same-store sales recovered to approximately 94% of the second quarter 2019. System sales grew roughly 9%, benefiting from new units and the consolidation of Huang Ji Huang.

Sales were recovering in April and May, but the trajectory was disrupted by the delta variant outbreak in Guangdong province at the end of May. Guangdong province is the largest economy in China and one of the largest markets. Housing 2 of the 4 Tier 1 cities, the outbreak led to temporary closures in the region and affected consumer behavior across China. Same-storedine-in volume is still well below 2019 levels. While off-premise occasions continue to grow rapidly.

KFC remains resilient and delivered robust growth. On a year-over-year basis, system sales of KFC grew 14%, led by strong unit growth and same-store sales growth. On a 2-year basis, system sales grew an impressive 7%, it is 2% faster than the Chinese restaurant industry growth of 5%. Despite subdued traffic at transportation and tourist locations, same-store sales recovered to approximately 93% with the same-store traffic at approximately 86%. Average ticket grew roughly 8% versus 2019, mainly due to the increase in delivery mix.

Pizza Hut delivered exceptional performance. On a year-over-year basis, system sales grew 16%, same-store sales grew 11%. On a 2-year basis, system sales growth in the quarter returned to positive. Same-store sales recovered to approximately 97%, a 2-point sequential improvement from the first quarter 2021. It was led by a 9% increase in traffic, driven mainly by more delivery and breakfast sales.

Restaurant margin was 15.8%, up 210 basis points compared to last year. This was mainly driven by sales leverage, favorable commodity prices and operational excellence. Cost of sales was 30.7%, 220 basis points lower than last year. Commodity prices declined by 7% year-over-year, mainly helped by lower poultry prices.

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JULY 29, 2021 / 12:00AM GMT, Q2 2021 Yum China Holdings Inc Earnings Call

Cost of labor was 24.2%, 150 basis points higher than last year. This was mostly due to lapping of COVID-related government subsidies received in 2020, and cost and wage inflation of 3%. Labor productivity and labor shortage partially offset the increase.

Occupancy and other was 29.3%, 140 basis points lower than last year, mainly attributable to sales leverage, savings in operating costs. G&A expenditure increased 10% year-over-year, mainly due to higher compensation costs, consolidation of Suzhou KFC and the resumption of some business travel.

Operating profit grew to $233 million, a 65% increase year-over-year or a 6% increase compared to 2019. The increase was mainly driven by system sales growth and restaurant margin improvement. Our effective tax rate of 24.8% is similar to last year. We expect full year effective tax rate to be 27% to 29%.

Net income was $181 million. Adjusted net income was $185 million. Excluding $5 million net investment gain, it was $180 million, up 55% year-over-year. Diluted EPS increased to $0.42 from $0.34 a year ago despite enlarging our share base by roughly 11% as part of our secondary listing in Hong Kong last year.

Now let's turn our attention to the outlook. As we continue to drive sales growth and accelerate store network expansion, we need to be mindful of the near-term challenges. It may sound like a cliche, but we continue to expect the impact of COVID-19 to linger and that there would be periodic regional outbreak.

So full recovery of same-store sales to pre-COVID level will take time. Sales recovery will continue to be uneven and not linear, impacted by a few factors. One, subdued traffic at transportation and tourist locations; two, some health measures and restrictions on mobility to remain in place that will continue to impact dine-in traffic; three, shortened school holidays.

Operating profits and margins have improved year-on-year. In the first half, benefiting from sales leverage, favorable commodity prices, moderate wage increase and labor productivity improvement. We expect certain tailwinds to turn into perhaps headwinds in the second half.

First, cost of sales, which will be pressured by our focus on value campaigns and increasing commodity prices. We have already seen an uptick in poultry prices and will lap the low prices in the prior year. Therefore, the commodity prices will potentially come into inflationary pressure later this year.

Second, cost of labor. Cost of labor will increase in the second half of 2021 for 2 reasons. First, most of our stores have increased restaurant staff wages in June and July. Therefore, wage increase will be higher in the second half compared to 3% in the first half. Second, we are also increasing staffing levels to ensure customer services. As a reminder, the speedy recovery last year creates a tough comparison in the second half of this year.

Now despite these challenges, we remain confident in the long-term potential of China. We're accelerating store network expansion with increased store density to capture market opportunity and to better serve the shifting demand to on premise. We now expect to open around 1,300 new stores in 2021. We also will incubate our emerging brands for future growth.

To support this growth, we will continue to invest ahead in technology and infrastructure to further solidify our competitive position. We now expect full year capital expenditure of approximately $700 million to $800 million. As we step up investments, restaurant margins as well as G&A will reflect higher depreciation costs. Finally, following an assessment of the COVID situation, our financial position, the Board has approved the resumption of share repurchases. There's over $690 million remaining under the current authorization. We are committed to drive long-term returns for our shareholders.

With that, I will pass you back to Michelle to start the Q&A. Michelle?

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