Earnings Report 2023 | Record-breaking YUM CHINA Q2: "Crazy Thursday" at KFC drives 50% growth on the day

YUM CHINA (YUMC.NYSE, 9987.HK), China's largest restaurant operator, has released a record-breaking quarterly earnings report.

Recently, YUM CHINA announced its financial results for the second quarter of 2023. In the first half of this year, the company achieved a revenue of $5.571 billion, a year-on-year increase of 16%; and a net profit of $486 million, a year-on-year increase of 166%. The strong recovery in offline dining has driven YUM CHINA's net profit for the first half of the year to exceed the full-year figure of last year, making it the best performance in revenue and net profit in the same period in history.

In the second quarter of this year, YUM CHINA's store opening progress has significantly accelerated, with 422 new stores opened in a single quarter and a total of 655 new stores opened in the first half of the year. The growth in same-store sales of Yum! Brands and Yum! Brands supports management's optimistic expectations, and YUM CHINA maintains its target of opening 1,100 to 1,300 new stores this year.

However, despite the increase in the number of stores, store efficiency has not increased linearly, and YUM CHINA's same-store sales have not yet recovered to the level of the same period in 2019.

According to YUM CHINA officials, "Currently, 40% of the existing stores have been opened in the past three years, which makes same-store sales less representative of the overall business. At the same time, the company is promoting same-store sales growth by expanding off-premise sales, especially through delivery, pickup, and new retail concepts. The company is introducing innovative business scenarios such as breakfast kiosks, pop-up stores, and coffee carts to drive same-store sales growth."

Since the opening of the first Yum! Brands restaurant in Qianmen, Beijing in 1987, Yum! Brands, a Western-style chain brand, has been a "textbook" for domestic restaurant chains. It took Yum! Brands 17 years to go from 1 to 1,000 stores, and it took 19 years or even longer to go from 1,000 to 10,000 stores.

As of the mid-year report of 2023, Yum! Brands has a total of 9,562 stores, with a net increase of 468 stores in the first half of the year. According to YUM CHINA's store opening guidelines mentioned above, it is expected to achieve the goal of 10,000 stores for the Yum! Brands brand by the end of this year.

Nevertheless, YUM CHINA still faces challenges.

Its localization strategy has failed in multiple segments. Chinese fast food chain brand Dongfang Jibai closed completely last year, boutique coffee brand COFFii & JOY also ceased operations, and Chinese restaurant brand Huangjihuang and hot pot brand Xiaofeiyang both closed a large number of stores in 2022.

In the Western-style restaurant chain segment where YUM CHINA has a leading advantage, there are constantly emerging local brands challenging its position in the lower-tier markets. For example, Hua Lai Shi achieved the goal of 10,000 stores ahead of Yum! Brands, and Chinese-style hamburger brand Tasty Burger is expanding at a rate of 2-3 stores per day, with a current total of 1,300 stores. In the pizza track where Yum! Brands has an absolute advantage, numerous challengers such as Domino's Pizza and Papa John's have emerged, seizing market share from Yum! Brands. As a result, Yum! Brands has had to react passively, with its average order value declining for four consecutive years from 2017 to 2020.

The consumer environment has changed, and YUM CHINA, which has been in China for over 35 years, is still adapting to this vast and diverse market. Currently, one of its targeted directions is to open more stores in lower-tier markets.

After the earnings report was released, YUM CHINA's stock price fell by 0.34% to HKD 475.34 per share, and on the following day, it fell by 6.6% to HKD 444 per share, with a market value of approximately HKD 185 billion.

Record-breaking quarterly performance

In the recovery of the restaurant industry, "Western fast food" is making an exceptionally strong comeback.

In the second quarter of this year, its quarterly revenue reached a record-breaking USD 2.65 billion, a year-on-year increase of 25%. Excluding the impact of exchange rates, the year-on-year growth rate was 32%. Operating profit increased by 216% year-on-year to USD 257 million, while net profit increased by 138% year-on-year to USD 197 million.

Looking at the individual brands, YUM CHINA's two major brands, Yum! Brands and Yum! Brands, saw same-store sales growth of 15% and 13% respectively, while operating profit increased by 125% and 216% respectively compared to the same period last year.

It is worth mentioning that YUM CHINA's same-store sales have not yet recovered to the level of 2019. As of mid-year, the average sales per store for YUM CHINA was USD 409,600, compared to USD 481,300 for the same period in 2019.

This may be due to YUM CHINA's "flexible adjustments" to prices during the reporting period. According to FT Chinese, in the second quarter of this year, Yum! Brands saw a 5% decrease in average order value, while Yum! Brands saw an 11% decrease. During the conference call, management pointed out that the "Crazy Thursday" promotion drove sales on Thursdays to be 50% higher than other working days.

However, thanks to measures such as increased rent negotiations and improved labor efficiency (one store manager overseeing multiple stores), YUM CHINA's restaurant profit margin increased by 4 percentage points to 16.1% compared to the same period last year. Additionally, the advantage of having a self-built delivery team allowed YUM CHINA to perform well during past epidemics.

YUM CHINA CEO Joey Wat stated in the earnings report, "Yum! Brands is already present in over 1,900 cities, and we are still tracking over 800 cities where Yum! Brands is not yet present. Similarly, Yum! Brands has tremendous growth potential." The company expects to achieve its goal of opening 1,100 to 1,300 new stores throughout the year.

By continuing to expand in lower-tier markets, YUM CHINA is gradually narrowing the gap between Yum! Brands and Yum! Brands' store count. In 2022, Yum! Brands introduced the "township model" and entered the sinking market with the "selected stores" model, which reduced both the store area and SKU to adapt to the purchasing power of the sinking market.

However, after more than 30 years of market education by KFC, Chinese consumers have long been "immune" to foreign brands, and it seems that local brands are more adept at reciting scriptures. For example, the local brand Hua Lai Shi staged a comeback under the nose of KFC, with the number of stores surpassing 2,000 in 2022, four times that of McDonald's and twice that of Yum! Brands during the same period.

KFC, positioned as fast food, does not have a price advantage in the sinking market.

According to data from Northeast Securities Research Report, compared to Yum! Brands' average customer price of over 35 yuan, Hua Lai Shi's average customer price is less than 19 yuan, fully demonstrating its "large quantity and fullness" nature. The ultimate cost-effectiveness is also the biggest reliance for Hua Lai Shi to open 20,000 stores. According to Narrow Gate Restaurant Eye, Hua Lai Shi accounts for as much as 54% in third-tier and below cities, which means it has reached the scale of tens of thousands of stores in the low-tier market.

Coffee Increment

In recent years, Yum! Brands and Yum! China have operated various brands outside of the Western fast food track, but the results have been unsatisfactory, and they have not been able to find performance growth outside of the Western fast food track.

In 2019, Yum! China acquired the hot pot-focused restaurant brand Huang Ji Huang and its fast food brand San Fen Bao, forming Yum! China's chain Chinese restaurant brand matrix together with Little Sheep, a hot pot brand privatized in 2012, and its own Chinese fast food brand Dong Fang Ji Bai.

However, to this day, Huang Ji Huang and Little Sheep can only be listed under the "other" column in the financial report. The number of Little Sheep stores has been declining for four consecutive years since 2019, with a net decrease of 127 stores in total. Last year, Yum! China chose to terminate the operation of Dong Fang Ji Bai, and its performance in the chain Chinese restaurant industry was not optimistic.

In the coffee track, which is currently highly growth-oriented, Yum! China seems to be "early risers and late joiners". In 2018, Yum! China opened the first COFFii & JOY store, a boutique coffee brand, in Shanghai, but chose to cease operations in 2022.

The reason is that in 2020, Yum! China chose to establish a joint venture with the Italian coffee company Lavazza Group to create the brand Lavazza, positioning itself as "affordable, light luxury, boutique coffee". The brand positioning seems unclear and does not match its customer price of over 40 yuan.

As of the end of 2022, Lavazza only has 85 stores. In comparison, Seesaw, another boutique coffee brand, has over 135 stores, and Mstand has over 350 stores. Public information shows that Lavazza plans to open 1,000 stores by 2025.

Regarding the company's plans in the coffee track this year, Yum! China officials told Xin Feng (ID: TradeWind01) that Lavazza opened its 100th store in China in July. In addition to expanding coffee shops, Lavazza also sells coffee beans and capsule coffee to high-end hotels, restaurants, and other channels, and has started supplying coffee beans to Yum! Brands.

Currently, Yum! Brands, which is on the verge of achieving the milestone of ten thousand stores, may be the best solution for YUM CHINA in the coffee race.

During the conference call after the second-quarter earnings report, YUM CHINA CEO Joey Wat revealed that K Coffee sold 47 million cups in the second quarter, with a 50% increase in sales.

In terms of price, both K Coffee and Luckin Coffee are positioned in the 10-20 yuan price range. In terms of store count, places where you can buy Luckin Coffee will also have Yum! Brands. The combination of low-price strategy and scale advantage makes K Coffee hopeful to replicate Luckin's rise and gain a share in the high-growth coffee market.

According to the research report from Northeast Securities, in 2020, Yum! Brands' K Coffee sold 140 million cups, equivalent to half of Luckin's sales during the same period. As of the first half of this year, K Coffee products can be purchased in all 9,562 Yum! Brands stores.

The advantage of Yum! Brands lies in its large number of stores and multiple sales outlets. Private equity investors in the southern region, who have been tracking the coffee industry for a long time, told TradeWind01 that, based on their research, when consumers choose coffee, convenience and accessibility of store locations are the primary driving factors, followed by product quality, while price is the least important factor.

However, Yum! Brands' store locations are not necessarily advantageous. According to the research report from Northeast Securities, Yum! Brands has six types of store formats, including subway station stores, community stores, and drive-thru restaurants, but none of them are specifically located in office areas with high coffee demand.

The aforementioned private equity investor stated that consumers' brand awareness of Yum! Brands is mostly limited to Western-style fast food chains: "Most of the time, people buy coffee while having a meal, and compared to the extensive SKU options in coffee shops, both K Coffee and McCafé have their limitations. The brand's coffee business cannot achieve linear growth with store expansion in the sinking market."