Yum China Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 2, 2023

There are 10 speakers on the call.

Operator

Thank you for standing by, and welcome to the Yum! China First Quarter 2023 Earnings Conference Call. All participants are in a listen only mode. There will be a presentation followed by a question and answer I would now like to hand the conference over to Ms. Michelle Shen, IR Director.

Operator

Please go ahead.

Speaker 1

Thank you, Ashley. Hello, everyone. Thank you for joining Yum China's Q1 2023 earnings conference call. On today's call are our CEO, Ms. Joey Wat and our CFO, Mr.

Speaker 1

Andy Yoon. Before we get started, I'd like to remind you that our earnings call and investor materials 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.

Speaker 1

You should carefully consider the comparable GAAP measures. Reconciliation of non GAAP and GAAP measures is included in our earnings release. You can find the webcast of this call in the PowerPoint presentation on our IR website. Now I would like to turn the call over to Joey Wat, CEO of Yum China, Joey?

Speaker 2

Thank you, Michelle. Hello, everyone, and thank you for joining us today. We are pleased to have set new records for Q1 revenue and operating profit. It's a wonderful start to 2023. Like the Chinese saying, I want to thank all of our 400,000 plus employees.

Speaker 2

Without their hard work and dedication, our performance would not be possible. System sales grew 17% year over year. Back in early January, we had low visibility into how conditions will unfold after the realization of strict COVID measures. Chinese New Year is a Chinese New Year is a critical trading period for us. This year and earlier Chinese New Year was particularly challenging Due to short term ramp up period, we planned for multiple scenarios incorporating regional differences and focused on driving sales Based on the more optimistic scenarios, therefore, we were able to effectively deploy resources as opportunities emerged.

Speaker 2

Operating profit more than doubled to $416,000,000 Our efforts in enhancing operational efficiency And rephrasing our cost structure in the past few years contributed to strong profitability in the quarter. And our system sales growth compared to 2019 is plus 20% and operating profit Also compared to 2019 is plus 37%. These results exemplify our ability to stay resilient In challenging times and these opportunities when better times emerge, our initiatives and investments Along with our resiliency, growth, moat, strategy have made us more agile and responsive. During the quarter, we were encouraged by early signs of recovery. Notably, dining, Takeaway delivery all grew year over year on a same store sales basis.

Speaker 2

Delivery accounted for Around 36% of sales, same as a year ago. Customers continue to love the convenience and delivery provides. Off premise was over 60% of sales. Same store sales grew year over year Across different regions and trade zones, we benefit from increasing mobility and saw a 40% -plus growth at transportation and tourist However, same store sales at these locations in the Q1 were still 20% to 30% below 2019 level. Weekend sales growth slightly outpaced with day sales.

Speaker 2

Apart from increased social gatherings, Value programs at SIN2022 also contribute to growth. Let me share about how we grow sales. We focus on our core pillars, good food at great value and good customer experience to capture demand. Good Food at Great Value is our hallmark. We refreshed several signature products and achieved great results.

Speaker 2

After doing it for more than a decade, people come to expect our Chinese New Year bucket at KFC To capture a home consumption around family reunion, we add the option to trade up for Juicy Whole Chicken, We sold 11,000,000 whole chickens in the Q1, more than doubled year over year. We gave our classic beef wrap a localized spicy twist. The innovation Spark's social buzz leading to a sellout in many markets in just 6 days. Pizza Hut, The Supreme Series is our most popular pizza lineup, accounting for nearly 30% of all the pizzas We sold in the Q1. We introduced Wagyu Beef and Seafood Supreme, in Chinese New Year.

Speaker 2

By including Premium ingredients like abalone, sea cucumber and wagyu beef, these pizzas became the perfect festive choice. We also created double durian Supreme, for durian strength, Two types of durian, soodanwan and dimzen were combined with grapefruit and pineapple to create an Flows and Tropical Flavor. Durian lovers love it. We continue to make our good food available at greater value continued to drive sales momentum in its segments. This year, We offered these great values even during Chinese New Year.

Speaker 2

We also revamped our weekday Value combos. Okay, Sanjian top with more choices and lowered prices of select burger combos to just RMB19.9. These 3 item combos attract new customers and grow frequency. We also expand our popular buy 1, get 1 free campaign, Pizza Hut, to include pizza and stick options. Customers can redeem the free item immediately or in the next visit within 30 days.

Speaker 2

The campaign significantly increased sales by encouraging repeat purchases during the promotion period. Now let's talk about operating efficiency. Late last year, a significant portion of our employees and riders were Infected with COVID. At the peak, over 4,000 of our stores were temporarily closed All offers only limited services. By early January, as people gradually recovered from COVID, We make every effort to keep our stores open and resume normal operations.

Speaker 2

We got ready for the Chinese New Year period. We planned for crews in inventory based on the more optimistic scenarios. We also account for regional differences and continuously fine tuned our plans based on regional learnings. We further improved hiring and incentive program to manage staffing and minimize labor shortages. To enhance productivity, we expand our initiative to share store management team across multiple stores.

Speaker 2

It also provides career development opportunities for our young talents. Now let me share with you about our digitization. We have built a powerful digital ecosystem that's instrumental to our innovations, while also enhancing operational efficiency. We leveraged AI to optimize demand forecasting, Inventory Management, Crew Scheduling and Production, Smart Order Systems, Streamlined the food preparation for dining and off premise orders. These capabilities are particularly important during the peak season like Chinese New Year.

Speaker 2

Also migrating our key infrastructure to private YAMC Cloud During campaigns like Crazy Thursday, Smart Delivery, Sunneng, Shenzhen continue To improve delivery coverage and flexibility, last year, we upgrade the system to dynamically adjust delivery coverage for each store by daypart. These capabilities along with our dedicated delivery riders allow us to capture more sales and fulfill orders even during the Chinese New Year peak season. We continued to improve digital touch points for better engagement with members. Digital orders Accounted for around 89% of sales in the Q1. Our loyalty programs exceed 430,000,000 members.

Speaker 2

Members steadily contribute to about 60% sales. We actively engage members and drive frequency with privileged Subscription plans. K Friends, Tsuyoka is an invitation only program for top 1,000,000 loyal Payfriends received exclusive coupons and puts and the Royal Crown on the core These help us gain valuable insights to improve service for our most loyal members and all customers. To sum up, we are extremely pleased to deliver Strong first quarter performance, multiple scenario planning, innovative products and value campaigns, Along with our agile supply chain and digital capabilities enable us to capture market opportunities. As we progress through 2023, we plan to stay nimble to the evolving market conditions.

Speaker 2

Looking ahead, we will focus on building sales momentum, expanding our store network and fortifying our competitors moat. With that, I will turn the call over to Andy. Andy?

Speaker 3

Thank you, Zhou Yi, and hello, everyone. Let me now share with you our Q1 performance. 1st quarter sales rebounded significantly from the 4th quarter. We made tremendous effort to drive sales since the reopening by offering innovative food and compelling value campaigns. Restaurant margin reached 20.3%, the highest since 2017.

Speaker 3

Our margin expansion was driven by sales leveraging, efforts to rebase our cost structure in recent years, investment in improving operating efficiency and temporary Change had a negative impact of approximately 8% in the quarter. 1st quarter total revenues were $2,900,000,000 In reported currency, a 9% year over year increase. In constant currency, Total revenue grew 18%. System sales increased 17% year over year in constant currency. The robust growth was fueled by same store sales growth of 8%, the contribution from new units and significantly fewer COVID related temporary store closures.

Speaker 3

Both KFC and Pizza Hut achieved 17% system sales growth. By brand, KFC same store sales grew 8% year over year, same store traffic grew 6% And ticket average grew 2%. Pizza Hut same store sales grew 7% year over year. Same store traffic grew 13% and ticket average decreased 5%. These results were largely due to the successful promotional Which drove strong traffic and lower ticket average.

Speaker 3

Net share margin was 20.3%, 650 basis points higher than the prior year. This leveraging contributed to approximately half of the margin expansion, Labor productivity gain and lower occupancy costs were key factors. We also enjoyed $18,000,000 benefit from additional VAT deductions, thanks to a government policy to help businesses dealing with the challenges posed by COVID-nineteen. These are partially offset by cost inflation and increased promotion expense. Let me go through the key items.

Speaker 3

Cost of sales was 30.1%, 100 basis points lower than prior year. We kept commodity prices low through tremendous effort locking in prices and innovating the menu. We also reduced wastage and benefited from higher VAT deductions. Gains were offset by increased promotional activity to drive traffic. Cost of labor was 24.6%, 160 basis points lower than the prior year.

Speaker 3

Sales leveraging and better labor productivity more than offset headwinds from low single digit wage inflation. We further improved labor productivity through store management team and crew sharing initiative. Occupancy and others was 25.0%, 390 basis points lower than the prior year. This was mainly driven by sales leveraging, lower rental expense as well as other cost saving initiatives. Rental expense improved due to what is the more favorable rental term for new stores and store portfolio optimization.

Speaker 3

We also recorded $8,000,000 in rental relief related to COVID surge last year. G and A expense increased 16% year over year in constant currency, mainly from performance based bonus and merit increase as well as additional travel expenses from the resumption of business activities. Operating profit was $416,000,000 increasing 118% in constant currency sorry, in reported currency. Our effective tax rate was 28.5%. We expect full year effective tax rate to be around 30%.

Speaker 3

Net income was $289,000,000 increasing 189% year over year in reported currency. Diluted EPS was $0.68 an increase of 196% year over year. In the Q1, we generated $507,000,000 in operating cash flow and $328,000,000 in free cash flow. We returned $116,000,000 to shareholders in cash dividends and share repurchases. At the end of the Q1, We had around $3,000,000,000 in cash and short term investments and another $1,000,000,000 in long term deposit, which would benefit from We expanded our store network and remain committed to capturing future growth opportunities.

Speaker 3

In the Q1, we opened 233 net new stores. In the Q1, we faced an earlier Chinese New Year and labor shortage as well as delays in contract signing and billing permit process due to the widespread infections in the Q4. However, We have a strong pipeline and are confident in reaching our goal of opening 1100 to 1300 net new stores this year. Our new store continued to perform well. We've paid a period of 2 years at KFC and 3 years At Pizza Hut, we'll continue to focus on expanding our store network in a systematic and disciplined manner.

Speaker 3

Let's turn to our outlook. We are encouraged by Q1 performance. Sales during the Chinese New Year trading period We're buoyant by pent up demand to travel. But same store sales post Chinese New Year have remained at teens level below 2019. Now we are still in the early stages of the recovery.

Speaker 3

The pace and the trajectory of the recovery are likely to be gradual and uncertain. Overall, global macroeconomic conditions remain Challenging when the pandemic is still lingering. So the impact of the top priority for us this year is still driving sales. Consumers are value conscious, so our investment in promotions to attract more traffic and sales are crucial. In the coming quarters, we expect gradual inflationary pressure, and we anticipate the benefits from additional VAT deductions and rental relief to face off.

Speaker 3

We have demonstrated our ability to capture opportunities in good times and manage the downside in bad times. We will continue to utilize extensive scenario planning, flexible cost structures and operational activities to navigate our churn environment. We remain committed to seeking the long term growth opportunities in China, Nothing in strengthening our strategic mode and creating value for our shareholders. With that, I will pass you back to Michelle. Michelle?

Speaker 1

Thanks, Andy. Before starting the Q and A, we'd like to share a heads up that we have scheduled our 2023 Investor Day for September 14 to 15. The event will take place in Xi'an, China, and it will also be webcast for those who can't join us in person. We will provide more details soon. Now we will open the call for questions in order to give more people the chance to ask questions.

Speaker 1

Please limit your questions to 1 at a time. Ashley, please start the Q and A.

Operator

Thank Your first question comes from Michelle Cheng with Goldman Sachs. Please go ahead.

Speaker 4

Hi, Joey, Andy. Congrats for the very strong results. My question is about the value content you mentioned on the project now. So since we have been going through this reopening of volatility for the past few months and given we see the trend is still Quite challenging. So can you share with us what is your thinking about the consumer spending power and our strategies on the product mix?

Speaker 4

And related to this question is about the food cost. So we see a pretty decent improvement on the food paper cost savings. But if we look into KFC versus Pizza Hut, it looks like KFC benefit quite a lot on this food cost saving, while Pizza Hut didn't see That much benefit. So can you also share with us how these value campaign and the Panamix adjustment impact the 2 brands' cost?

Speaker 2

Thank you, Michelle. Let me comment on the Value campaigns and then Andy can follow-up with the Kohl's comment. There are economic challenges Right now and therefore consumers are quite value cautious. The key question here is what are our strategy? There are 3 prongs Three pillars of our strategy.

Speaker 2

1 is menu. We really focus on the food, the tasting and innovative food On top of value campaign, because the pure value campaign is not enough. The value campaign must Come with good food in order to get the benefit. So you will see the new fund, but Mao Xiaone And that is right after Chinese New Year value campaign product. And that was doing very well.

Speaker 2

And then The good value, of course, is important. So you can see we have KFC, we have the Prezi Thursday and we add We say value combos right now and then on top of that we introduced the Zodua Fung Huanting, The Sunday value campaign is middle of last year and all of these work quite well. So we'll continue to work on that because let's not forget Prezi Thursday has been working since 2018. So it takes Many years hard work to build that as a platform. And then with Pizza Hut, we have this Green Wednesday, which has been working quite well.

Speaker 2

On top of the food Good Value, we have good fun. We even right now delight customers with some fun toys or even luxury to a trip to Maldives, etcetera. So that's the first pillar of the strategy. 2nd is pricing. When we raise price, we always do it very, very Carefully and prudently.

Speaker 2

And we also carefully designed trade off options to protect the ticket average and margin. So while we are going Heavy with the value campaign, you can see management team has been able to protect the margin for the shareholders. And on top of that, we introduced good selection for each price range, including entry Price point products and let the customer choose. The first pillar of the strategy is to keep the cost competitive In inflationary environment, our supply chain has been doing amazing work to secure Supply and product innovation at scale. So while these value campaign seem Amazing marketing campaign, well, they are amazing, but these are not possible without the very strong supply chain behind that.

Speaker 2

And then we also drive operational efficiency, including staff sharing, lowering the foot weight And then also save a lot of money from rents. In order to pass these savings back to the customer, I'll pause here and I pass to Andy for comments related to COS.

Speaker 3

Thanks, Oli. Yes, so I think when you look at Pizza Hut, we're very encouraged and very happy with the results. If you look at the same store growth of Pizza Hut, we saw 7% same store growth. And then if you look at over system growth, and it grew 70%. Pizza also have seen acceleration in store opening.

Speaker 3

At the same time, we obviously see very strong margin expansions. We saw almost 350 basis point restaurant margin expansion. And if you look at the operating profit itself, It's almost double, 85% increase on a yearly basis, which is slightly less than KFC, which is 90%, but still very, Very respectable. And I think when we look at the cost structure on line item basis, obviously, the 2 business are slightly different In the way they operate and also the material that they use. So when you look at the food cost, KFC obviously have More important components are beef, cheese, dairy products, etcetera.

Speaker 3

And then also for The 2 brands, they also have different sort of like pace of promotional activities. And if you look at Pizza Hut, we have very strong value campaign, and it drove very strong store traffic growth. And so I think the strategy, Although slightly different for all the 2 brands are working quite well both at Pizza Hut and KFC. Thanks.

Operator

Thank you. Your next question comes from Lilyanne Lu with Morgan Stanley. Please go ahead.

Speaker 5

Thank you. Congratulations again, Joey and Andy for the strong results. My question is actually On the cost side, because I think Joey and Andy did mention that there are some benefits From a cost rate base, in the Q1, significant margin improvement aside from the self leveraging. And especially, I think, if we look into the details, there has been significant savings The depreciation and amortization compared to last year. So my understanding going forward, what's The margin outlook on a year over year basis, are we can we expect a similar pattern of Cost savings from our patient put aside the phasing out and of relief and also with your guidance on the depreciation cost for the full year given the significant decrease in the Q1?

Speaker 5

Thank you.

Speaker 3

It seems like another question for me, so I will take this question. So in terms of margins, I think when we look at 1st quarter margin improvement, we're very encouraged obviously. As we have expected, with increasing sales, we're going to see Sales leveraging, so approximately almost half the improvement are coming from the sales leveraging. Now in terms of the overall Cost structure, we can see that labor productivity, some of the effort that we put into rebasing our cost structure there Benefiting the CLL as well. So you can see that they're Optimizing labor scheduling and labor mix.

Speaker 3

And then we also have their initiative, as we mentioned, on the prepared remarks, restaurant management team and crew sharing And then on the opportunity and efficiency side, I think you obviously see that in terms of some less wage stage because we have Better sales forecast and real time inventory visibility. So that's the benefit of investing in technologies and digitization. We also have installed some smart utilization smart utility devices in the restaurant. So we also see better utility usage. In terms of what you mentioned in terms of our O and O expenses and depreciation, I think one is that The rental expense, as I mentioned before, we have markedly more favorable rental trends for our new store.

Speaker 3

And also, we have a store portfolio optimization that should also help us in terms of our depreciation. And then if you look at our overall investment for newer store, we also have bring up some investment And that will also benefit in the long term our depreciation expense as well. Now in the Q1, we also Benefited from some temporary relief, as you mentioned, dollars 8,000,000 from rental relief that we did from last year, COVID surge And then also about $18,000,000 from additional VAT deduction, which is a government policy That's how business deal with COVID challenges, and we will see how long that option would continue. In China, outlook, I think one thing that I want to emphasize on is that, as I mentioned, sales is a very important factor In determining our overall margin. And so with sales improving year over year, we should see sales leveraging.

Speaker 3

However, I want to point out that we do have seasonality with our sales. Same quarter, generally, we use a solid quarter for sales And therefore, margin. The other one is that our When we look at the pace of recovery, I think post as I mentioned, post CMI, we see more gradual pace of recovery. And still, like if you look at the cost of the solar, we'll have a rapidly stable A quarter of sales are footwear to commodity prices, but we're already seeing from the spot market that some of their inflationary pressures are building, although Much more gradual compared to overseas. We're also likely to see wage inflation through the year.

Speaker 3

Normally, we see mid to high single digit. Currently, we're at low single digit. So I think we're going to trend back to normal So that's sort of like the way we look at it. For our margin improvement, I think a large degree, it's clear by sales leveraging. I think the cost reduction, cost rebasing initiative, we continue to take hold.

Speaker 3

But some of the temporary relief will go away for the rest of the year. Thanks.

Speaker 2

Thank you, Lily. I just want to add Your comment on the question. The current cost base is certainly more resilient than 3 years ago. Last 3 years have been difficult, challenging, particularly 2022. Therefore, we really Have been pushing a lot to rebase the cost and the result is showing right now.

Speaker 2

Let me give you some specific example. For the rent, it's better. It's actually the best rent in the last decade For two reasons. One is our store portfolio is better because we have been able to prune some low performing store while still New stores with much better rent structure. Think about over 40% of our stores We're still in the last 3 years.

Speaker 2

For depreciation, roughly even for just 2022, our CapEx for new store is down by 25% to 35% Just for 2022. If we add up the improvement in the last 3 years, the improvement is more. Well, the WPSA, the sales per week is also coming down. However, the profit margin Maintain or even improve. And the benefit of lower CapEx is not only benefiting depreciation.

Speaker 2

Think about the sales side, Lily, it also benefits the new store opening. With the lower CapEx for new store, we are able to open stores in trade zone that we were not We were not able to open in the past, but lower CapEx allow us to have more flexibility to open Stores and still maintain the profitability. And third one is the labor cost. I think this is an ongoing challenge, but as Andy mentioned, we have Initiative working on cruise sharing, starting with the delivery rider and now moving to So staff as well and that is something that we'll continue to work on and it's still quite early in the process, But we'll continue with that. Thank you, Billing.

Operator

Your next question comes from Lena Yan with HSBC. Please go ahead.

Speaker 6

Hi. Thanks for taking my question. So I want to compare The recovery pattern on same store sales basis, Q1 2023 versus Q1 2021. So as you mentioned in your presentation with offline traffic recovered, you still see positive growth in delivery. This was Different from what happened in Q1 2021.

Speaker 6

So my question is, was this due to a structural shift in the spending Pattern of consumers like Dai Yi might never come like a near to like a 2019 level Or it means with delivery still growing in the post pandemic age, we actually have more room to grow our offline Traffic and dining service, actually we have like bigger potential versus 2019 to grow our single store sales. So that's my question. Hope I explained it well. Thank you.

Speaker 3

I

Speaker 2

understand your question. Maybe Andy, you go ahead.

Speaker 3

Yes. So thanks, Angel, yes. So I think, obviously, In 2021 and today, it's quite different macro environment and also in term of The overall COVID recovery. So at different times, different place, I'm not so sure if it's comparable, just looking at 2020 3 was the 2021. What I can say is that if you look at delivery, delivery were and off premise in general have been growing Before the pandemic and continue to grow throughout the pandemic.

Speaker 3

As we have mentioned in last quarter and We do expect dine in traffic to Weeban indeed, but we also see that delivery remain Very robust. I think we're looking at delivery sales overall. Last year at the end of last year, because of pandemic, Back to about 39% of over sales. Now it's roughly about 36% of our sales. I think Within that 35% up and down or 2% up and down, it's within our expectation.

Speaker 3

Now we also benefit not just because of overall, obviously, consumer continue to get The favorite and the benefit from enjoying that benefit of off premise dining, the convenience and whatnot. But also, we also benefit from our strong network restructuring. You can think about that. We have mentioned over the past couple of years, we continue to build more densities within the city that we have already Have stalled and with stalled platform that are more catering to our Delivery and takeaway business. And so we are seeing some network effect there, right?

Speaker 3

So we're benefiting And then also, if you look at our delivery business model, it's very unique in a way that we deliver We have dedicated riders delivering our food to consumer for the last month, and that allow us to Ensure good service quality, good food, in a timely manner. And then more importantly, when The labor shortage in rider were acute like Chinese New Year or what we have in Christmas Day or Rainy Day or whatever. We do have ability to provide that delivery subsidies when other perhaps may not. So overall, I mean, we also have continued to improve our trade zone. As we mentioned, we have invested in technology to help us to more Practically manage our trade zone for delivery and also the efficiency in terms of our delivery services, both in terms of Food production process are queuing and also logistics size on the routing for You're our writer.

Speaker 3

So I think digital delivery will continue to be a very important What drives for us going forward? Obviously, with the rebound in store traffic, we may see a percentage Change and fluctuate, but I think long term we're pretty confident in the off premise timing. Thanks. Audrey, do you have anything to add?

Speaker 2

That's it. Thank you, Andy.

Operator

Thank you. Your next question comes from Xin Liu with Bank of America. Please go ahead.

Speaker 7

Hi, Joey and Andy. Congratulations again on the solid results. So my question is also related to same store sales growth as I like to get more Detailed color on the Q1 same store sales. So first of all, our result announcement mentioned that of CMY, our same store sales actually was below the 2019 level by teens level. So it seems that there could be some sequential weakness.

Speaker 7

But on the other hand, is it fair to say that on a year on year basis or If we compare it with 2022 level, actually in March we are seeing even better year on year same store sales growth as the Shanghai lockdown Actually started from the middle of March in Qudong. And secondly, by city tier and regions, which parts Have we have actually registered even better growth? Are we seeing better growth in Tier 1, Tier 2 cities or lower tier cities? Or in which regions such as in Eastern China or Southern China, which part of the regions actually have seen even better growth? And also lastly, when it comes to dining, which was also the focus of the previous question by Lena, Apart from the fact that we mentioned that our stores in transportation hubs and tourist locations Still saw 20% to 30% same store sales decline versus 2019.

Speaker 7

Are there any other drags That we have observed in terms of the same store sales at the dining level, is it because of too many new stores In our mature markets, which may cause cannibalization, or are there any other drugs? And how are we going to do to address these issues So that we can see further improvement of the dining traffic. Thank you.

Speaker 2

Thank you, Lawson. I'm going to address on the same store sales, but let me also emphasize for Our Q1 number is also equally to look at the system sales compared to 2019, Because there's a gap of same store sales versus 2019, but the systems sales growth, as I Mentioned from my opening remarks, it's plus 20% versus 2019 and our OP is plus 37% versus 2019. So I think we like to focus on single sales, but it's equally important to note the impact of better Store portfolio and also the new store opened in the last 3 years. I'm going to go through a bit more color The same store sales breakdown and then come back to the dining comment. We see strong rebound from quarter 4 2022 And we grow year over year.

Speaker 2

1st 2 months in Q1, we benefit from the pent up demand for Chinese New Year's travel. But more than that, We have multiple scenario planning, and we invest heavily in both ingredients and staff Starting. Therefore, I believe we have better than industry average results. After the Chinese New Year, the same store sales continued to grow year over year. But yes, It remains below 2019, but the good momentum continues into quarter 2.

Speaker 2

So I think you can see from all the picture May 1, holiday, the trading was vibrant. It's still low single digit below 2019, but it's catching up quite nicely. The encouraging sign is that the sales Growth year over year is led by transaction growth in both KFC and Pizza Hut. And you know in our business, this is Absolutely important. As I mentioned already, system sales improved significantly with much larger store network.

Speaker 2

But Also despite the same store sales gap, the older stores are much healthier because We have been pruning store portfolio and the new stores are more resilient because by redesigning the store network as Andy Mentioned before and adjusting the store format to capture off premise demand With more convenience, less investment, flexible cost structure. So net net is more resilient than store So let's move on to the more specific by brand, by region, by city area, etcetera. So by brand, KFC and Pizza Hut single sales is similar. But versus 2019, it's interesting. The Pizza Hut single sales Versus 2019 is slightly higher than KFC.

Speaker 2

Pizza Hut is minus 4% versus 2019 and KFC is minus 8%. So it's partly because KFC has a higher ratio of stores in transportation and tourist location, But also it shows that Pizza Hut had good improvement since its revitalization program. KFC system sales growth higher than Pizza Hut because we opened more new stores for KFC in the past few years. Therefore, it's plus 19% for KFC. By region, year over year, all markets grew for quarter 1, except Beijing, Because remember, last year, we had Winter Olympics.

Speaker 2

But by March, Subsequently, the number improved and turned positive. Versus 2019, KFC, Eastern China outperformed other regions because of its very vibrant economy. Pizza Hut, Northern China outperformed because it has less competition. Our business of Pizza Hut in Northern China actually is quite strong. By city tier, year over year, lower tier cities performed well as people return home for Chinese New Year.

Speaker 2

Tier 2 cities also performed well because last year, the control The street control on COVID impact the tourism. And this year, We are getting the benefit out of it because domestic tourism in cities like Changsha, Tianan, Hanzhou helps a lot. Transportation Hub. Year over year, we see substantial improvement with increased mobility. The momentum obviously further improved During the May holiday.

Speaker 2

So I think I hope that give you some color of the Different angle of the same store sales. In terms of sign in, it improved the computer improved Because we have increased mobility After the COVID policy change, and it's important to see whether signing, delivery or takeaway, All the things themselves improved. It's not only just focused on one. And of course, it improved more for Pizza Hut than for KFC, because we rely more on buying business for Pizza Hut. But I would like to ask you to look at the other side of our business, which is the resiliency.

Speaker 2

KFC, It took us a lot of hard work and determination to get the off premise sales to as high as 60%, 70%. And that means it's a very resilient business model Because even with Dai Ying were significantly impacted, we are able to still do the business And Renee, that's where Pizza Hut also improved a lot because the percentage of all premise Business for Pizza Hut for 2019 was only 30%. That's between Take away and deliver it. By 2022, that ratio It's 50%. Back to 2023, now the ratio is down to 46%.

Speaker 2

But it would be very good For Pizza Hut, if we continue to improve the ratio of takeaway and delivery, because that improves The resiliency of the business is a good thing. So I hope that give you Some color of our thinking of the dyeing business versus the others. Is there any other threat? Well, there are always market uncertainty, particularly the macro environment we can forecast, we can't We did too well, but what I would like to remind our analysts is we have Always have multiple scenario planning. In the last three years, I hope we have also demonstrate our ability to deliver And to have the resilience in our business during bad times and during the past quarter, we also have demonstrate Our ability to seize opportunity during good times.

Speaker 2

Are too many new store address? Not really From our point of view, therefore, we are still sticking to our new store opening guidance because As Andy mentioned again and again, we have very disciplined and systematic way of opening new stores. And one thing I would also like to mention is and to emphasize is the agility and the flexibility of the new store Portfolio is very important going forward because instead of investing too much money On big store, we are investing in smaller lower investment store, but With shorter distance between the stores and to make it a more convenient network for the customer, But also a lower cost of delivery network for the operation, because it's more efficient and it's lower cost to deliver our products to a customer when the store business is shorter and closer to the customer. Thank you, Roger.

Speaker 3

Julie, I just want to add a couple of few quick ones there. One is that When we look at when we mentioned like we see low teens level compared to 2019 post CNY. But like if you look at CNY, we're also at the teens Level BMO 2019. And I think the main thing is that what we're trying to say is that we saw a very sharp recovery After the reopening and during the Chinese New Year period, then we see more gradual sort of like recovery. It's not to say like a recovery stall.

Speaker 3

Other one is that Raul mentioned is an SSG comparison. So our SSG calculation Exclude the temporary store closure. And so but our system sales include same store sales growth, Temporary store closure and also net new store growth. Correct. So when analysts and investors compare the SSG number, They need to factor in the impact of Tempur stock closure.

Speaker 3

For example, this quarter, we have about 8% SSG. There's a few points impact from Tempur stock closure. So you add that back there, then you would see a probably double digit efficiency improvement. And so I just wanted to make sure that people don't forget that a slightly different way of capturing as distributed content come out of here. And so if you look at the overall industry growth, we're probably going top end to overall China signing industry.

Speaker 3

Thanks.

Operator

Your next question comes from Ann Lin with Jefferies. Please go ahead.

Speaker 8

Thank you. Thank you, management team. Excellent results. But I also have some question on the cost side. Regarding the VAT benefit, maybe like would you Elaborate a little bit more the nature of this VAT benefit, which contributed $80,000,000 for this quarter.

Speaker 8

And like what is the nature And like, will the next few quarters will we be seeing something similar? What is it based on cost of goods or particular Like commodity or packaging product. So we would like to know a little bit more about that part. And also going back To the same store sales number. So if we are talking about like same store sales or sorry, To recover back to year 2019, given the fact that especially in Tier 1 cities, you are increasing your store Density, so meaning that we should be looking at like your new store your store Growth, rather than like fixate on the same store sales number.

Speaker 8

Yes, so this is my second question. And my first one is, I'm still a little bit confused. You just mentioned about the CapEx decline was about on a per store basis about 20%. But during this period, as Elena mentioned, The depreciation expense actually down 41%. But of course, I do not know like whether there's any difference in any mix in terms of Like the back end CapEx versus the storefront CapEx.

Speaker 8

So maybe you can help us understand a little bit more of this excellent cost savings On your side.

Speaker 2

Hi. I'll make a quick comment on the CapEx, Andy, and then you can come in. And the CapEx, the new the CapEx for new store is down 20%, but we also save a lot of money from pruning the Original store portfolio and that's very important. So both the old store and new store help. Okay.

Speaker 2

Andy, back to you.

Speaker 3

Okay. So let me try to address the VAT deductions questions. If you look at the Chinese government policy, the VAT deductions, the policy came out In 2019, and it cover some of the accelerated reductions for VAT input. However, because of the COVID-nineteen, the policy has continued to be extended over the past couple of years and now the policy has continued to be extended This year. And depending on various situations and how the business operates, it may be benefit it may be able to benefit from the additional VAT deductions.

Speaker 3

And so this policy currently as it stands right now It's extended to the same half of the full year. But the level of benefit that we may be able to join May phase out, it has to do with how the input cost and output VAT value is. So it's a little bit complicated to talk about it on the conference call, but you can study the VAT policy from the Chinese government website. The other one about the about, I think, The depreciation and amortization costs are different. I think the one thing that we want to emphasize is that There's 2 components to that.

Speaker 3

1 is depreciation. The other one is amortization. The big drop there is coming from amortization, as we have mentioned, In the past years that when we acquired the controlling stake in Hangzhou, we also have a We acquired Franchise Right and each quarter is roughly about like $15,000,000 of sales. And so that's one of the big factors there. And that basically So they expire at the end of last year.

Speaker 3

And so that's why we see that sort of thing we include depreciation and amortization. In terms of SSG recovery, I think It's we're only in the Q1 of recovery. So based on what other countries experienced, Overall, recovery to the pandemic level will likely take time and it's likely going to be uneven. And certainly, as we mentioned, the pace and the structure of that would be gradual and uncertain. And so if you look at the like I think we'll be hard pressed to see the industry itself and also any large Restaurant like Minsheng will be rebounding immediately to the prepayment level in the Q1 after reopening.

Speaker 2

But we

Speaker 3

are confident, as we have demonstrated in the Q1, we're able to capture the opportunities when it presents itself. Chinese New Year, I think, Despite a lot of uncertainty at that time, because our planning, our team's Agility and artificial intelligence infrastructure, we're able to capture those opportunities as we have back then in 2021 when Now obviously, we cannot predict, as Joey mentioned, what's uncertainty in the market, but we are also confident that given our Our cost structure rebasing initiative are more flexible and we saw in business model, we can also deal with any potential downtime During this recovery, so but again, the recovery we should expect to fully recover to Chris, that level will take some time and will be some up and down, but I think we're confident that either way we can deal with it. Thanks, Dan.

Operator

Your next question comes from Christine Peng with UBS. Please go ahead.

Speaker 9

Thank you, management, for taking my questions. I think most of the questions I have have already been addressed by Joy and Andy. But if I can just ask a follow-up question on the depreciation side. I think many analysts have already I asked this question, but I just want to understand a bit more why there is such a big drop in terms of depreciation expenses, if you calculate. On a year on year basis, it dropped by around $50,000,000 And you mentioned there was a $50,000,000 Impact from the Hangzhou franchise rights.

Speaker 9

So other than that, are there any factors that investors should be aware of? Or should we consider This is about $110,000,000 depreciating expenses as recurring, while we're tackling the full year depreciating expenses the full year? Thank you.

Speaker 3

Christine, yes, let me address that. So sorry, I quote myself here, we will acquire franchise, right? It's actually $25,000,000 per quarter, as we mentioned before, and then for full year, it's almost $100,000,000 And so the other one is, obviously, Remember, our access in China is based in China. And then so You will be impacted like the value and the depletion amount will be impacted by currency exchange. In the quarter, R and D depreciated against The U.

Speaker 3

S. Dollar by almost 8%. And so that would have an impact on branches and also the depreciation in because of currency translation as well. And then finally, we as we mentioned before, we have also done some store optimizations during the pandemic. So we decided to come out of our network.

Speaker 3

And obviously, we closed out some of the more challenging stuff. And so that also have an impact on The depreciation and amortization as well. So all in all, so you can think about this, dollars 25,000,000 from up, up And then you have also almost like $15,000,000 from foreign exchange and then you know about optimizations in our overall Our portfolio, and so all the impact is going to be generated for some $400,000,000 reduction in depreciation and amortization. We will have more details in our 10 Q statements. So if you guys are interested in more, I'd like that's one of the 3 key factors that will drive the depreciated advertising cost.

Speaker 3

I just want to remind analysts and investors that don't forget the impact of foreign exchange. The foreign exchange has been pretty volatile Over the past year, and as I mentioned, foreign exchange have a negative impact of 8% because of their RMB depreciation. So that's going to have an impact On P and L and also on the balance sheet. Thanks.

Operator

Thank you. That is all the time we have for questions today. Now hand back to Ms. Michelle Shen for closing remarks.

Speaker 1

Thank you for joining the call today. If you have further questions,

Operator

That does conclude our conference for today. Thank you for participating. You may now disconnect.

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Earnings Conference Call
Yum China Q1 2023
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