Yum China Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 5, 2024

There are 11 speakers on the call.

Operator

Thank you for standing by. Welcome to the Yum! China Second Quarter 2024 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.

Operator

Florence Lip. Please go ahead.

Speaker 1

Thank you, operator. Hello, everyone. Thank you for joining Yum China's Q2 2024 Earnings Conference Call. On today's call are our CEO, Mr. Joey Watts and our CFO, Mr.

Speaker 1

Andy Yong. I'd like to remind everyone that our earnings call and investor materials contain forward looking statements, which are subject to future events and uncertainties. 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 and a PowerPoint presentation on our IR website. Please note that during today's call, all year over year growth results exclude the impact of foreign currency unless otherwise noted. Now, I would like to turn the call over to Joey Wat, CEO of Yum China.

Speaker 1

Joey?

Speaker 2

Hello, everyone, and thank you for joining us. Today, Yum China reported record levels of revenue, operating profit and EPS for the Q2. System sales grew 4% on top of 32% growth in the same period last year. Core operating profit grew 12% to US275 $1,000,000 EPS increased 19%. I would like to thank our colleagues for their hard work and innovative spirit.

Speaker 2

We are navigating a complex and dynamic environment. Yes, but we see the many challenges more as opportunities. With our industry leading capabilities and our scale, we are turning these situations to our competitive advantage. We have taken aggressive steps to drive revenue and profitability. I would like to highlight 3 of them.

Speaker 2

1st, we took a fresh look at every key process and cost element in our businesses. We make countless innovations to improve our operational efficiency, enhance profitability and increased resiliency. We are already seeing results. We are achieving major cost savings and reinvesting them into food and value. 2nd, we broadened our addressable market and held market share with our sharp focus on value for money and innovative products.

Speaker 2

Our transactions and delivery sales both grew by double digits in the second quarter. We will continue to innovate across our menu to address customer needs. 3rd, our breakthrough business models, K Coffee and Pizza Hut Wow! Achieved encouraging initial results. These stores delivered incremental same store sales and incremental profit.

Speaker 2

They are showing great future potential. These strategies are working well. Q2 was our most profitable second quarter since our spin off. Restaurant margins stabilized, OP margin expanded to 9.9%. Let me first talk about our initiatives to drive operational efficiency.

Speaker 2

These initiatives cover all aspects of our organization. 1st, Project Fresh Eye launched in quarter 4 last year helped improve OP margins this quarter. We are shooting for best in class and best in course. We are assessing our operations from our RGM, in other words, store managers' point of view, supporting our RGM better and faster. From our restaurants to back offices, we are reducing complexity and simplifying operations.

Speaker 2

All our major initiatives are now in place. The result is fewer unnecessary process burdens on our LGMs and better efficiency. Separately, we launched Project Redeye at the end of quarter 1 to improve our supply chain efficiency. Our goal is to spend better and buy better. To spend better, we are assessing our operations from our customers' point of view, identifying areas that add no value for them.

Speaker 2

We are also simplifying our ingredient SKUs, packaging and menu in a certain segment of stores and select dayparts without compromising sales. To buy better, we are sourcing directly from farmers and producers for certain categories. By systematically examining our operations from fresh perspectives, we are uncovering numerous opportunities. We are doing all of this while ensuring food safety and quality. Lastly, AI and automation will continue to play a big role in our business.

Speaker 2

We have automate major restaurant management tasks from sales forecasting to labor scheduling and inventory management. We have rolled out Ikitchen to all Pizza Hut stores. This integrated AI system enhances food quality and improves operational efficiency. We were among the 1st in our industry in China to adopt generative AI in 2023 to turbocharge our back office processes. We are working on a few dozen generated AI applications, including consumer insights, customer support, food safety and new product innovation.

Speaker 2

These tools are already helping us improve efficiency and make more informed data driven decisions. We are making great progress with these measures. Some have already impacted our 2nd quarter results, while others will take more time to bear fruit. Importantly, these are structural improvements that will bring long lasting benefit. With these measures in place, we have the bullet to compete on value and pursue growth in these dynamic environments.

Speaker 2

With that, let me turn to our brand strategy, starting with KFC. In our 37 years in China, KFC has introduced many popular product categories. Recent innovations include our Juicy Beef Burgers and Whole Chicken. Customers appreciate these new products, but they also love the fresh energy we bring to our iconic classics. In May, we combined our original recipe chicken and mashed potatoes to create a brand new burger, the original recipe chicken burger, By the way, the classic way to enjoy KFC's original recipe chicken is with mashed potatoes at least for kids in China.

Speaker 2

In the past, they were offered separately. Now we put them together into 1 burger. As one customer told me, it is a childhood dream come true. This innovative burger sold out in many locations in just 2 days and drove incremental sales and profits. Since it was so popular, we launched it again for a limited time in June.

Speaker 2

K Coffee is available in all KFC stores. Its sales exceed RMB 1,000,000,000 in first half of twenty twenty four, up 26% year over year. During this period, we sold nearly 120,000,000 cups, up 36% year over year. We have been accelerating the rollout of our groundbreaking side by side K Coffee Cafe since late last year. From just 100 stores in March, we tripled the number to nearly 300 in July.

Speaker 2

Side by side K Coffee Cafes feature a distinct dining area and menu, starting at RMB 9.9 at our campus stores, customers can enjoy our innovative coffee and a hotdog. We also took our popular sparkling Americano to the next level with the introduction of the iced orange creamy sparkling latte, very long name. The mood like smoothness, crispy birds and citrus flavor are mind blowing. Thanks to our superb supply chain and efficient operations, we are making healthy margins too. This is a winning model.

Speaker 2

By year end, we expect to roll out our K Coffee Cafe to 500 to 600 stores. Delivery sales continued via double digit growth momentum at KFC. We lowered the delivery fee in quarter 1 to capture the underserved smaller ticket segment. These strategic moves proved successful as we gained market share on aggregator platform. We drove incremental sales and profit without impacting margins.

Speaker 2

By introducing platform riders at select locations, we optimized rider cost while maintaining service quality and customer satisfaction. Now turning to Pizza Hut. This quarter, Pizza Hut achieved its most profitable 2nd quarter since spin off. On the sales side, we were up against an outsized comp in April from a successful IT marketing campaign last year. In May June same store sales improved.

Speaker 2

Despite sales deleveraging, we improved our profitability by enhancing operational efficiency. For example, we significantly reduced product preparation time by simplifying menu and kitchen operations. We also deployed automated fry rice machines and robotic servers to make our crews' workload lighter. Pizza Hut just hit the 3,500 store mark. We believe Pizza Hut has huge potential.

Speaker 2

Now present in over 7 50 cities, there are 1300 cities that have a KFC, but no Pizza Hut as yet. In addition to expanding its footprint, Pizza Hut is also reaching new consumer groups with amazing value, innovative products and business models. Here are some highlights. 1st, menu innovation. Our entry price pizzas are addressing previously underserved segments and grew double digit this year.

Speaker 2

Our new pizza dough burger, Pizza Bao is attracting many solo diners. This unique burger, made with a freshly baked pizza so fun is receiving great customer feedback. In quarter 2, we sold more burgers than Hawaiian Pizza, one of our signature. Encouraged by its success, we will be rolling the Pizza Store Burger out to all 3,500 stores later on this month. 2nd, our Pizza Hut Wow store model marks a major breakthrough.

Speaker 2

We successfully attract solo diners, young people and more value cautious customers. The model features simpler operations, good food variety and excellent value for money. It is the fast casual format with lighter service. Since opening the pilot store just in May, we have converted over 100 existing stores to this model by end of July. Initial result of the Wow!

Speaker 2

Model are encouraging. I visited some of our newly opened stores last month. Sales were vibrant with customers queuing outside. Our first batch of new stores achieved significant same store sales uplift. Given the encouraging results, we are accelerating the store rollout.

Speaker 2

By year end, we expect to more than double our Wow store count. Now let me talk about our store expansion. We are seeing fantastic long term growth opportunities in China. Our flexible new store formats allow us to penetrate profitably across city tiers and locations. Our new stores maintained good returns.

Speaker 2

Their payback period held steady at 2 years for KFC and improved to 2 to 3 years at Pizza Hut. Around 80% of our new stores achieved monthly breakeven within 3 months. We focus on white space to minimize the impact on existing stores. KFC's small time mini model is unlocking new site possibilities in lower tier cities. We have also identified opportunities in strategic locations like college campuses, guest stations, highway service centers and other transportation hubs and tourist locations.

Speaker 2

KFC's new store at Shanghai Jiaotong University, Jiaoda, for example, is enjoying busy on campus traffic. We are also leveraging partnerships with franchisees to unlock opportunities in lower tier cities and strategic locations. In the Q2, net new stores from franchising reached 25%. We expect the ratio will go up slightly exceeding the 15% to 20% target we set at our Investor Day last year. Now let me recap the 3 key messages I want you to take away today.

Speaker 2

First, we took actions to drive operational efficiency, which enable us to invest in value for money and to support our margin. These efforts were not just one off cost cuts, they were structural improvement that should deliver benefits for years to come. 2nd, we embraced consumer needs and succeed in driving robust transaction growth. We are confident that our sales initiatives will drive sustainable long term system sales and same store sales growth. 3rd, innovations in new store models will continue to power our long term growth.

Speaker 2

Our Q2 results show that our strategies are working. Great companies thrive in tough conditions and turn challenges into opportunities. I'm confident in our ability to navigate the current environment and emerge stronger than ever. Before we move on to our financial results, I would like to take a moment to recognize the tremendous contribution that Andy has made to Yum China. Andy has played a critical role in enhancing the company's financial strength, establishing robust cost discipline and supporting our growth strategy.

Speaker 2

Under his leadership, the finance team further strengthened its core capabilities and upgraded its system and processes in key areas. He also successfully led the completion of our listing in Hong Kong. I would also like to thank Andy for his commitment to transitioning Adrian Ding into the acting CFO role. Please join me in wishing Andy the very best. I am very pleased that Adrian will step up as adding CFO.

Speaker 2

Adrian is our current Chief Investment Officer and General Manager of Lavasa. Over the past 5 years, Adrian has led multiple investment and capital market projects to enhance our portfolio and organizational strength. He was instrumental in establishing the LOVAZA joint venture and building the LOVAZA business in China. With his financial and operational expertise, I'm confident that Adrian will support our growth objectives to create sustainable value for our shareholders. With that, I will turn the call over to Andy.

Speaker 2

Andy?

Speaker 3

Thank you, Joey, and hello, everyone. As this will be my last earnings call with Yum China, I want to express my sincere gratitude to Joey, my colleagues and shareholders and our analysts. Over the past 5 years, it has been a rewarding experience working closely with such a talented and dedicated leadership team. I'm proud of the accomplishment that we have achieved together, navigating the challenges posed by the pandemic and its aftermath. Yum China emerged from the pandemic more resilient and ready to accelerate growth.

Speaker 3

I'm confident in the company's continued success under the capable leadership of the existing management team. Now let's turn to our financial results. In the Q2, we delivered a solid performance and set numerous new records, including revenue of $2,680,000,000 operating profit of $266,000,000 operating margins of 9.9 percent and diluted EPS of $0.55 That's particularly impressive given the current market conditions. As Zhou Yi shared earlier, the initiative that we launched beginning in Q4 of last year to drive sustainable growth and protect margins are beginning to pay off. While tough lapping and current market conditions impacted same store sales, our margin stabilized.

Speaker 3

Our sales growth was led by healthy traffic. Total transactions grew 13% and same store transaction grew 4% year over year in the Q2. This is a testament to how well our brands, products, marketing and promotions resonate well with consumers. We attract new customers and capture more occasions from existing customers by broadening our price range and offering delicious food at a favorable price point. Despite a lower ticket average, restaurant margin was markedly flattish year over year on a comparable basis.

Speaker 3

Core operating margin actually improved year over year, setting a new quarterly record for operating margins, thanks to our e commerce scale and cost measures. Taking a longer view, our system sales grew 25% compared with the Q2 2019, outperforming the restaurant industry. Operating profit increased even more by 38% compared to 2019, excluding foreign exchange. Now let's take a closer look at our 2nd quarter performance. By brand, KFC system sales increased 5% year over year.

Speaker 3

Same store sales were at 97% of prior year level, with 4% same store traffic growth and 7% lower ticket average. Looking at it from a longer term perspective, our ticket average in the 2nd quarter was RMB 37, higher than the RMB 35 ticket average in the Q2 of 2019. Our strategy is to widen the price range and capture low ticket average delivery orders are paying off. Our entry price combo drove incremental traffic. Delivery sales grew 12%.

Speaker 3

Pizza Hut system sales increased 1% year over year. Same store sales were at 92% of the prior year level with traffic growth of 2% and a 9% lower ticket average. Pizza Hut continued to tap into more volume conscious consumer and solo diner segments with entry price pizzas, burgers and 1 person meal. The ticket average went down in keeping with our strategy, but probably improved year over year through our team's relentless effort to drive efficiency. Now let's go through our margin and key cost line.

Speaker 3

Our operating margin as a percentage of revenue was 9.9%, the highest second quarter record since our spin off. Resilient restaurant margins and proactive savings in G and A expenses helped us achieve that. Our restaurant margin was 15.5%, 60 basis points lower than last year or approximately the same on a comparable basis. Saving in cost of labor and occupancy and other costs offset increases in cost of sales. Cost of sales was 31.5 percent, 80 basis points higher year over year or 70 basis points higher on a comparable basis.

Speaker 3

POS was at a healthy level and consistent with our long term range of 31% plus or minus 1%. We manage our COF pipeline despite offering more value for money. Our food innovation capability and superb supply chain allow us to invest in sales driving initiatives and promotions. Cost of labor was 26.3 percent, 10 basis points lower year over year. Improved operational efficiency more than offset last year's wage increases for our frontline staff and the sales deleveraging impact.

Speaker 3

Occupancy and other was 26.7%, 10 basis points lower year over year or 50 basis points lower on a comparable basis. This comes from lower marketing and advertising expenses and other cost optimization. Our G and A expenses decreased 11% year over year. We drove operational efficiency gains. We also saved on lower performance based compensation this year.

Speaker 3

G and A expenses as a percentage of revenue was 5% in the quarter, improving from 5.8% a year ago. For the full year, we aim to keep the G and A ratio around 5%. Our effective tax rate was 25.2% in the 2nd quarter, on par with the same period last year. We expect our full year effective tax rate to be in the high 20s. Operating profit was $266,000,000 a 2nd quarter record, growing 7% year on year.

Speaker 3

Core operating profit was $275,000,000 growing 12% year over year. Adjusted EPS was $0.55 also a 2nd quarter record, growing 19% year over year. Finally, moving on to our outlook. The market conditions remain challenging. We will continue to invest in value for money and step up product and marketing innovations to drive transaction growth.

Speaker 3

Our operational efficiency, buy better and spend better projects are not temporary measured. We expect cost savings from Project Fresh Eye and Project Red Eye to continue in the second These transformative changes should position us well to remain best in class and best in class in our business, making our value proposition sustainable and profitable in the long run. Our disruptive new business model like KFC's side by side K Coffee Cafe and Pizza Hut's Vowel store are promising to further same store sales growth potential. As a reminder, we recorded around $15,000,000 in temporary relief and VAT deductions in the Q3 of last year. We do not expect this to re recur this year.

Speaker 3

We expect rate inflation for our Sunrise staff to remain at low single digit. We opened a record 779 net new stores in the first half and reached 15,423 total number of stores. We are on track to achieve our full year target of 1500 to 1700 net new stores. We are also on track to return $1,500,000,000 to shareholders. In the first half, we returned nearly $1,000,000,000 including buying back 21,700,000 shares.

Speaker 3

This is equivalent to over 5% of our outstanding share. Our strong cash flow generation and healthy cash position continue to power our capital return to shareholders. At the end of the Q2, we had $3,100,000,000 in net cash. Our 3 year growth target remain unchanged. We are committed to returning at least 3 burned down to shareholders, while driving long term and sustainable growth.

Speaker 3

Now with that, I will pass it back to Phuong. Phuong?

Speaker 1

Thanks, Andy. Now we will open the call for questions. In order to give more people the chance to ask questions, please limit your questions to 1 at a time. Operator, please start the Q and A.

Operator

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

Speaker 4

Hi, Joey and Andy. Congrats for the they are very strong and the resilient numbers and also and the all the best. So my question is about these new business format and store concept and it's really impressive that we have a very aggressive opening year to date. And thank you, Joey, also sharing the target by end of the year. But can you please give us more color about the economics and also the contributions like K Coffee side by side stores, incent door sales for those stores, we already have these openings in the past few months.

Speaker 4

And given it's still more value position, so shall we when we think about economics, shall we see that these full cost ratio will be higher, but this will be offset by like more simplified cost structures in O and O payroll. And then that's on the margin perspective, structurally, we will see more upside from this new model. And also are we going to see more new concept in addition to the cake, coffee and wall in the next few quarters? Thank you.

Speaker 2

Thank you, Michelle. It's truly amazing for our team to have this breakthrough and we are very excited about it. And I will answer your last question first is we are going to focus on these 2 breakthrough model out of KFC and Pizza Hut. And I think the initial results are very encouraging and we'll focus on that for the rest of the year and going forward. Come back to the content of the new concept, first of all, the easiest way is travel to Shenzhen.

Speaker 2

I encourage all our analysts just close the border. I recently just visited the one in Yifan Chang, Uni Center, I think, is the Pizza Vow. And then we have few other K Coffee side by side. Then you can see the menu, the operation and you have very good feel about it. So for K Coffee, it has its own menu.

Speaker 2

The menu is very simple. And then in terms of the product, we have some winning product, the sparkling coffee is a fantastic product and food is also important. And that comes to the next characteristic of K Coffee is we share the kitchen and the operation with the normal KFC store. So the kitchen is share, operation team is share, but it has its own distinct area. And then for the customer, the value for money is amazing and I will highlight one particular offer, which I mentioned in my remarks is the in the campus or campus K Coffee Store, we actually offer sparkling coffee with a hotdog at 9.9 years.

Speaker 2

You might naturally ask the question, how does it work for the margin? Well, think about this way for many years already, we offer our breakfast at 9 year, 8 year. We offer the food and the coffee comes for free. In K Coffee is the reverse. We sell the coffee at 9.9 year, food is free.

Speaker 2

So it's in our surprising capability that we can do these at very competitive ways. So the net net, the margin is healthy. So and then in terms of result, it add both incremental same store sales and incremental profit. Now come to the KA, Wow Pizza Hut Store. So it's sort of a bit more fast casual with a bit less service just a little bit.

Speaker 2

How do I describe this? The food offering is a bit like Pizza Hut, but tapas. Smaller portion, lower price, but if you go in there by yourself, you can order a bit more for variety, but total ticket average is less than the normal pizza store. But the traffic is fantastic. So overall it was and the same store sales increase is very encouraging.

Speaker 2

And for the Pizza Hut Vowel store, we just convert some of our Pizza Hut store into this new concept, is conversion basically. So right now, we have 100 stores convert by the end of July and we plan to achieve over 200 by the end of the year. And in terms of COS margin, it's actually better. Although it's early days, but the unit economics is better because COS is COL and O and O is a bit less. So that's what we can share with you right now.

Speaker 2

But the number one suggestion is across the board goes to see some incentive. Thank you, Michelle.

Speaker 4

Thank you, Joey. Very looking forward to.

Operator

Your next question comes from Lillian Liu with Morgan Stanley. Please go ahead.

Speaker 5

Thanks. Hello, Joey and Andy. My question is about recent trend on the same store sales. And also again congratulations on giving such a good result and even under a bit challenging environment. So I want to understand getting into quarter, Q4 when the top comp kind of eliminated a bit and with all this cost efficiency put in place, how we should look at the operation on a holistic basis?

Speaker 5

And have we seen a different trend in different tier of markets in terms of demand and the cost management like high tier city and lower tier cities? Thank you.

Speaker 2

Thank you, Lily Anne. Let me share a little bit learning from the quarter 1 trading pattern and then make few comments about the quarter 2. By region, the Eastern part of China is still the most resilient one, but city tier, lower tier city recover faster than higher tier city, both year on year and versus longer term like pre pandemic 2019. By location, the residential locations are more resilient and shopping centers are almost back to 2019 level. And moving on to the business environment, there's been a lot of attention to the business environment and consumer sentiment in China.

Speaker 2

We are not seeing significant change in market condition and consumer sentiment going to quarter 2. With that said quarter 3, sorry, my with that said, my management team and I share one particular philosophy on that. Yes, business is tough right now, but much like life, right. It's always tough. In business, as in life, we always expect the unexpected.

Speaker 2

We don't whine about it. We accept whatever comes our way and we adapt and do the right thing. Often in doing so, we are able to turn the disruptions to our competitor advantage by deploying our scale and our capabilities. In terms of how to do it, etcetera, I have covered them in my remarks regarding the specific actions, but the three key points bear repeating in summary. First of all, to answer your question about the cost efficiency, we have tuned every process and cost element to drive operational efficiency, make our store managers' workload lighter and reinvest into our value for money offerings and support our margins.

Speaker 2

2nd, we have innovate creative new products, which have lovely pictures in the PowerPoint app and we widened our price points to broaden our expressible market and drive traffic. So we innovate breakthrough store model, such as the K Coffee Cafe and mini store for small times for KFC and the fast casual model called Pizza Hut Vow, which I described to power future growth of KFC and Pizza Hut. All three strategies are showing strong initial results. As a result, for quarter 2 this year, we see robust growth, well actually double digit growth in transaction and delivery sales. Our restaurant margins stabilized and core OP grew by 12%.

Speaker 2

We see the most profitable quarter 2 since spin off despite the industry dynamic. Thank you, Lillian. Thanks a lot, Joey and the best wishes to Andy.

Speaker 3

Thanks, Lee.

Operator

The next question comes from Chen Luo with Bank of America. Please go ahead.

Speaker 6

Hi, Joey and Andy. This is Chen. And congrats again on the strong result and also my best wishes to Andy. I'd like to take a deeper look at margins. So definitely, our Q2 margins beat the expectation.

Speaker 6

And when you are looking into the details, I noticed, first of all, the food and paper costs as per central sales edged down by 60 bps on a Q on Q basis despite the fact that our promotion seems to be very intense in Q2. So what is driving that? Is it because of the falling commodity cost? Or it's because of our smart value or supply chain initiatives? And secondly, if you look at the cost of labor, it has declined big time on a year on year basis for Pizza Hut.

Speaker 6

And also for the group, it's largely flattish versus the usual upward trend. So what is also driving all these changes? And lastly, I noticed that our first half retro margin is actually pretty much on par with first half of twenty nineteen, which is usually regarded by the market as a normalized comparison base. Is it fair to say that going forward, our margins can be largely comparable for 2019 for the rest of the year? Thank you.

Speaker 3

Thank you, Laozheng, for your question. And in terms of short term, I think, obviously, we are narrating some pretty dynamic, pretty complex operating environment in the short term. And consumer remains very value conscious. And so that's an important thing to keep in mind. So from our perspective, if you look at Q3 last year was not particularly low base.

Speaker 3

If you think about last year, we did see the consumer space softened in late September. So that's something to keep in mind. So in the short term, obviously, sales would be an important driver for margins, as we have mentioned on the call. But nevertheless, as you we have mentioned in our prepared remarks, we have taken very decisive actions to adjust our cost structure and so that and then also we have very decisive action to change some of our business model to embrace the market change. And so as a result, we're able to see stabilized UC margins and then also we see expansions in our operating margin to assume that it's the best since our spin off.

Speaker 3

Now if you look at our initiative, those initiatives are not a short term measure. They are longer term structural change in a way how not only the cost structure, but also how we operate our business, make it more efficient. In the short term, I think like if you think about commoditized in the short term, some of commoditized more favorable. But at the same time, we again have mentioned over and over again that it's important for us to invest in value, invest and embrace the consumer changes. And so still as sometimes it fluctuates, as we have mentioned before, we always in the long term target 31% plus or minus 1%.

Speaker 3

And sometimes seasonality is on the fluctuations. I think all in all, we have few on market for that. This quarter is around 31.5%. So in terms of fill out, yes, you did see quite a bit of improvement in labor productivity, and that will be continuing some of our focus. We will continue to look into our operations, simplify some of the procedures and make sure that what we do actually add value.

Speaker 3

If what we do don't add value, they're not valuable for the RGM or consumer, we'll take it out. So but when we look at in the second half this year, but somewhat the full year this year, we do expect CLL inflation at the soften level to be at low single digit. And then in CHAM O and O, I think it continue to be an area that we have initiatives to try to improve that. But obviously, it is composed of many, many things, right? Capital allocations for store investment that impact depreciation and then also rent.

Speaker 3

Rent is a big thing, so we're going to continue to work on marketing leverage from our digital program. And so we will have many initiatives try to improve it incrementally. And so the one thing I want to remind you folks as we have been remind folks in the Q1 earnings call, which is last year, our company did enjoy some one times, right, like rental relief and also VAT deduction, which was a big government support policy that we don't didn't experience in the first half this year and we don't expect in the second half this year. So that item that impact comparably for the Q2 was last year was about US12 $1,000,000 and then in the Q3, it's about US15 million And so that's could be I think that's one factor that when you guys look at the model, I should keep in mind. And so in terms of G and A, I think as we have mentioned before, we will aim to keep G and A this year around 5 percent of our total sales revenues.

Speaker 3

And that is a significant improvement compared to last year and it is an improvement even compared to 2019. And so again, like in the short term, those are how we look at it. But longer term, I think we aim for more stable, largely stable margins and look for a way to improve our operating margins in the long run, if possible. And then we I think we have demonstrated and I think we're confident that we can manage both growth and profitability in good time and bad time. And do we face challenge in the short term?

Speaker 3

Sure. But we have demonstrated, I think, and you can see the action that we are taking to embrace the market changes, to adjust our cost structure, improve our operating efficiencies and also change our business model. So that I think that ability to make these negative changes to embrace change should help us to sustain margin in the long term. Thank you.

Speaker 2

I'll just give 2 concrete example for you, Lawson. For example, COS, right? We in select carrier right now we go straight to the farmer and producer. We get really good ingredient at better price. You can totally imagine.

Speaker 2

We'll continue to do that. In the CLL, what are the specific things that you can see in our kitchen? 80% of our Pizza Hut store right now have automatic fried rice machine. It's pretty cool. You might consider to have one in your house.

Speaker 2

It's actually very small. So it really solve the labor shortage or labor problem, particularly during the peak time. And then 50% of our Pizza Hut store right now have robotic server, not all the store can do it because store too small cannot benefit from it. So these definitely are structural change to the COL. And then we have, as I mentioned in my prepared remarks, we have fewer SKU at selected daypart.

Speaker 2

What does that mean? It means that we take out some tail for selected daypart, not throughout the whole day, but just throughout certain time of the day, so that it has less wastage, spend better, right? Less wastage, therefore less U. S, less U. L.

Speaker 2

That all makes sense. And these are the specific example. Thank you, Walter.

Speaker 6

Thanks a lot, Joey and Andy. And also look forward to that automatic rice fry machine if it is available on share. And also that's my best wishes to Andy again.

Speaker 3

Thanks, Rosy.

Operator

Your next question comes from Anne Ling with Jefferies. Please go ahead.

Speaker 7

Hi. Thank you very much for taking my question. So I have a small one. It's just on like the new format again. So moving forward, for example, for Pizza Hut Wow, does it mean that in the future on the store opening that because currently you're mainly doing a conversion on the store.

Speaker 7

So moving forward for your new opening, will that also means that some of the new opening will also be strict on like PCI as well? And based on your current store network, how many of them do you think that currently you can make this kind of shift? And how quickly you can do that? Or like at one point you will make a decision in terms of accelerating like on this rollout? And then for the K Coffee store, the same question is that under your current like store network, how many store are actually visible for this kind of like adjacent store format?

Speaker 7

Thank you.

Speaker 2

Thank you, Ann. For Pizza Hut Wow! Model, it's one of the model. For both KFC and Pizza Hut, we actually have multiple store model for multiple locations and formats and facility, etcetera, etcetera. Currently, for Pizza Harbor, we are testing this model in different parts of the country and also top tier city, low tier city, you can imagine.

Speaker 2

So we will be a bit more clear later on the year about how many of the existing store that have the potential to be converted. And you can imagine some of the new store is suitable for this model, we will open Pizza Hut Vow as a new store as well. Similar story for K Coffee, but not so similar. K Coffee is not so much a conversion. K Coffee Cafe is a bit like identify existing store and we kind of have a side by side add on sort of a distinct store to the existing KFC store.

Speaker 2

But again, we are testing it in different parts of China right now and the most remote part is in Shikaste, right, Sichuan, Tibet and in tourist location and then Hanzhou Dongzhang, the Hanzhou high speed railway station, you can imagine. So different locations, different city tier, we are testing it and then we are building our food and also the drink of the K Coffee as well. So we have a bit more aggressive number of K Coffee, which is by the end of the year stores. But this is what we have in our mind and we'll continue to learn and then we adjust and adapt and we accelerate the speed if we need to and we'll continue to learn. Thank you, Anne.

Speaker 7

Thank you. And I'll be all the best.

Speaker 3

Thanks, Anne.

Operator

The next question comes from Brian Fittner with Oppenheimer and Co. Please go ahead.

Speaker 8

Thank you. Andy, it's been a pleasure working with you. Thanks for all the help over the years and I wish you the best. I was hoping you guys could put some guardrails on how to think about the second half of the year for same store sales. Of course, if we look at last year, the comparison gets a lot easier in the 3rd Q4.

Speaker 8

But given the operating environment, I'm not sure how relevant comparisons are. So is there in fact an opportunity for same store sales to show some improvement in the second half, first to first half? Or is the message from you that we analysts should remain pretty conservative and maybe expect more of a similar second half as what we saw in the first half?

Speaker 3

Hi, Brian. Thank you so much for your kind, Ward, and then also thank you for your question. I think in terms of macro, I think there's a lot of news on the macro side. I think some of the complexities and potentially challenges in the Chinese consumer space or economies is well discussed. What we try to as we try to mention on this call is that as a company, we continue to be able to take decisive actions to one, to drive sales and the other one is to control costs.

Speaker 3

Those are 2 are actually hand in hand, right? So something some of these initiatives, we would be able to take more control and then yield results quickly. And so as a result, you can see our cost structure has improved quite significantly. And I think the strategy is working. On the other hand, we also pass along the savings to consumer, especially in the market where consumer are more value conscious.

Speaker 3

And so we'll continue to do that, channel some of the savings to invest in value campaign, some promotional activities to drive traffic. And I think we also have some results that were pretty encouraging. If you look at our traffic growth, we achieved same store traffic growth of low single digit this quarter. And then if you look at our overall traffic growth for our franchise, overall, like the brand, we are seeing double digit growth in our store traffic. And that is very important for our restaurant industry because traffic growth is what sustain long term growth and profitability for our business.

Speaker 3

And so in terms of the macro outlook, I think as Joey mentioned earlier, we don't see significant change going into the Q3. And we might focus that last year's Q3 was not particularly easy as you put it because we only begin to see some softening in the consumer space in late September last year. And so you can if you go back to last year, the trend and what we have coming at that time. And so but good news is we have a lot of initiative and to drive that. We have some breakthrough in our business model with Pizza Hut Bao model, with KFCs, K Coffee side by side model.

Speaker 3

And obviously, we also have a lot of initiative on food innovation. As a restaurant industry leading player, we are very proud of our innovative capabilities. And that is very important to drive consumer to the store. And so we'll continue to do that. But I will cautious people be overly optimistic in the second half.

Speaker 3

We're not pessimistic, but we shouldn't be overly optimistic.

Speaker 2

Thank you, Brian. Maybe I just add a few comments here. I mean, obviously, nobody has the crystal ball here. And I just want to emphasize that Yum China is a growing company in a growing market called China. It seems quite fashionable these days to be bearish on China.

Speaker 2

But I just want to add that even at its current growth rate, China still accounts for almost 1 third of the world's annual growth. And particularly the shift to the shift of growth to lower tier city kind of reminds me of the push into the frontier in the U. S. And part of yesterday's Wild West become today's Silicon Valley. And something like that has already happened in Shenzhen.

Speaker 2

So I'm confident that it will happen elsewhere in China as well. Therefore, system sales is equally important compared to systems same store sales. And we will try to focus on both system sales and same store sales to have the balanced approach. And you will appreciate that we are also opening a lot of new stores and that will have certain sales transfer in terms of same store sales. However, even with that we are taking a balanced approach as well, because 30% of our new stores actually are more on the strategic location or small tier city, where the sales transfer can be managed better and more than half of our new store are in lower tier city these days.

Speaker 2

And last but not least, the K Coffee Pizza Hut Vial actually are very focused on growing the same store sales. So we try to focus and have a balanced approach. Last but not least, it's not recorded in media, but last year alone China actually opened 400 shopping malls, mostly in Tier 2 and below. Think about how many countries in the world these days open 400 shopping malls. And for this year alone, 2024, we are expecting another 300 shopping malls to be opened in China.

Speaker 2

So when new shopping mall open like that, we shall open new stores. Even though it might imply sales transfer from the traditional high street to the new shopping mall, because that's how economy evolves and low tier city develop. So just try to put some content into the background macro here. Thank you, Brian.

Speaker 8

And I do appreciate the system sales side of the equation, but that the unit growth is what's known and the same store sales is kind of what's unknown. And that was the essence of my question. But thank

Speaker 2

you. Thank you, Brian.

Operator

The next question comes from Sajai Lin with CICC. Please go ahead.

Speaker 9

Thank you, Joe and Andy. Congrats for the high operational efficiency and strong bottom line and best wishes to Andy. So I want to better understand our pricing strategy in the coming quarters, especially KFC because for Pizza Hut, we want to introduce entry level pizza and lower the ticket average. But for Pizza Hut, the TA is relatively stable over a longer period, although we are expanding price range. So recently, we observed that some other restaurant companies may hope to keep relatively stable TA this year after a TA cut last year.

Speaker 9

So how about our pricing strategy, especially for Cap C, where we keep it relatively stable? Or we may further increase promotion because elasticity of the money is still high and to pass savings to the consumer? Thank you.

Speaker 2

Thank you, Sujie. So the question is about the TA basically. And I presume the TA's hidden question is about the margin. So the TA trend for both KFC and Pizza Hut is consistent with our strategy to drive traffic. Driving traffic is the most important thing in our business and we see robust same store transaction growth at both KFC and Pizza Hut.

Speaker 2

And we see 13% total transaction growth for the business and that represent the health of our business by the way. Point 2 is even with the lower TA, Q2 stabilized restaurant margin and improved operating margin, because we take proactive steps to improve the operational efficiency as well. So for KFC in the long term, we will take a balanced approach to maintain a steady TA. TA fluctuate quarter by quarter and particularly compared to pandemic. However, if we take a long term view, quarter 2 TA actually is RMB37 and it's still higher than the quarter 2 TA of 2019, that's pre pandemic and that's 35.

Speaker 2

So in the long term, KFC, we have a very balanced approach. But in the short term, we will have sharp focus value, widen the price range because that worked well and that drove traffic as we can see. However, with that said, we also will continue to offer higher ticket items with strong value for money such as Whole Chicken, Family Bucket because they continue to do well and they balance out the TA as well. For Pizza Hut, TA come down by design since 2017. Every year, we want to take the TA down a bit.

Speaker 2

For the quarter 2, it's probably a bit more than we expected, but it's okay. And let me add the Pizza Hut actually April, the same store sales TA suffer because of outsized promotion campaign last year, April. And by May June actually it recover the particular same store sales recover pretty close to KFC. But Pizza Hut will continue to tap into more value cautious consumer and solo diner segments with entry price pizzas, burgers and 1 person meal, etcetera. And then of course, the Pizza Hut Vial.

Speaker 2

By the way, for the entry price pizza, which is below RMB 50, which we talked about it in the last earnings release, This particular price point pizza is growing at double digit for us. It's very nice because it's expanding our market share in this particular segment. Thank you, Suji.

Operator

Thank you, Joey. That's very clear. The last question comes from Xiaopo Wei with Citigroup. Please go ahead.

Speaker 3

Hi. Can you hear me? Yes. Hello. Yes.

Speaker 10

Okay. Thank you for taking my questions. This is Xiaopo Yao of Citigroup. Yes. A lot of things have been discussed in the prepared remarks and the prior Q and A.

Speaker 10

I just want to understand that given this environment, a lot of things have been done by Julie and her team on the efficiency improvement. Have you thought about any disposal of a small business in this environment? Because the small business in the past was intended for expansion of the business, but giving all the environment and focus on efficiency. The small business may be a distraction of the resources. I just want to seek Joey's thinking on this perspective.

Speaker 10

Thank you.

Speaker 2

Thank you, Xiaopo. I mean, your thinking is completely along the line of our thinking. We constantly review our portfolio of the smaller business. And then if I would like to make a few comment here is, for example, the new retail, I mean some packaged food, that smaller business serve us well during the pandemic, when we could not open any stores in certain markets. However, now business sort of more back to normal and we can see the historical mission of the packaged food is probably accomplished.

Speaker 2

So we are going to probably reduce our imports and net debt by bit very soon. So that's one example. And then for other smaller business, we always have a very disciplined approach, which Endy have shared in previous interactions with our shareholder and analysts. We only invest a very small percentage of our profit on the small business. While it give us the opportunity, the smaller business give us opportunity to learn, to train our staff and to fail.

Speaker 2

It's not set up to fail, but smaller business is very challenging. So we'll continue to review our portfolio. LABASA actually is making really good progress. We have more significantly more breakeven sold this year than last year. We are happy about it.

Speaker 2

The retail beam business of LAVASA is actually turning profitable in quarter 2, 2024 and we expect meaningful sales growth this year. And for Lovaza, we actually are moving coffee bean production from Italy to China, so that we have fresher bean, more nimble innovation, lower cost, etcetera. So Lovaza will continue and it takes time to build a good business, but it's really building step by step. And then the Huang Zhihuang and Littoshi Huangshihuang is a very resilient business. We are adding 15 new stores in the first half, bringing our total to over 800 stores globally.

Speaker 2

And little ship we have this new model called is to convert part of the store, sometimes a new store to serve 1 person and has achieved initial success and we are building more store this year. And then Taco Bell is having a bit of a harder time because it is indeed a bit more self foreign concept to Chinese consumer. So we need a bit more time and we are starting out the portfolio to further improve the business model. And that's where we are, but Xiaopo, we are constantly reviewing the health of the smaller business. Thank you so much.

Speaker 3

Yes, Xiaopo, I will add a little bit more there. As any capital deployment in our company, we're store model or be it the brand. I think we have demonstrated in the past and we'll continue to do that, which is when we see something that have potential, we'll continue to invest in that. And we don't have a discipline we don't have a requirement that you immediately need to be profitable for smaller brands. For example, building a coffee brand in China will take time, right?

Speaker 3

But we see great progress and we'll continue to invest in that. We also saw that we have closed some brand like C and J, right? Like when you think we need to consolidate, our resources are focusing on the coffee business on Babasa and now K Coffee at the lower end functional end of the coffee business. And so yes, so like capital deployment, including for the brand, for the store, the overall portfolio, we continue to remain very disciplined about it to make sure that capital is deployed efficiently for our shareholders. Thank you, Xiaopo.

Speaker 1

Thanks, Xiaopo. Great.

Speaker 10

Thanks. And Andy, all the best.

Speaker 3

Thank you so much.

Speaker 2

Thank you all. Thank you.

Speaker 1

Thank you for joining the call today. For further questions, please reach out through the contact information in our earnings release and on our website. Thanks.

Speaker 6

Thank you.

Speaker 2

Thank you so much, guys.

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Earnings Conference Call
Yum China Q2 2024
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