Yum China (YUMC), a licensee of Yum! Brands (YUM) in mainland China, is trading sharply lower (-12%) today after reporting Q2 (May) earnings last night. A little context would be helpful here. YUM owns several fast food chains, including KFC, Pizza Hut and Taco Bell. Expansion into China has been a huge focal point for YUM over the past several years. China accounted for more than half of total revenue. However, YUM was clearly struggling in China, in large part due to a slowing economy. There also has been some food safety issues and there is increasing competition.
Investors had been clamoring for YUM to spin-off its struggling China segment, which has been the laggard on overall results. In November 2016, investors got their wish when YUM separated into two independent, publicly-traded companies: Yum! Brands (YUM) Yum! China (YUMC).
Yum! China is a franchisee of Yum! Brands in mainland China. It has exclusive rights to three brands: KFC, Pizza Hut and Taco Bell. Yum China also owns the Little Sheep and East Dawning concepts outright.Yum China currently has more than 7,600 restaurants in 1,100+ cities. KFC is by far its largest brand with nearly 5,300 locations, followed by 1,700+ Pizza hut locations. Taco Bell is just getting off the ground in China.
Of note, Taco Bell had no presence in China until Yum China opened the first Taco Bell in China in January 2017 near Shanghai's landmark Oriental Pearl Tower. YUMC researched and fine-tuned the Taco Bell menu for China and the early response from customers has been very encouraging.
YUMC says that a new generation of younger consumers who are digitally sophisticated and brand driven are fueling growth in consumption in China. The ongoing growth of the middle class and urban population in China is expected to create the world's largest market for restaurant brands, with Yum China poised to be the market leader. Of note, YUMC has a strong capital position with no long term debt.
Turning to the Q2 (May) results, non-GAAP EPS rose 42% YoY to $0.27, which was slightly below market expectations. Revenue rose 0.4% year/year to $1.59 bln, which was basically in-line. Excluding FX impact, total system sales grew 7%, including growth of 8% at KFC and 7% at Pizza Hut. Same-store sales grew +3%, including growth of +4% at KFC, flat at Pizza Hut. In terms of new openings, YUMC opened 90 locations in MayQ (62 KFC, 25 Pizza Hut, 3 other) to finish the quarter with 7,685 restaurants. The company opened 223 new locations in 1H17 and expects to open 550-600 new locations in 2017.
YUMC says it's pleased with its overall performance during the quarter, including continued strength at KFC. Operating profit, restaurant margin and net income all showed robust improvement. YUMC says it's making progress in the key themes it's investing in: loyalty programs, digital and delivery capabilities, and the continued upgrade/remodeling of restaurants. YUMC is making some progress as loyalty members for KFC and Pizza Hut have surpassed 100 million in total, and mobile payment exceeded 40% of company sales in MayQ. Also, over 4,900 of its restaurants offer delivery service. Delivery sales accounted for 13% of total sales in MayQ. Loyalty, mobile and delivery are key growth areas for YUMC.
So why is the stock down so much on a basically in-line quarter? A big reason is that the stock has been on a strong move (+40%) since YUMC reported a large FebQ beat in early April. And that had followed a strong Q4 (Nov) result as well. As such, it seems expectations were quite high going into this report so an in-line result was seen as a big disappointment. Another thing to consider is that it has not even been a year since YUMC separated from YUM so investors are still getting used to how YUMC looks/performs as a stand alone unit. And apparently there will be some up and down quarters. It's not always going to be big upside.