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High Cost of Operation to Hurt Yum China's (YUMC) Q4 Earnings

Zacks Equity Research

Yum China Holdings, Inc. YUMC is scheduled to report fourth-quarter 2018 numbers on Jan 31, after the closing bell.

The company’s fourth-quarter earnings are expected to have been affected by high costs of operations and a lesser franchised business model. Lower-than-expected performance at the Pizza Hut division has also been plaguing the company’s revenues of late and the trend might have continued in the fourth quarter as well.

Shares of Yum China have lost 26.7% over the past year, underperforming the industry’s 5.6% rally.

Factors at Play

Yum China is facing the structural high cost of labor and rentals. Apart from wage inflation, the company is bearing additional costs, stemming from promotion, menu innovation and technological novelty. In order to curb labor cost, it is increasingly focusing on delivery channels, which is again expected to curb margins in the near term.

Further, costs related to transactions and franchises are expected to gear up in the near future. The non-franchised model makes Yum China susceptible to increased expenses. The company, not signing enough franchise agreements, is unable to put the burden of costs onto the franchise and is solely responsible for expenses of operating the business.

Notably, in the third quarter of 2018, total costs and expenses increased 4% year over year to $1,943 million. Restaurant margin in the quarter was at 17.6%, reflecting a 40-basis point (bps) decline from the year-ago quarter. The fall in restaurant margin was due to investments in product upgrades, promotions at both KFC and Pizza Hut, and Yum China’s sales deleverage at Pizza Hut.

We believe the above factors to have continued in the fourth quarter as well. Subsequently, the Zacks Consensus Estimate for revenues and earnings in the to-be-reported quarter predicts year-over-year declines of 13.1% and 63.2%, respectively.

Despite effective innovation across products, marketing and promotions, sales trend of Pizza Hut has been choppy in the recent quarters. In the third quarter of 2018, system sales were down 2% and comps declined by 5% in Pizza Hut restaurants.

What Does the Zacks Model Unveil?

Our proven model does not show that Yum China is likely to beat earnings estimates this quarter. This is because a stock needs to have both — a positive Earnings ESP and a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) — for this to happen. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

Yum China has an Earnings ESP of 23.08%. However, the company’s Zacks Rank #4 (Sell)decreases the predictive power of ESP.

Yum China Holdings Inc. Price and EPS Surprise


Yum China Holdings Inc. Price and EPS Surprise | Yum China Holdings Inc. Quote

Stocks to Consider

Here are a few stocks from the Retail-Wholesale space that investors may consider as our model shows that these have the right combination of elements to post an earnings beat in the fourth quarter:

Amazon AMZN has an Earnings ESP of +0.68% and a Zacks Rank #2 at present. The company is scheduled to report quarterly results on Feb 7.

You can see the complete list of today’s Zacks #1 Rank stocks here.

Caseys General Stores CASY has an Earnings ESP of +18.15% and it currently sports a Zacks Rank #1. The company is expected to report quarterly results on Mar 6.

RH RH has an Earnings ESP of +15.19% and it presently flaunts a Zacks Rank #1. The company is expected to report quarterly results on Mar 26.

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