Yum China Holdings, Inc. (NYSE:YUMC) Q4 2023 Earnings Call Transcript
Yum China Holdings, Inc. (NYSE:YUMC) Q4 2023 Earnings Call Transcript February 7, 2024
Yum China Holdings, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Thank you for standing by, and welcome to the Yum China Fourth Quarter and Fiscal Year 2023 Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to Ms. Michelle Shen, IR, Director. Please go ahead.
Michelle Shen: Thank you, Operator. Hello, everyone. Thank you for joining Yum China's fourth quarter 2023 earnings conference call. On today's call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung. 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. 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. Joey?
Joey Wat: Thank you. Hello, everyone, and thank you for joining us today. As Chinese New Year is coming Saturday, I want to wish everyone a happy and healthy Year of the Dragon. I would like to kick off today's call by expressing my sincere appreciation to all our employees. Their incredible effort help Yum China deliver exceptional growth in the fourth quarter and for the full year. 2023 was a pivotal time for our business. This transformation of our business fundamentals in the past few years has enabled us to seize opportunities emerging from China's reopening and evolving market conditions. In 2023, we hit record breaking revenue of $11 billion and grew system sales 21% year-over-year, outperforming the industry. Operating profits soared to $1.1 billion, an all-time high excluding special items.
Core operating profits grew 79%. We opened a record 1,697 net new stores, expanding our total store count to 14,644 stores. KFC reached 10,296 stores, Pizza Hut reached 3,312 stores. On today's call, I would like to walk you through the tremendous growth opportunities we see and discuss our strategies to capture them in 2024 and beyond. For the past 36 years, we have been the market leader in China. During this time, hundreds of restaurant operators have passed in and [indiscernible]. Instead of being Huang Ji Huang, or the flavor of the month, we want to be [indiscernible] or the flavor of the decade, or even next several decades. In this developing market, where the restaurant industry is still growing double-digit, even during 2023 we see a long runway of growth for our brand.
KFC still only serves 1/3 of the China population. Our next ambitious target is to extend our reach to half of the population by 2026. How? By being closer to our customer. That means adding store density in existing cities and entering new cities. KFC currently operate across 2,000 cities in China, and is tracking an additional 1,000 cities. For Pizza Hut and our emerging brands, the whitespace is even larger. China is fast with significant regional and city tier [ph] differences. In lower tier cities, urbanization and long-term consumption upgrades are presenting attractive opportunities for us. With lower living costs, consumers in these cities have significant purchasing power for our products. So as an example, premium beef burgers sell well in lower tier cities, just as in high tier cities.
Over half of our new stores in recent years are in lower tier cities. These stores have performed well benefiting from lower labor costs and rent, and the ticket average is as good as in higher tier cities. For now, we are mainly serving middle class consumers in these markets. As we expand, we see further opportunity in widening price points to broaden our addressable customer base. Our mission is to reach 20,000 stores by 2026. We will continue to protect our new store pay back at 2 years for KFC and 3 years for Pizza Hut. Over the past years, we have been improving our fundamental capabilities to reach this target. This is the key reason we can expand at an accelerated speed. Some of these improvements include: first, flexible store format with lower upfront investment, open up more sites potential across at APS [ph].
Second, cost structure rebasing lower our rent ratio in 2023 to 8.7% of sales, the lowest level in the past 10 years. The majority of our leases are based on variable risks. Third, improved operating capabilities. AI enabled digital tools empower our capable restaurant managers to oversee multiple stores without compromising quality. This also solves the bottleneck of having enough good RGM as we expand rapidly. Finally, strategic franchise partnerships allow us to gain access to locations that were beyond our reach before, such as highway service centers. In addition to a new store growth, our same-store sales grew 7% in 2023. It was fueled by a 12% increase in transactions indicating healthy growth. Our innovative menus, excellent value for money and effective online channels captured over 1.7 billion transactions last year.
Now, let's talk about food innovation. In 2023, we rolled out more than 500 new or upgrade products. That means we offered something new every week. Some examples include KFC's Beef Wrap with spicy blood and Chicken Taco with bull sauce and Pizza Hut's [indiscernible] pizza. This may sound a bit exotic, but I can assure you they're very popular in China. Over the years, many of our most popular products have entered our 100 million club in U.S dollar sales and 2023 was no exception. Our Golden SPA chicken burger, (Huang jin SPA ji pai bao) launched in quarter four of 2022 joined our 100 million Club in 2023 with very little spent on marketing. It offers amazing value for money using chicken breast meat and is very popular with younger customers.
Chicken breast meat is very high-quality protein, but the cost of breast meat is much cheaper in China than that meat. Our juicy whole chicken, means [indiscernible] is another remarkable success story. We launched it in 2021 and by 2023, We sold over 50 million whole chicken. Whole chicken and beef burgers combined now contribute close to 6% of our sales, more than the original recipe chicken that we have been selling in the last 36 years. K-COFFEE also grew rapidly in 2023, driven by product innovation and improving accessibility. 190 million cups were sold last year, a 35% increase year-over-year. Our coffee offers great value for money as low RMB9.9 per cup. Great value for money remains a key factor to drive traffic. In addition to the great food that I just mentioned, we have strategically enriched our menus with entry price point products to attract incremental customers.
Our super in-house supply chain empowers us to innovate and offer fantastic value, while protecting margins. At KFC, apart from our long lasting value platform, Crazy Thursday, (Feng kuang xing qi si), we identified entry price combos as huge underserved market segments. Last year, KFC expand the choices of its RMB20 combo including our recent Chinese burgers [indiscernible], which has been well received by customers. For pizza, the under RMB50 segment represent a significant portion of the market, but it's underserved at Pizza Hut. In November last year, we launched four entry priced pizza, including the delicious Texas barbecue chicken pizza. We will continue to add more cost cautious choices to our menu this year to capture incremental sales.
We also see amazing potential to further grow delivery sales. We are adjusting our delivery pricing structure to be more aligned with market norms. This will help us capture incremental traffic, especially in the smaller ticket segment and from more price sensitive customers. Our third traffic driver is the effective use of our own and third-party online channel. In 2023, our digital sales surpass $9.2 billion, of that about 1/3 came from our own Super APP, 1/3 from many programs, and 1/3 from aggregators. Our own Super APP sales grew rapidly last year, up 35%. We continue to actively recruit and engage members. Our loyalty program exceeds 470 million members, who contributed a record 65% of our sales. The purchase frequency of our K-Friends, our most loyal customers, was more than 100x a year.
Our collaborations with major eCommerce and social media platform extend our reach beyond physical stores. This allows us to attract new customers and promote new offers in a cost effective manner. We consistently lead the industry in terms of sales generated on this platform. A brand that deeply ingrained in China, well loved and trusted by consumers, we continued to deliver amazing growth despite operating in a challenging environment. KFC's pricing remains our key growth engine with a record operating profit of $1.2 billion in 2023. Pizza Hut is taking off adding 409 stores in 2023 alone, compared to just 41 stores in 2019. Their 2023 core operating profit tripled year-over-year. Lavazza is on the right track with sales support and notable improvements in store economics.
Taco Bell is making notable progress. Yet, there's more work in store model refinement and manual localization to be done. Little sheep returned to profitability in 2023. Its innovative store model which caters to smaller party sizes has achieved initial success. We expect good momentum in opening stores, both in China and overseas. Huang Ji Huang continues to be resilient, maintaining profitability every year since we acquired it in 2020. In 2023, Huang Ji Huang tripled profit and opened 14 net new stores. We will continue expanding our store footprint in China and overseas this year. Over into 2024, we are serving up a combination of exciting menu items, awesome choice and gains for Chinese New Year. KFC's newest innovation, the [indiscernible] fried egg in spicy sauce chicken burger [indiscernible] is absolutely delicious.
Its comfort food for your soul. We are also offering our widely popular Golden Bucket again this year. It has a very lucky and down to earth name, [indiscernible], which means get rich soon. And the first letters also stands for KFC. So right now it's getting around, getting more popular to reach each other KFC in China. Pizza Hut is launching a key new product, including Wagyu beef pizza [indiscernible] at just RMB69. The abundant choices and value are amazing. Although consumers are more rational and price sensitive in the current economy, there is a strong desire to indulge, especially during holidays. Our enticing offers are designed to generate excitement and attract traffic. I eagerly anticipate this vibrant trading period. With that, I will turn the call over to Andy.
Andy.
Andy Yeung: Thank you, Joey, and Happy Chinese New Year everyone. Today I will discuss our fourth quarter and full year 2023 financial results followed by our outlook for 2024 as well as our capital allocation strategy. We deliver robust results in the fourth quarter and reached significant milestone for the full year. In response to current operating environment, we adopted our strategy and launched attractive campaigns. This allow us to drive incremental traffic and sales. We maintained 21% of system sales growth in the quarter, same as the full year. Core operating profit in the fourth quarter quadrupled year-over-year and restaurant margin improved on a comparable basis. As you may have noticed, we have introduced core operating profit to enhance comparability of our results and provide additional transparency on how we evaluate the performance of our core operations.
This metric excludes for exchange impact, special items and other items affecting compatibility. For further details, please refer to the reconciliation table in our earnings release, and presentation. Let's now look at our fourth quarter performance in more detail. System sales increased 21% year-over-year, led by 12% net new unit contribution, 4% same-store sales growth and lapping temporary closure from the pandemic in the prior year. By brand, KFC system sales increased 20% year-over-year. Same-store sales grew up 3% mainly came from 16% same-store traffic growth and 11% lower ticket average. To put it into perspective, ticket average in the fourth quarter was RMB, the same as last quarter and higher than 2019. Overall ticket average remain stable in the past 5 years and our focus has been to grow our traffic.
A strong rebound of dine-in-sales, especially for breakfast daypart and successful expansion of our entry price offering contrary to lower ticket average. Pizza Hut system sales increased 24% year-over-year. Same-store sales growth of 6% was driven by strong traffic growth of 15% and ticket average decrease of 8%, is by design and consistent with our revitalization strategy since 2017. Our recent focus has been to expand pizza offering below RMB50 and smaller party size options. The strategy has proven effective in expanding our addressable market and capturing incremental traffic. Our restaurant margin was 10.7%, 30 basis points higher than last year. On a comparable basis, our restaurant margin grew by 170 basis point. The improvement was mainly from sales leveraging, lower rider costs, more favorable commodity prices and lower advertising expenses.
This more than offset increased marketing campaigns and wage inflation. Now, let's go through the key item. Cost of sales was 32.4%, 50 basis points higher year-over-year. During the quarter, commodity prices were favorable. We passed that to consumer by offering better value for money. Cost of labor was 29.0%, flattish year-over-year, or improved 40 basis points on a comparable basis. Sales leveraging, lower rider costs and efficiency gains more than offset ratio increases for frontline staff. Occupancy and other was 27.9%, improved 100 basis points year-over-year or up 180 basis points on a comparable basis. This came from lower rent and depreciation expenses as well as more efficient management of marketing and advertising expensive. G&A expenses increased 6% year-over-year, with highly managed costs and headcount to keep G&A both below revenue growth.
Operating profit was $110 million. Core operating profit quadrupled. Our effective tax rate was 24.2% in Q4 and 26.9% for the full year. Lower effective tax rate on a year-over-year basis was mainly due to more preferential tax benefits and higher pre-tax income. Diluted EPS was $0.23, excluding special items, foreign exchange and major investment, the increase was 164%. Now let's turn to our outlook. We remain excited about the vast growth opportunities in China. In 2024, we anticipated opening 1,500 to 1,700 net new store. After 36 years in China, it's amazing that we're still growing our store at double digits. Our heavy new store payback give us confidence to continue expansion and reach 20,000 store by 2026. As we shared at our Investor Day last year, we aim to grow system sales and operating profit by high single-digit to double-digit compound annual growth rate, and EPS by double-digit compound annual growth rate from 2024 to 2026.
We'll continue to capture our new opportunities by innovating new products, launching engaging camping and widening price points. These help us to expand our addressable customer base and drive incremental sales. We're confident in executing our 3-year plan, cost structure rebasing continues to be a key focus. Our efficient cost management will enable us to pass the savings back to customers and drive traffic, while protecting margin. Before I delve into the first quarter outlook, I would like to remind everyone that first quarter 2023 was a phenomenal quarter, during which we achieved record setting profit. We capture robust demand from the reopening, delivering solid sales. On the cost side, we benefited from substantial temporary relief in VAT deduction benefits, which is not expected to recur this year.
We also benefited from labor productivity gains from labor shortage in the first quarter last year. Looking ahead to the first quarter this year, as Joey mentioned, we're now operating under a new normal. Consumers are more rational in spending, yet have great expectations and appetite for new and exciting products and that can offer great value for money. In response, we have statistically planned a very intensive number of new product launches and attractive promotion. We have also dedicated more resources to drive sales and capture the peak Chinese New Year traffic. In light of these challenges, we will work hard on productivity improvement and cost control, including G&A expenses. Our aim is to maintain our core operating profit markedly stable on a comparable year-over-year basis in the first quarter.
This will exclude temporary relief, VAT deduction benefits and changes in foreign exchange rates. Now, let's turn to capital allocation. There's no better investment than investing in our own organic growth, while delivering excellent returns to our shareholders. With a strong focus on efficient capital return, CapEx in 2023 totaled $710 million at the low end of our original target. In 2024, CapEx is expected to be in the range of $700 million and $850 million. Since the spinoff, we have returned $3 billion to shareholders, and we plan to return another $3 billion in the next 3 years. We accelerated return to shareholders in 2023, returning a record $833 million in cash dividends and share repurchases. In 2024, we plan to further accelerate return to shareholders to around $1.5 billion.
We raised our dividends by 23% from $0.13 to $0.16 cents, that would be roughly $250 million for the full year. As for share repurchases, we already have a $750 million program in place and plan to further increase repurchases by around $500 million. So, a total of $1.25 billion share repurchase in 2024. This is equivalent to around 9% of our market cap at the current share price. The setting up of returns demonstrate our confidence in our cash sharing capability and commitment to return accepted cash to our shareholders. Let me pass it back to Joey for closing remarks. Joey?
Joey Wat: Thank you, Andy. Before we turn to Q&A, I would like to just summarize, in 2023, we reached record, top line and bottom line as well as net new store opening. And we returned record level of cash to our shareholders through dividends and buybacks. These achievements were made possible by the transformation we implemented in our fundamental capabilities ranging from flexible store format and put innovation at scale to support supply chain management and industry leading AI application. We have showcased our expertise and agility to navigate diverse market conditions. And knowledging the high expectations our shareholders hold for us, we in turn, set equally high standards for ourselves. We are fully committed to a 3-year growth target and generating long-term sustainable value for our shareholders. I would like to thank our shareholders for your continued support. With that, I will pass it back to Michelle.
Michelle Shen: Thank you, Joey. Now we will open the call for questions. In order to give more people the chance to ask questions, please limit your questions to one at a time. Operator, please start the Q&A.
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