YumChina (NYSE:YUMC)

YumChina is a company that possesses exclusive rights to operate the KFC, Pizza Hut and Taco Bell concepts in in the People's Republic of China (excluding Hong Kong, Taiwan and Macau.) Balance date is 31st December. At that date on 31st December 2018 YumChina operated 7,983 restaurants. This makes it by far the largest operator of chain restaurants in China, with the majority of those outlets being KFC. As I write there are only three Taco Bell restaurants in the whole of China, all in Shanghai. Taco Bell is currently a concept in development in China. Decisions on when or whether to roll it out further are yet to be made.

Some may be surprised to learn that the largest restaurant chain 'brand' in China is KFC, and not a Chinese home grown brand. Chinese home grown fast food brands have been relatively unsuccessful because Chinese food by its nature is already fast and convenient. The exotic nature of the American brands has made them more desirable. Reversing the situation in the United States, McDonalds is very much in second place in China with 2500 outlets open by August 2017. Possibly helping KFC is that they have adapted their menus to Chinese tastes. The chain boasts a full Chinese breakfast menu alongside fish and shrimp burgers, vegetable soups and full-plate meals with vegetable sides. Contrast this to McDonalds who have stringently stuck to their American food concepts. Dominos Pizza has only a very small presence in China for possibly the same reason. A further advantage card the American concepts can play is that their standards of restaurant and toilet cleanliness is generally higher than the Chinese competition.

YUMC is listed on the NYSE. Yet the annual meetings so far have been held in Hong Kong. Although the reporting currency for the company is USD, the functional currency in which business is transacted in China is the Chinese Renminbi ("RMB"). Unusually for an Asian corporate, the company Chief Executive is a relatively young woman, Joey Wat, aged 46 at last balance date. The goal of the company is to triple the number of restaurants they operate in China over the next 20-30 years. They are currently opening on average more than two new restaurants for every day of the year.

YUMC was spun off from the parent YUM Corporation in October 2016. So it doesn't have a long history as a listed entity, even though they opened their first restaurant (a KFC) in China as long ago as 1987.

Why should an investor in NZ be interested in YUMC? It is an example of a comparable company to the likes of Restaurant Brands, who also license most of their restaurant developments from the concept owning YUM parent. With a partial takeover offer in the market for RBD as I write, a look at YUMC gives us an independent reference point for valuing this kind of business.

Some analysis of YUMC will be forthcoming.

SNOOPY

discl: hold YUMC

YumChina is the largest restaurant company in China, employing over 400,000 people (including part timers). YumChina has entered into a master license agreement with a subsidiary of YUM (the owner of the intellectual brand property) providing the exclusive right to use and sublicense the use of intellectual property owned by YUM and its affiliates for the development and operation of KFC, Pizza Hut Casual Dining, Pizza Hut Home Service, and Taco Bell restaurants in China, and for the conduct of all related development, promotional and support activities. The license term for all YUM concepts is 50 years, with a further successive 50 year renewal options in perpituity.

YumChina lists their competitive advantages as:

• A company culture based on global systems and local spirit.
• Category-leading brands in one of the world's fastest growing economies.
• High-quality, great-tasting food, including local favourites with compelling value and a Western experience.
• Strong unit economics. (Cash on cash payback period of 3-4 years for new PH and KFC restaurants)
• Extensive experience in developing new restaurants.
• Knowledge and understanding of Chinese consumers and versatile approach to marketing.
• Supply chain management with a focus on food safety and quality. (Eighteen distribution centres are strategically placed around China.)
• Internal people development culture and training systems. (own internally developed management training system called 'Whampoa Academy')
• World class operations led by certified restaurant managers. (Every restaurant manager has an assistant manager, providing an ideal training ground for future managers of new restaurants).
• Digital and technology capability, especially in mobile and social media.
• Experienced senior management team (many still employed from the early days in China).

In terms of actual store numbers verses competitors in the Chinese market, these are the latest figures that I can find:

1/ YUM China: 7983 stores (Dec 2017) with principal brands: KFC (5,400+stores ) and Pizza Hut (2,100+stores)
2/ McDonalds: 2625 stores (CY2017 end)
3/ Dicos: 2600 stores (CY2017 end). Dicos' feature “Crispy Fried Chicken”, and serve other local flavours like rice burgers and teriyaki chicken rice sets. Dicos aim at a slightly lower price point than KFC and McDonalds. Dicos is owned by Ting Hsin International Group, a Taiwanese based corporate.

Conclusion: Pass Test

SNOOPY

	FY2013	FY2014	FY2015	FY2016	FY2017
Operating Profit (excluding Impairments (1))	$384m	$354m	$488m	$640m	$785m
subtract Insurance Payouts		($25m)	($5m)	($3m)
adjust Corp Jet Disposal			$15m	($2m)
adjust Foreign Currency Adjustments		$5m	$4m	$3m	$0m
add Interest Earned	$5m	$14m	$8m	$11m	$25m
Equals Adjusted Normalised EBT	$389m	$348m	$510m	$649m	$810m
subtract Tax at 27% (2)	$105m	$94m	$137m	$175m	$219m
Equals Adjusted Normalised NPAT {A}	$284m	$254m	$372m	$474m	$591m
Shares on Issue EOFY {B}	363.758m	363.758m	363.758m	383.344m	388.860m
eps {A}/{B} {C}	78.1c	69.8c	$1.02	$1.27	$1.52
Share Price 31 March (following) {D}	NA	NA	NA	$27.20	$41.50
PE Ratio (D)/(C)	NA	NA	NA	21.4	27.3

Notes

1/ Significant impairment write offs for the 'Little Sheep' casual dining concept occurred in 2013 and 2014. YUMC own the intellectual property of the 'Little Sheep' brand. 'Little Sheep' had its foundation in Inner Mongolia, China. It specialises in 'Hot Pot' cooking popular in in China, especially in the winter months. 'Little Sheep' has more than 280 restaurants operating. A wholly-owned business that sells seasoning to retail customers is part of the 'Little Sheep' operation. But total turnover at 'Little Sheep' is less than 1.5% of the turnover of YUMC.

2/ The US corporate tax rate up to 31st December 2017, for the last few years, has been 35%. Looking at Note 17 on Income Tax in AR2017, the actual tax paid by YUMC on operations has been less than this. For the years 2017, 2016 the 'Statutory rate differential attributable to foreign operations' was 8.4% and 7.5%. I have rounded this off to 8%, subtracted the 8% from the 35% US statutory rate and come up with 27%. This is still above the 25% Chinese Corporate Income tax rate, and I cannot explain the difference.

Conclusion: Pass Test

SNOOPY

	FY2013	FY2014	FY2015	FY2016	FY2017
Adjusted Normalised NPAT {A}	$284m	$254m	$372m	$474m	$591m
Shareholder Equity EOFY {B}	$2,344m	$1,945m	$1.979m	$2,443m	$2,859m
ROE {A}/{B}	12.1%	13.1%	18.8%	19.4%	20.7%

The trend is encouraging, but we have to stick to our rules.

Conclusion: Fail Test

SNOOPY

	FY2013	FY2014	FY2015	FY2016	FY2017
Adjusted Normalised NPAT {A}	$284m	$254m	$372m	$474m	$591m
Revenue {B}	$6,905m	$6,934m	$6.909m	$6,752m	$7,144m
Net Profit Margin {A}/{B}	4.11%	3.66%	5.38%	7.02%	8.27%

Inflation in China is around 2%. The smallest gain in margin has been from FY2016 to FY2017. 2% of 7.02% (margin for FY2016) is 0.14 percentage points. That means as long as the FY2017 margin is greater than 7.02% + 0.14% = 7.16%, then our requirement is satisfied. They actual margin is 8.27%, so our requirement is met, and has been met over each of the last three 'year on year' comparisons.

Conclusion: Pass Test

SNOOPY

When I first heard about the KFC drive into China, I thought of a vast receptive open audience just ripe for the picking. It would simply be a mechanical process to roll the US model for KFC success onto a blank Chinese canvas.

However, here is a detailed history of what has happened with the roll out over the last 30 years:

https://macropolo.org/how-kfc-change...a-changed-kfc/

This article clearly shows that even with a prescriptive management plan tightly overseeing the business development, there have been many hiccups along the way. 'First mover advantage' saw KFC off to a flying start. But the novelty lustre was lost by the early 2000s. So KFC changed focus by becoming more attuned to Chinese customs. Breakfast is very important in China. So KFC began introducing a wide variety of breakfast products tailored specifically to Chinese customers: soymilk drinks, savoury fried dough (youtiao), and congee. Later the company also introduced rice-based meals to its lunch and dinner menus.

Greater competition from 2010 to 2014 has seen KFC target 'small' fourth tier cities (still with populations greater than 2.5m) and gear their offerings to the upcoming 'digital generation'.

What went wrong in the early part of our five year analysis? Specifically failure of certain upstream poultry suppliers to meet YumChina standards in late 2012 as well as adverse publicity relating to improper food handling practices by a separate, small upstream supplier in mid-2014 badly affected the same store growth picture. The poultry supply issue from 2012 emerged when the Chinese Central Television (CCTV) broadcast an investigative report about some poultry farmers ignoring regulations by using excessive levels of antibiotics in chicken. Some of the product was purchased by two of KFC China's suppliers. The story led to an investigation by the Shanghai FDA and snowballed into a negative media and social media firestorm lasting six weeks. To underscore its effect, same-store sales declined 41 percent at KFC in January 2013. Returning to 2014 , specifically, on July 20, an undercover report was televised in China depicting improper food handling practices by supplier Shanghai Husi,a division of OSI, which is a large, global supplier to many in the restaurant industry. This triggered extensive news coverage in China that shook consumer confidence and impacted brand usage. Immediately following the incident, YUM experienced a significant, negative impact to sales and profits at both KFC and Pizza Hut Casual Dining.

There are clearly issues with operating a food business in China that mean that investment success is not a foregone conclusion. Nevertheless YumChina fought off a private equity takeover valuing the company at $18billion (around $40 per share) in 2017. So clearly there are enough shareholders out there who believe YumChina is doing something right, even if Buffett would not be investing at this point.

SNOOPY

	FY2013	FY2014	FY2015	FY2016	FY2017
Normalised EBT	$389m	$348m	$510m	$649m	$810m
add Net Interest Paid (or Earned)	($5m)	($14m)	($8m)	($11m)	($25m)
Normalised EBIT {A}	$384m	$334m	$502m	$638m	$785m
Share Price 31st March {C}	NM	NM	NM	$27.20	$41.50
Shares on Issue EOFY {B}	363.758m	363.758m	363.758m	383.344m	388.860m
EBIT /share {A}/{B} [D]	$1.06	91.8c	$1.38	$1.66	$2.02
EBIT Multiple {C}/{D}	NM	NM	NM	16.4	20.5
Depreciation & Amortisation {E}	$394m	$411m	$425m	$402m	$409m
Normalised EBITDA {A}+{E} [F]	$778m	$759m	$927m	$1,040m	$1,194m
EBITDA /share {F}/{B} [G]	$2.14	$2.09	$2.55	$2.71	$3.07
EBITDA Multiple {C}/{G}	NM	NM	NM	10.0	13.5

So now we have got down to the nitty gritty of determining EBIT/EBITDA ratios. This allows us to prepare the market value of this company with the RBD partial takeoffer price (based on EBIT/EBITDA ratios)..

Notes

1/ YUMC is bank debt free. So all interest is 'interest earned'.
2/ YUMC was first listed in October 2016. So to demand a 'market share price' prior to that date is not a meaningful request.
3/ The RBD.NZX partial takeover offer has used the 'Enterprise Value' (EV) to underlying EBITDA as a valuation statistic. Enterprise value is calculated by taking the market value of the company's shares and adding on bank debt. In the case of YUMC, there is no bank debt. So the EV for YUMC is simply the market value of the shares.

For the $9.45 per share RBD partial offer, Enterprise Value for RBD is calculated as equity value of NZ$1,175.4 million plus net debt of NZ$157.7 million as at
26 February 2018. This gives an Enterprise Value of NZ$1,333.1m. FY18 RBD EBITDA was NZ$94.4m. So the EV/EBITDA statistic comes out at:

NZ$1,333.1m/NZ$94.4m = 14.3

If we calculate a comparable statistic for YUMC as at 31st March 2018, I get:

($41.50 x 388.860m) / $1,194m = 13.5

From the Grant Samuel Report on the RBD takeover, Section 6.3.1, the comparative historical multiples are:

1/ EBIT for RBD are 18.5 to 20, while (c.f. 20.5 for YUMC)
2/ EBITDA multiples for RBD are 12.2 to 13.2. (c.f. 13.5 for YUMC)

So the RBD historical figures correlate closely with the YUMC EBIT and EBITDA historical multiples (the FY2017 figures for YUMC reflect the now withdrawn takeover offer) . By these figures, it looks like the market premium offered for RBD shares is fair (to those who only want to sell 75% of their RBD stake).

SNOOPY

The most striking thing I found from looking at the YUMC results is how well profits are growing with respect to revenues. This is great for shareholders. But ultimately a company will run into the 'squeeze the orange' argument. Put simply, you can squeeze an orange harder and harder, but ultimately there will be no more juice that you can get out of it. 'Squeezing the orange' that is the fast food restaurant market and eventually your 'profit growth' dries up unless revenues grow. Over the last five years reported, revenues have grown:

US$6,905m x (1+g)^5= US$7,144m => g= 0.683% (compounding)

But profit growth has been

US$284 x (1+g)^5= US$591 => g=15.8% (compounding)

It is hard to imagine that profit growth could outstrip revenue growth like that going forwards. However, there is another angle that needs investigating. The functional currency of YUMC is the RMB, not the USD. So what happens if the revenue is converted to RMB?

	FY2013	FY2014	FY2015	FY2016	FY2017
Adjusted Normalised NPAT {A}	$284m	$254m	$372m	$474m	$591m
Revenue {B}	$6,905m	$6,934m	$6.909m	$6,752m	$7,144m
RMB/USD Exchange Rate	6.1932	6.1428	6.2284	6.6423	6.7518
Revenue	RMB42.764	RMB42.594	RMB43.032	RMB44.849	RMB48.235
Net Profit Margin {A}/{B}	4.11%	3.66%	5.38%	7.02%	8.27%

The revenue growth rate in local currency was

RMB42.764 x (1+g)^5 = RMB48.235 => g=2.44% (compounding)

This is not great when you consider:

1/ local inflation is around 2%
2/ there has been a substantial number of new outlets created over the study period.

But it does show that the revenue is growing above inflation, albeit modestly. This was not apparent when the results were presented in USD.

SNOOPY

https://money.cnn.com/quote/forecast...html?symb=YUMC

https://newburghpress.com/2019/01/09...-inc-nyseyumc/

Following two things suggest this is a business worth watching.

• Very respectable ROE(Yum China Holdings has a return on equity of 18% for the last year)
• Its debt to equity ratio is very low

According to my book the highest quality companies have high return on equity.

Quote:

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Originally Posted by Valuegrowth

[*]Very respectable ROE (Yum China Holdings has a return on equity of 18% for the last year)

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If we take the headline NPAT of $429m and divide that with shareholder equity at last reported balance date (31-12-2017) I get a 'Return on Shareholders Equity' of:

$429m / $2,859m = 15.0%

Alternatively, and more correctly, you could use the averaged shareholder equity over the last two balance dates:

$429m / ($2,859m+$2,443m) = 16.2%

Not sure how you got your 18% ROE ValueGrowth. You may have noticed my quoted ROE figure for the 2017 year was 20.7% based on $591m of NPAT earnings. So there are obviously quite a few differences out there, depending on how you calculate the figures.

Most here will probably be aware of the 'Trump Tax Reforms'. Newsmedia have focussed on the reduction of the US corporate income tax rate from 35% to 21%. Nevertheless I don't expect this to help US domiciled YUMC, because almost all of their operations pay tax in China at the business income tax rate there of 25%. And that won't change post the Trump tax reforms.

However if you look at Note 17 of the YUMC AR2017, you will see that the FY2017 results have been hit by a $164m one off income tax charge. This is a result of a less publicised part of the Trump tax reforms. The 'deemed repatriation of accumulated and distributed foreign earnings'. YUMC have treated this as a one time adjustment of $164m. Nevertheless I disagree with this treatment, because this tax bill will be paid back over eight years (YUMC AR2017 p76). So it seems to me it would be better to consider this as approximately $20m of extra annual income tax to be paid over the next 8 years, and not a one off event. This disadvantage of deviating from the official accounts like this is that I will have to remember to put in $20m of extra income tax every year for the next eight years!

From the YUMC accounts, the tax bill for FY2017 was $381m. OTOH I used normal historical tax rates of 27% and came up with a tax bill of only $219m. This is the biggest difference in how I calculated my own normalised earnings verses the 'official' approach taken by YUMC. I think I am right doing things this way (from an investment perspective) although I accept others out there may disagree with my approach.

SNOOPY

Thank you for the analysis.

18% = 532 ÷ US$3.1b (Based on the trailing twelve months to September 2018.)

As per the following link ROE: 27.13 %( As of Sep 2018) for the quarter that ended in Sep. 2018.

https://www.gurufocus.com/term/ROE/Y...a-Holdings-Inc

Quote:

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Originally Posted by Valuegrowth

Thank you for the analysis.

18% = 532 ÷ US$3.1b (Based on the trailing twelve months to September 2018.)

As per the following link ROE: 27.13 %( As of Sep 2018) for the quarter that ended in Sep. 2018.

https://www.gurufocus.com/term/ROE/Y...a-Holdings-Inc

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OK I accept that looking at the latest quarterly result and annualising the most recently declared twelve months of earnings from that base is another acceptable way to work ROE out. I guess the main point to come out from this though is, whatever method you use, ROE still comes up looking good (more than 15%)!

SNOOPY

Quote:

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Originally Posted by Valuegrowth

[*]Its debt to equity ratio is very low

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I see from AR2017 p76, the total borrowing facilities are listed to be "Approximately $US261m." I further note that "As of December 31, 2017, the full amount of borrowings were available under each facility."

I took that to mean that, despite these facilities being negotiated, nothing had yet been drawn down. There is no term debt listed on the balance sheet. So that is consistent with my interpretation.

$US261m on an asset base of $4,263m would only represent:

$261m / ($261m+$4,263m) = 6% of total assets, even if all of the facilities were fully drawn down. This isn't much. And it does suggest that the statement on p74 of the 'General Form of Registration of Securities' issued on 3rd May 2016 that:

"Our operating discipline has allowed us to deliver a new restaurant cash-on-cash pre-tax payback period of approximately three to four years for KFC and Pizza Hut Casual Dining."

is all that is needed for funding the business going forwards. Being able to fund the business by upsizing it by 20% just every four years from existing cashflows is more than enough to fund all the YUMC growth plans going forwards.

SNOOPY

https://macropolo.org/how-kfc-change...a-changed-kfc/

How KFC Changed China and How China Changed KFC

https://www.businessinsider.com.au/k...8-12?r=US&IR=T

How KFC became China's most popular fast-food chain and made nearly $5 billion last year

I don’t think fast food culture will disappear anytime soon.

Quote:

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Originally Posted by Valuegrowth

https://www.businessinsider.com.au/k...8-12?r=US&IR=T

How KFC became China's most popular fast-food chain and made nearly $5 billion last year

I don’t think fast food culture will disappear anytime soon.

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I hadn't heard about the "K Pro" way of presenting KFC before. Here is the article published when "K Pro" opened in Shanghai.

http://www.timeoutshanghai.com/featu...-Shanghai.html

"The inside looks less KFC, more salad bar with a counter featuring fresh vegetables on display (mostly to show off the staff as they prepare your food)"

Looks like YUMC are treating healthy eating seriously! Mind you they aren't abandoning the traditional KFC way, with a 'hedging the bet' regular KFC right next door!

SNOOPY

Quote:

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Originally Posted by Valuegrowth

https://newburghpress.com/2019/01/09...-inc-nyseyumc/

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The press release for the FY2018 results is out. Rather annoyingly, YUMC have chosen to release their results -only- in constant exchange rate terms. That means I will have to wait until the annual report before the actual results are put on paper. Yet with the RBD takeover offer closing in a month or so, and my need for a measuring stick for that, this means I can't afford to wait that long.

The issue here is that YUMC results are ultimately reported in US dollar terms. But the functional currency for the business is the Chinese Renminbi. The revenue is coming in all through the year. So it is appropriate to look at averaged exchange rates throughout the year. Using wiki, I got:

	CY/FY2017	CY/FY2018
Average Exchange Rate	USD1- = 6.7518Rmb.	USD1- = 6.6174Rmb

This means that, on average, comparing FY2017 and FY2018, that we shareholders shared in less "Rmb revenue per US dollar reported" in FY2018 compared to FY2017.

It also means that:

1/ IF we use a constant currency based on the averaged FY2017 exchange rate as a base rate, THEN
2/ The 'constant currency' FY2018 earnings results, based on this representative FY2017 exchange rate (but reported in USD), means the USD earnings reported in this way are less than actually occurred. AND
3/ To return these earnings to actual USD levels, we must multiply the earnings given in 'constant currency terms' by a factor of: 6.7518/6.6174 =1.020

Note: The above assumes that YUMC earnings translated back to a US reference currency were actually cross currency valued at that average exchange rate.

SNOOPY

PS I think my logic and maths is right. But as to whether the base constant currency figure used was 1USD = 6.7518Rmb, that is the bit I am not sure about.

Quote:

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Originally Posted by Snoopy

PS I think my logic and maths is right. But as to whether the base constant currency figure used was 1USD = 6.7518Rmb, that is the bit I am not sure about.

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There is another way to produce constant currency earnings results. You could start with the exchange rate on the first day of the financial year and assume that remains constant throughout the year.

	SOCY/SOFY2018	CY/FY2018
Average Exchange Rate		USD1- = 6.6174Rmb
Daily Exchange Rate	USD1- = 6.488Rmb

This would mean that, on average, comparing 'constant exchange rate earnings based on the opening day exchange rate' and 'actual earnings over all of FY2018', that we shareholders would have shared in more "Rmb revenue per US dollar reported" in FY2018 compared to the unadjusted case where earnings were translated at different exchange rates throughout the year.

It also would mean that:

1/ IF we use a constant currency based on the first day of FY2018 exchange rate as a base rate, THEN
2/ The 'constant currency' FY2018 earnings results, based on the representative opening day in FY2018 exchange rate (reported in USD), means the USD earnings reported in this way are more than actually occurred. AND
3/ To return these earnings to actual USD levels, we must multiply the earnings given in 'constant currency terms' by a factor of: 6.488/6.6174 =0.9804

Note: The above assumes that YUMC earnings translated back to a US reference currency were actually cross currency valued at that average exchange rate.

By changing the reference point, our adjustment has gone the other way! I don't know which of 'Aspect1' or 'Aspect 2' is the more correct way of making a constant exchange rate correction. But given we are looking at a 2% change from the quoted figures either way, I might just forget about doing any corrections and stick with the quoted figures that I know are wrong, but not by much.

SNOOPY

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018e
Operating Profit (excluding Impairments (1))	$384m	$354m	$488m	$640m	$785m	$941m
subtract Insurance Payouts		($25m)	($5m)	($3m)
adjust Corp Jet Disposal			$15m	($2m)
adjust Foreign Currency Adjustments		$5m	$4m	$3m	$0m	$?m
subtract Wuxi KFC equity revaluation						($98m)
add Duojia Intangible Write Off						$12m
add Interest Earned	$5m	$14m	$8m	$11m	$25m	$36m
Equals Adjusted Normalised EBT	$389m	$348m	$510m	$649m	$810m	$891m
subtract Tax at 27% (2)	$105m	$94m	$137m	$175m	$219m	($241m)
subtract Foreign unrepatriated earnings Tax (3)						($20m)
Equals Adjusted Normalised NPAT {A}	$284m	$254m	$372m	$474m	$591m	$630m
Shares on Issue EOFY {B}	363.758m	363.758m	363.758m	383.344m	388.860m	392m
eps {A}/{B} {C}	78.1c	69.8c	$1.02	$1.27	$1.52	$1.61
Share Price 31 March (following) {D}	NA	NA	NA	$27.20	$41.50	$40.52 (4)
PE Ratio (D)/(C)	NA	NA	NA	21.4	27.3	25.2

Notes

1/ Significant impairment write offs for the 'Little Sheep' casual dining concept occurred in 2013 and 2014. YUMC own the intellectual property of the 'Little Sheep' brand. 'Little Sheep' had its foundation in Inner Mongolia, China. It specialises in 'Hot Pot' cooking popular in in China, especially in the winter months. 'Little Sheep' has more than 280 restaurants operating. A wholly-owned business that sells seasoning to retail customers is part of the 'Little Sheep' operation. But total turnover at 'Little Sheep' is less than 1.5% of the turnover of YUMC.

2/ The US corporate tax rate up to 31st December 2017, for the last few years, has been 35%. Looking at Note 17 on Income Tax in AR2017, the actual tax paid by YUMC on operations has been less than this. For the years 2017, 2016 the 'Statutory rate differential attributable to foreign operations' was 8.4% and 7.5%. I have rounded this off to 8%, subtracted the 8% from the 35% US statutory rate and come up with 27%. This is still above the 25% Chinese Corporate Income tax rate, and I cannot explain the difference.

3/ The 'deemed repatriation of accumulated and distributed foreign earnings' tax saw a provision of $164m made in the YUMC accounts for FY2017. But this tax bill is to be spread out over eight years. Because it is in integral part of the Trump tax reforms, I do not feel that it should be recorded as a one off. Therefore I am recording a $20m charge every year from 2018 to 2025 inclusive.

4/ Share price at 5th February 2019. 31st March date still in the future when table was compiled.

Conclusion: Pass Test

SNOOPY

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018e
Adjusted Normalised NPAT {A}	$284m	$254m	$372m	$474m	$591m	$630m
Shareholder Equity EOFY {B}	$2,344m	$1,945m	$1.979m	$2,443m	$2,859m	$2,873m
ROE {A}/{B}	12.1%	13.1%	18.8%	19.4%	20.7%	21.9%

Conclusion: Pass Test

SNOOPY

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018e
Adjusted Normalised NPAT {A}	$284m	$254m	$372m	$474m	$591m	$630m
Revenue {B}	$6,905m	$6,934m	$6.909m	$6,752m	$7,144m	$7,774m
Net Profit Margin {A}/{B}	4.11%	3.66%	5.38%	7.02%	8.27%	8.10%

Inflation in China is around 2%. The smallest gain in margin has been from FY2016 to FY2017. 2% of 7.02% (margin for FY2016) is 0.14 percentage points. That means as long as the FY2017 margin is greater than 7.02% + 0.14% = 7.16%, then our requirement is satisfied. The actual margin is 8.27%, so our requirement is met, and has been met over the FY2017/FY2016, FY2016/FY2015 and FY2015/FY2014 'year on year' comparisons. The decrease in margin over the latest year does not invalidate this company's ability to increase margins for an extended period over the last five years.

Conclusion: Pass Test

SNOOPY

SNOOPY: I see you're a big fan of fast food, particularly fast food in China.

Can I ask your thoughts on BABA and it's future outlook (after Jack Ma no longer the CEO) ?

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Originally Posted by SBQ

SNOOPY: I see you're a big fan of fast food, particularly fast food in China.

Can I ask your thoughts on BABA and it's future outlook (after Jack Ma no longer the CEO) ?

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SBQ, I don't follow Alibaba closely, but these guys obviously do:

http://knowledge.wharton.upenn.edu/a...thout-jack-ma/

Operationally, I don't see any problems in the medium term. Jack Ma will have stepped away from that part of Alibaba long ago. But as a charismatic figure head, Jack will be impossible to replace. So investors might not be prepared to pay such a high multiple for the company once the media fronting founder goes. Thus I see the 'investment risk' for shareholders as higher than the 'business operational risk'.

There are 'investors' (that I would call mathematically challenged gamblers) who are prepared to pay any market price to get on the share register of a globally big name company. At some point they will pay too much. But what point is that? This is a difficult question to answer. So difficult, that I prefer to leave those kinds of investments to others.

As far as doing business in China goes, there are special risks that the article I quote outlines. If we look at YumChina, which has a longer track record than Alibaba, their success seems due to their ability to be seen as a Chinese company (the senior executive team is Chinese, they sell franchises to local Chinese) that provide tangible benefits for Chinese workers. Raising the standard of living of the Chinese people is something the Chinese government have been very successful at. And I would say any China based business that produce for all stakeholders benefits in line with the Chinese government's vision will continue to do well.

SNOOPY

All of the Buffett tests have been passed. This is a rare event for any share and some may think that this is an invitation to buy. This would be a wrong conclusion to draw. Passing the Buffett tests means that you get a seat at the table to fire up the Buffett growth model to see what comes out. The price an investor has to pay for YUMC will largely determine an investors return after ten years. A great company bought at a high price will likely end up an average investment proposition at best.

There is one more hurdle to pass before we get to sit at the Buffett growth model table. High ROE can be contrived to be higher than intrinsic, if a company has a very high level of debt.

Total borrowing facilities are listed to be "Approximately $US261m." (from AR2017 p76), I further note that "As of December 31, 2017, the full amount of borrowings were available under each facility." I took that to mean that, despite these facilities being negotiated, nothing had yet been drawn down. There is no term debt listed on the balance sheet for FY2017. So that is consistent with my interpretation. If we now look at the 31st January preliminary release of the FY2018 results, the balance sheet there once again shows no term debt. The entry under which any current bank debt might be hiding ( 'Other Liabilities and Deferred Credits') is broken down into:

1/ Deferred and escalating minimum rents.
2/ Deferred Credits
2/ The 'Trump Tax' on deemed unrepatriated earnings.

This means there is no current bank debt nor term bank debt - still. If there is no bank debt, then we can't be worried about the repayment of something that doesn't exist. So it is time to take our seat at the 'Buffett Growth Model' table.

SNOOPY

The objective of the Buffett growth model is to sum the gains of dividends and capital appreciation over an extended period, and calculate a compounding rate of annual return taking into account all tax liabilities incurred on the way.

The Buffett growth model operates by:

1/ Starting with shareholder equity at the start of Year 1,
2/ Working out a projected return on this equity using an averaged return on this equity from previous years.
3/ Apportioning this return between dividends, share buybacks and what remains to be reinvested within the company. New Capital raised outside of normal operations during the year must be taken into account.
4/ Recycling any retained earnings into subsequent year shareholder equity. Then using this new Shareholder equity total as the earnings base for the subsequent year. The subsequent year becomes the new starting point for this process to repeat.

YUMC is an 'overseas share', caught by NZ's FIF tax regime. FIF tax is paid on 5% of the opening balance of each share owned. At a tax rate of 30%, this works out at:

0.3 x 0.05 = 0.015, or 1.5% of the opening balance total, payable each year (actually FIF tax is charged on a whole of portfolio basis. But for the purpose of this exercise, we shall assume the entire FIF portfolio consists of YUMC shares only) For NZers, this FIF tax has to be separately accounted for in this calculation each year, and summed over the study period

We are looking at a study period, ten years into the future. The amount that must be paid for this FIF tax can be netted off against any overseas withholding tax paid on dividends. That is because, under the FIF regime, there is no separate tax on dividends. The withholding tax on dividends on NYSE listed YUMC and paid by YUMC on the investor's behalf is currently 15%.

Return On Shareholder Equity: Working Figure

Post 21 allows us to calculate an averaged five year ROE figure:

( 13.1% + 18.8% + 19.4% + 20.7% + 21.9 %) / 5 = 18.8%

Price Earnings Ratio: Working Figure

To value our share each year, we need to calculate an appropriate PE value to use. Despite operating for some thirty years, YUMC has only been separately listed for three. Using just three data points is not a very reliable way to calculate a representative average PE figure. This is particularly so when one of those figures was inflated by a since withdrawn takeover offer (Year 2017). I have taken 15% off the year 2017 PE figure to remove this takeover premium.

( 21.4 + 0.85x27.2 + 25.2 ) /3 = 23.2

The derivation of this PE figure has been calculated using a shallow data set. Nevertheless it is the best figure we can get, based on the possibly not representative three year sharemarket trading period we have to draw information from.

Dividends

Only one dividend of 10c per share has been declared over FY2017, the latest year in which an annual report was published. This relates to the period Q4 for FY2017. Over FY2018 there have been four quarterly dividends declared: 10cps, 10cps, 10cps and 12 cps. Given the growth path of the company, I am forecasting dividends for FY2021 to be 13cps, 13cps, 13cps and 13cps. Following an incremental pattern, I am going to model future dividend payments for the years in which we are studying to be as follows:

	Forecast Dividend
FY2018	42cps
FY2019	42cps
FY2020	46cps
FY2021	52cps
FY2022	58cps
FY2023	64cps
FY2024	70cps
FY2025	76cps
FY2026	82cps
FY2027	88cps
FY2028	94cps

Share Buybacks

On 4th October 2017, the board increased the aggregate quantum of shares to be repurchased to $550m. As of the end of FY2018, the aggregate of share repurchases had reached $455m. That leaves $95m worth of shares still authorized to be bought back. Yet counter intuitively, the number of shares on issue continues to go up year on year. What is the explanation for this?

As stated in AR2017 p37:

"The company's executive compensation program has three primary pay components: base salary, annual performance based cash bonuses and long term equity awards."

We learn on p119 of AR2017 that:

"The company has reserved for issuance under the "Yum China Holdings Inc. Long Term Incentive Plan" 45 million shares of our common stock. Under this plan, the excise price of stock options and SARs (Stock Appreciation Rights) granted must be equal to or greater than the fair market value of the company's stock on the date of the grant"

Options and SARs vest after three to five years and expire ten years after they were granted. Share based compensation is recognized in the "Consolidated and Combined Financial Statements" on a straight line basis over the service period based on their fair value on the date of the grant. When the options are redeemed, the company gets a cash injection based on the awarded price of the share options granted. But the employee gets to keep the difference between the price at the time the option was awarded and today's market price.

Again from p121 of AR2017, at the end of that year, 14.072m shares become exercisable at a weighted average excise price of $16.69. If all of these were exercised, this would represent a capital inflow to shareholders equity of:

14.072m x $16.69 = $235m

Actual new equity inflow over the period was $27m. That is equivalent to about 1.617m new ordinary shares created. ( 1.617m x $16.69 = $27m ).

The current authorized buy back limit of $95m would buy back 2.375m shares at $40 each. 2.375m shares to be redeemed is way short of the new 14.072m -1.617m = 12,455m shares that could be created at any time. it looks like the number of shares bought back will continue to be outweighed by the number of employee earned new shares vesting.

SNOOPY

The following information is derived from the "Consolidated and Combined Statements of Equity" (p93 AR2017). This reference shows the 'change in shareholder equity' over the previous three years. The FY2018 information, which I have added, has been plucked from the press release issued on the 31st January 2019 titled:

"Yum China reports fourth quarter and Fiscal Year 2018 Results."

http://ir.yumchina.com/phoenix.zhtml...cle&ID=2385649

	Equity SOFY	Net Income + Foreign Translation Gain (A)	Dividend Declared {B}	Share Buyback {C}	New Shares Subscribed + New Capital on Business Acquisitions {D}	New Retained Equity {A}+{B}+{C}+{D}
2016				($20m)
2017	$2,443m	$571m	($60m)	($128m)	$33m	$416m
2018	$2,859m	$606m	($197m)	($307m)	$27m	$129m
2019	$2,988m

Note that:

1/There were 383.344m shares on issue at the start of FY2017.
2/There were 388.860m shares on issue at the start of FY2018
2/There were 392m shares on issue at the start of FY2019.



We can rewrite the above table on a 'per share' basis as follows:

	Equity SOFY	Net Income + Foreign Translation Gain (A)	Dividend Declared {B}	Share Buyback {C}	New Shares Subscribed + New Capital on Business Acquisitions {D}	New Retained Equity {A}+{B}+{C}+{D}
2017	$6.37	$1.49	($0.16)	($0.33)	$0.09	$1.09
2018	$7.35	$1.56	($0.51)	($0.79)	$0.07	$0.33
2019	$7.62

It is the 'earnings per share' equity bridge that forms the basis for the Buffett growth model

SNOOPY

Quote:

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Originally Posted by Snoopy

Share Buybacks

On 4th October 2017, the board increased the aggregate quantum of shares to be repurchased to $550m. As of the end of FY2018, the aggregate of share repurchases had reached $455m. That leaves $95m worth of shares still authorized to be bought back. Yet counter intuitively, the number of shares on issue continues to go up year on year. What is the explanation for this?

As stated in AR2017 p37:

"The company's executive compensation program has three primary pay components: base salary, annual performance based cash bonuses and long term equity awards."

We learn on p119 of AR2017 that:

"The company has reserved for issuance under the "Yum China Holdings Inc. Long Term Incentive Plan" 45 million shares of our common stock. Under this plan, the excise price of stock options and SARs (Stock Appreciation Rights) granted must be equal to or greater than the fair market value of the company's stock on the date of the grant"

Options and SARs vest after three to five years (the actual vesting normally takes place over an extended time frame of four years) and expire ten years after they were granted. Share based compensation is recognized in the "Consolidated and Combined Financial Statements" on a straight line basis over the service period based on their fair value on the date of the grant. When the options are redeemed, the company gets a cash injection based on the awarded price of the share options granted. But the employee gets to keep the difference between the price at the time the option was awarded and today's market price.

Again from p121 of AR2017, at the end of that year, 14.072m shares become exercisable at a weighted average excise price of $16.69. If all of these were exercised, this would represent a capital inflow to shareholders equity of:

14.072m x $16.69 = $235m

Actual new equity inflow over the period was $27m. That is equivalent to about 1.617m new ordinary shares created.

The current authorized buy back limit of $95m would buy back 2.375m shares at $40 each. 2.375m shares to be redeemed is way short of the new 14.072m -1.617m = 12,455m shares that could be created at any time. it looks like the number of shares bought back will continue to be outweighed by the number of employee earned new shares vesting.

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The playing field seems tilted to me, in favour of 'employees' over 'shareholders', with all these new shares coming and old shares going.

Employees get their shares that 'vest today' at a price three to five years in the past (at least). They may even choose to hold their share options for ten years in total. Thus at redemption time, they get a 'three to ten' year price discount. I think I am right when I say:

"the only money the company gets when the employee options are exercised is the value of the option when it was issued."

The employee pockets the difference between 'today's market price' and the 'option issue price'. I am not complaining about that. This is how long term incentives work. But such a mechanism can carry a cost for the shareholder.

If YUMC wants to neutralize any 'eps' dilution, by buying back an equivalent number of shares compared to those options that vest, it must do so by buying the shares on market at the market price up to ten years down the track from option issue time. Needless to say, the share price 'today' will have likely grown over ten years. In this example, if the employee share option was purchased at an equivalent price of $16.69, and today's market price for YUMC shares is $40, then we shareholders must spend $40 to neutralize the effect of each $16.69 'paid' by those employees as a long term incentive, all those years ago.

The vesting of these awards is complicated by the fact that many were issued before YumChina separated from the parent YUM Company, the ultimate US based franchise holder for KFC, Pizza Hut and Taco Bell.

"Under the employer method, employees holding YUM awards prior to separation had their awards converted into awards of the company they worked for subsequent to the separation."

This explains why the 'weighted average excise price' for partly paid shares outstanding at the end of FY2017 is only $16.69. Yet YUMC shares have never traded below $24. The 'switch' between YUM Options and YUMC options was done using the 'Black Scholes' model and 'contemporary interest rates' and 'discount rates' to ensure the transition to YUMC options was handled fairly.

The next step is to forecast the dollar value of YUMC share options to be redeemed in future years. There were no stock options on the books at the start of FY2016 (AR2016, Note 15 'Share Based Compensation' p115). That is because YUMC only became split off as a separate entity in October of that year. The picture of total options granted and options exercisable on record is as follows

	Total Options on Books	Options Exercisable	Options Exercised During Year
EOFY2016	24.728m	14.883m	0.590m
EOFY2017	21.595m	14.072m	4.168m

The 'options exercised' figure for FY2016 may have been affected by the 2016 'year' for YUMC being only two months long. Multiply the 0.590m figure by 6 to normalize it and I get: 6 x 0.590m = 3.540m. My hunch is that the since withdrawn 'takeover offer' at the end of FY2017 was - a trigger - to cause an abnormally high number of option holders to cash in. I am therefore taking 3.540m as a more normal number that might be redeemed in any one year. At a redemption price of $16.69 per share, that equates to $59m or 15cps for FY2019.

I shall further assume that the number of shares bought back in future years total $128m at the indicative market price of the year. For FY2019 this is $33.53. And that equates to 3.818m shares, or 33cps for FY2019.

Note that over FY2019, the number of shares on issue is modelled to change according to the difference between 'new shares subscribed' and 'shares bought back'. Specifically for FY2019, this calculates out at:

3.540m - 3.818m = -0.278m (the negative sign means the number of shares on issue has reduced over the year)

All of the options listed on p121 of AR2017 are well in the money. But if an employee entitled to share options leaves before the first vesting date, then they may still be forfeited.

SNOOPY

Quote:

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Originally Posted by Snoopy

It is the earnings per share equity bridge that forms the basis for the Buffett growth model

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The dollar figures in the table below are all on a 'per share' basis.

Note: To compile the table below, I have assumed:

1/ an ROE figure of 18.8%
2/ a PE ratio of 23.2.
3/ a constant dollar amount of shares being bought back every year amounting to $128m, The actual number of shares this buys back is determined by the modelled share price.
4/ $59m of new shares being subscribed to via the employee share scheme each year. These shares are assumed to be subscribed to at a redemption price of $16.69 each. This rate of subscription creates 3.542m new shares each year.

	Modelled No. Shares SOFY	Modelled Share Price SOFY {SP}	Equity SOFY	Net Income + Foreign Translation Gain {A}	Dividend Declared {B}	Share Buyback {C}	New Shares Subscribed + New Capital on Business Acquisitions {D}	New Retained Equity {A}+{B}+{C}+{D}	FIF Tax Liability {SP} x 0.015
2017	383.344m	$26.12	$6.37	$1.49	($0.16)	($0.33)	$0.09	$1.09
2018	388.860m	$40.02	$7.35	$1.56	($0.51)	($0.79)	$0.07	$0.33
2019	392m	$33.43	$7.62	$1.43	($0.58)	($0.33)	$0.15	$0.67	$0.50
2020	391.722m	$36.19	$8.29	$1.56	($0.58)	($0.33)	$0.15	$0.80	$0.54
2021	391.725m	$39.67	$9.09	$1.71	($0.64)	($0.33)	$0.15	$0.89	$0.60
2022	392.038m	$43.62	$9.98	$1.88	($0.72)	($0.33)	$0.15	$0.98	$0.65
2023	392.646m	$47.79	$10.96	$2.06	($0.80)	($0.33)	$0.15	$1.08	$0.72
2024	393.510m	$52.43	$12.01	$2.26	($0.88)	($0.33)	$0.15	$1.20	$0.79
2025	394.611m	$57.54	$13.17	$2.48	($0.96)	($0.32)	$0.15	$1.35	$0.86
2026	395.928m	$63.10	$14.47	$2.72	($1.04)	($0.32)	$0.15	$1.51	$0.95
2027	397.411m	$69.37	$15.92	$2.99	($1.12)	($0.32)	$0.15	$1.70	$1.04
2028	399.108m	$76.56	$17.55	$3.30	($1.20)	($0.32)	$0.15	$1.93	$1.15
2029	400.978m	$84.68	$19.39	$3.65
Sum 2019-2028					($8.52)				$7.80

Question/ On 1st March 2019, the YUMC share price closed at $41.40. What is the expected 10 year compounding rate of return for a New Zealand investor if you bought that share today, assuming exchange rates remain constant??

Answer/ 41.40 x (1+r)^10 = [ ($84.68+$8.52 - $7.80) ] => r = 0.075 = 7.5%

Question/ Warren Buffett likes to get a 15% compounding return on any share he invests in, What price would he need to pay for YUMC today to achieve that?

Answer/ P x (1.15)^10 = [ ($84.68+$8.52 - $7.80) ] => P = $21.10

Conclusion:

YumChina is a great company. But to purchase shares in it today would see you pay a high price. While a 7.5% after tax compounding return over ten years is OK, this is below the kind of return that Warren is seeking. I don't think Warren would be investing in YUMC, unless that acquisition price comes down.


SNOOPY

There is an old phrase in computation. 'GIGO' which means 'Garbage In, Garbage Out'. The practical translation of this glib phrase is that, no matter how sophisticated your mathematical model, if you put unreliable numbers in a sophisticated front end, then the output will be a sophisticated but unreliable result.

Return on Equity

In the 'Buffett Growth Model', it is 'Return on Equity' that is the most important factor in determining earnings for the year. I am happy with assuming a return on equity for Yum China of 18.8%. In absolute terms, this will be a high number to roll over on itself for the next ten years. Yet the actual ROE over the last three years (the time since YUMC has been listed as a separate entity) have been noticeably higher than this. I am not expecting the high ROE figures from the last three years to continue. Profits have been growing a lot faster than sales. And I expect some re-balancing of costs upwards. Indeed, over FY2018, the 'Net Profit Margin' was, apparently, already shrinking.

Dividend Payments

YUMC was demerged without the promise of paying dividends. Yet by the last quarter of FY2017 the first of what have become quarterly dividends (10cps in this case) was declared and paid. Total dividends declared over FY2018 amounted to 42cps. The share price on 31st March 2018 (the tax year boundary in NZ) was $41.50. But this price was inflated as the result of a now withdrawn takeover offer. So I am going to use an indicative normalised price of 0.85 x $41.50 = $35.28. Based on that price, the dividend yield for FY2018 looking forwards was:

$0.42 / $35.28 = 1.19%

This is not great. But it is close to covering the FIF tax liability of 1.5%, which is a good thing for shareholders. An overseas shareholding that does not cover the FIF tax liability via dividend yield means a negative cashflow liability for New Zealand holders indefinitely into the future, just to maintain the existing FIF holding you have.

The ability to pay a dividend for a company which operates in the Chinese market is restricted. I quote from Item 5 (p54 AR2017).

"The laws rules and regulations applicable to our Chinese subsidiaries permit payments of dividends only out of their accumulated profits, if any, determined in accordance with applicable Chinese accounting standards and regulations. Under Chinese law, an enterprise incorporated in China is required to set aside at least 10% of its after tax profits each year, after making up the previous year's accumulated losses, if any, to fund certain statutory reserve funds, until the aggregate of such a fund reaches 50% of its reserve capital." As a result, our Chinese subsidiaries are restricted in their ability to transfer their assets to us in the form of dividends,"

Since YUMC is now paying dividends, it follows that at least a proportion of these Chinese subsidiary companies have accumulated an aggregate fund reaching 50% of its reserve capital. But did that happen only at the start of Q4 FY2017, when the first YUMC dividend was paid? Or did it happen before that? And what is 'Reserve Capital' anyway?

From " http://www.businessdictionary.com/de...e-capital.html "

"Reserve Capital" is the authorized capital of a firm that has not been called up and is, therefore, available for drawing in case of a need.

So it looks to me as though 'reserve capital' is probably a moving target. This would make sense as the bigger the company gets, the more capital/ retained earnings are needed to keep it running. At EOFY2017/SOFY2018, the capital position of YUMC, just after the first dividend was paid, was like this:

	Total Equity	50% of Total Equity
SOFY2017	$2,443m	$1.222m
SOFY2018	$2,859m	$1,430m
SOFY2019	$2,976m	$1,488m

Note that for comparative purposes, I have included the one year either side figures as well. Can we then say that $2,443m was insufficient capital to pay dividends, while $2,859m was enough? Or is this whole dividend thing an 'operating free cash flow' question? I pose that last question because it is 'cash flow' that eventually builds 'shareholder equity'.

	FY2017	FY2018
Net Cashflow from Operating Activities	$884m	$1,333m
less Stay in business Capital Expenditure (1)	$415m	$470m
add Net Interest Gains	$25m	$36m
equals Operating Free Cashflow	$444m	$899m
Compare with
Dividends Paid during Year	$60m	$197m
add Repurchase of Shares over Year	$128m	$307m
equals Total Discretionary Payments to Shareholders over Year	$188m	$504m

(1) I have equated 'Stay in Business Capital Expenditure' with 'All Capital Expenditure'. Capital expenditure each year is substantial in total. But this is directed towards a large number of small sites, in general. Most of these new stores will last for ten years before any lease renegotiations. But payback, in the case of KFC at least, can be as short as two years. Capital expended in constructing new restaurants is expected to continue at current levels or accelerate as part of the YUMC business plan going forwards. So I think it is fair to consider the capital used in developing new additional restaurants as 'stay in business capital.'

My interpretation of the above two tables goes like this:

1/ If $2,859m (balance SOFY2018) is a sufficient capital base from which it is legal to consider paying dividends AND
2/ the operating free cashflow over the FY2018 year generated an additional $899m of discretionary capital AND
3/ $504m in discretionary payments were made to shareholders over the FY2018 year THEN
4/ There remains $395m (=$899m-$504m) of new capital that could have been paid out to shareholders on the books at YUMC

Why is this important? I have shown in the Buffett model an increasing stream of dividend payments over the next ten years. And the above calculation shows that even if earnings per share do not rise in the future, then total discretionary payments to shareholders could rise by $395m/$197m = +78% right now. This shows that my projected dividend increases, at least in the medium term, are doable.

New Shares Issued

The Buffett modelling shows a 'net increase' in YUMC shares over ten years, up from 392m to 400.178m. This is an 'net increase' of 8.178m. The 'net increase' is the difference between new shares issued as part of long term employment bonuses ( 10x 3.542m = 35.420m ) and those bought back on market. By simple subtraction the number of shares modelled to be bought back on market is therefore:

400.178m - (392m + 35.420m) = -27.242m

(Note: this result is a negative number, because buybacks remove shares from the total).

Over FY2017, 2.254m new share options were granted an average exercisable price of $26.56. With the current share price now 60% higher than that, it is likely that future share options issued will be lower in number to equate to a similar dollar value of compensation. Even so, if the number of shares issued over the next ten years was comparable in quantity to those issued during FY2017, then that would only equate to:

2.254m x 10 = 22.540m

of new shares being issued. This is rather less than the number of shares I have modelled being bought back. Yet we also need to consider that the balance outstanding of previously awarded share options was 21.595m at EOFY2017 (the latest figure available). And I am modelling 2.254m options to be added to the current 21.595m pre-existing total this year, and every future year. If this grand total gradually reduces over time (IOW relatively more options are exercised than are issued), that means my apparently excessive modelling of buybacks may indeed only just balance the options exercised.

I feel, on balance, it is likely that I have overestimated the number of new shares coming on stream in the next ten years as a result of employee remuneration packages. This is because with new options being listed at a much higher excise price, and the YUMC share price perhaps getting a little ahead of itself, there is a chance more newer options will expire unexercised. Fewer options exercised means less capital available to the company for future expansion. But it also means a lower level of on market buybacks will be required to neutralise the earnings dilutive impact of these new shares. And that it turn means more cashflow available for dividends.

Starting Share Price

The modelled share price on 1st January 2019 was $33.43 - the actual opening price on the day. The implied share price, based on, starting shareholder equity, projected earnings using an 18.8% averaged ROE rate, and an averaged 23.2 PE ratio is:

23.2 x [0.188 x $7.62] = $33.24

The fact that these two figures are similar is pleasing, but largely a co-incidence. Guessing with precision the PE ratio the market will assign to a share at any one particular time is a game of luck. Besides, the annual estimate of the share price in the calculation table is only there to estimate the FIF regime tax bill for the year. It does not affect the compounding calculation as regards future earnings and dividends as modelled.

Similarly, my modelled share price for starting the years 2020 and 2021 are lower than today's share price, even though the growth outlook for the company is good. However this is because the model is a mathematical construct based on averaged assumptions. For this model, the averaged assumptions are likely to get better the more years roll by. But to single out any particular year and declare that figure as a 'prediction' is something that is technically beyond the scope of this 'Buffett Growth Model'.

'ROE normalised' -as derived- applied to unnormalised unadjusted capital

On the surface, what I have done is derive an ROE figure from my adjusted profit data, then applied this figure to model the growth of 'something else'. This does not sound good. My adjustments are most distorting to the published result figures (or put another way the published result figures are most distorting to realistic operating results) over FY2018. But the way the 'Buffett growth model' is constructed, such a distortion will compound through ten years of future earnings data. So the overall effect may not be trivial!

The 'Wuxi KFC equity revaluation', which I have ignored for profit purposes, has resulted in a 'realistically realisable capital gain' of $98m coming onto the books. This is incorporated in the company's $2,873m of 'shareholder equity on hand' at the end of the FY2018 financial year. Consequently, when I apply an averaged normalised ROE figure to this 'inflated capital', in order to estimate FY2019 earnings, I am applying that ROE figure to more capital than would otherwise be on the books through normal operating trading. Is this a problem? Particularly when we realise that there is more capital on the books than there would be as a result of normal operating trading. The answer to that question depends on how 'capital constrained' YUMC is. IOW, if YUMC suddenly had a windfall of capital (which they did), could this capital be redeployed to open new restaurants at a faster rate than would otherwise be possible? I believe the answer to that question is 'yes'. So, in this instance, I am convinced that applying normal operating earnings rate to a larger than expected capital pile will not result in an overestimate of YUMC earnings going into the future.

The $98m of 'bonus capital' that I am talking about here represents:

$98m/$2,873m = 3.4% of the total company capital.

So what I am saying here is that an incremental restaurant build rate of 3.4% every year for ten years is sustainable. I am very comfortable in saying this.

SNOOPY

Hi Snoopy,

if you want to chat with china based investors:
https://xueqiu.com/S/YUMC

right click, and use translate to english

"Over the past three decades, we have built a significant lead not just in number of outlets, but also in brand awareness and loyalty, proprietary consumer know-how in individual provinces and city tiers, a national supply-chain network, product innovation and quality processes, a motivated and highly-educated workforce and a long-tenured and passionate local management team. We believe that these competitive strengths are difficult to replicate."

The above is a quote from the 'Yum China' listing prospectus p69. It is referring to the roll out of KFC and Pizza Hut in China. But if you read the paragraph, it is clear that it can apply to any new 'western' product that is rolled out for sale in China. With one exception - the very first sentence. There aren't many western products that have a thirty year history in China and are still on a successful growth path. So what can we learn from 'Yum China' story about the way other consumables might be successfully rolled out across the country with the fastest growing middle class in Asia? A lot I think.

Over the years Yum China has built:

1/ An increasing number of distribution outlets.
2/ Brand Awareness and Loyalty.
3/ A motivated and highly educated workforce.
4/ A long tenured and passionate local management team.

We can regard the above as key 'check points' for any foreign consumables business, making a success of itself in China.

A local management team is important because it means that a company that follows such a recipe can adapt to local tastes. That doesn't necessarily mean the core product needs changing. But it might mean resizing the quantity of what you sell and adopting the distribution systems to get the product to the end line customer in a more convenient and timely way. By using the above recipe, 'Yum China' have been able to integrate into Chinese popular culture and consumers' daily lives.

How fast has Yum China managed to grow in terms of outlets? Some day I hope to be able to fill in more gaps in the table below. But here is a flavour of what has happened.

Year	No. Of Outlets
1987	1
2005	1,792
2010	3,906
2011	4,493
2012	5,726
2013	6,243
2014	6,714
2015	7,176
2016	7,562
2017	7,983
2018	8,484

From 1987 to 2017, this gives us a 30 year annual compounding growth rate of:

1(1+g)^30 = 7983 => g=0.35

In round figures the business has grown by 35% every year for 30 years! This includes the early stage of the growth cycle where growth was higher. Perhaps more indicative of what we might see from now on is what has happened between 2015 and 2017:

7176(1+g)^2 = 7983 => g=0.05, or 5% per year.

That is nevertheless a strong underlying growth rate, as it excludes inflation.

Continuing to quote from the listing prospectus:

"The development and growth of our business has benefited from China's rapidly growing middle class and increasing urbanization. The size of the middle class is expected to continue to grow significantly. According to a 2012 McKinsey study, between 2002 and 2022, the number of middle class and affluent households is expected to increase by 283 million. A significant portion of this growth will be driven by upper middle class households, which are expected to increase from 2% of total households in 2002 to 54% by 2022, or an increase of 188 million households. The Company will continue to focus on this core consumer segment and on serving China's growing middle class."

What the McKinsey report says about the distribution of middle class households is equally interesting:

"According to the McKinsey study referenced above, in 2002 87% of the middle class lived in coastal China and only 13% of the middle class lived in inland provinces. By 2022 it is expected that only 61% of the middle class will live in coastal cities as the middle class expands more rapidly in inland cities. Likewise, according to the same study, by 2022 it is expected that 39% of the middle class will live in cities with a population of more than one million."

The response from Yum China, is to target new trade zones and build more new restaurants further inland. This includes targeting those 'small' (sic) cities with a population of 'only a million'.

There are interesting parallels with the development of quick service restaurants in China, and China's milk market.

https://www.theguardian.com/environm...hirst-for-milk

Dried milk powder first appeared in small shops in China in the early 1980s, about the same time the first KFC in Beijing opened.

"In a little over 30 years, milk has become the emblem of a modern, affluent society."

We could say the same about the arrival of KFC in China. (KFC had a somewhat more up market image in China than it has in the west!)

China has the ambition of tripling its milk production. Yum China has a plan to triple the number of quick service restaurant outlets in China from the 2016 base year.

"As populations urbanise, they have always moved up the food chain, making the transition from diets largely based on grains and vegetable staples to ones in which meat, dairy, fats and sugars feature more prominently. China has followed the same trajectory."

One way to interpret that is to say that 'KFC' and 'milk' are driven by the same trend to urbanisation.

"By the end of the 90s, the eastern cities of China were booming, and people were consuming more dairy foods, but a gap was growing between there and the interior, where people were much poorer and still drank little milk."

This is exactly the same geographic spread of sales as reported in period by Yum China.

In response to the melamine milk contamination scandal:

"Consumers remain deeply suspicious about the safety of local food, fearing adulteration, residues from the overuse of agrochemicals, toxins from the pollution of ground water and air by industrial waste and excessive use of antibiotics. Many affluent parents still only buy foreign brands of milk for their young children."

Here we have yet another parallel with foreign owned chain restaurants. The food isn't necessarily better than the local offering. But hygiene standards are much more consistent.

"The Chinese Communist Party is obsessed with feeding this enormous population – it will go on growing until at least 2030. The reason it bangs on about food security and food safety is that it’s a potential source of instability. People come out on the streets about it."

This indicates that despite the risks of investing in a country with absolute autocratic control, companies that 'feed the masses' with verifiably quality controlled food, will likely remain politically favoured. This is a security blanket, both for imported milk and imported restaurant concepts.

In summary, I think there are real lessons to be learned here for those NZ listed food businesses selling their product into China. Perhaps the most important being that despite the tailwinds some investors see, the positive progress will probably be interrupted by scandals and setbacks along the way. Rather than panic and pull out, savvy investors can take these as discounted investment entry points to take advantage of what seems to be a relentless longer term upwards trend.

SNOOPY

So Snoopy, after all this analysis, have you invested? I've opened an account with Hatch, might buy a few YUMC to get started.

Quote:

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Originally Posted by Cricketfan

So Snoopy, after all this analysis, have you invested? I've opened an account with Hatch, might buy a few YUMC to get started.

---

Hi Cricketfan,

Yum China was a spin off from the parent franchise holder for KFC, Pizza Hut and Taco Bell, YUM Brands, which I held. So in a sense my 'Yum China' shares 'fell into my lap' at spin off time, and I have held them since. It has been a wild ride, mostly upwards, after that. Yum China was long touted as having big growth potential within YUM Brands. I was a little surprised, although happy enough, when it was carved out as a separate listed entity, two and a half years back. Back in the early 2000s, if you forgive the baseball analogy, Yum China was sold as being in the second innings in a ten inning ball game. To carry the analogy through, I would say we are in about the fourth innings now. So plenty of growth within China is still to come, albeit at a growth rate slower than in those earlier heady days.

As you have read on this very thread, I have researched Yum China extensively in recent months. I think it is a better company than I had thought it was, before I started my big read up. Like Restaurant Brands in NZ, they are cursed with the task of rolling out 'Taco Bell', the Mexican restaurant brand, in their own territories - a brand that hasn't really resonated outside of the Americas so far. I hope they make a go of it. But in the short term Taco Bell is a loss making distraction, with just a couple of test stores open in Shanghai.

Another 'distraction' is the new 'COFFii & JOY' café brand, an apparent attempt to head off the likes of Starbucks expansion into China. The 'COFFii & JOY' brand has been developed 'in house' at Yum China. Potentially we have another growth arm to exploit. However the reality is there were only 15 'COFFii & JOY' outlets at EOFY2018 end, When you operate close to 8,000 restaurants in total, this is not material. For now, I am sure that 'COFFii & JOY' is yet another loss making distraction. But in the future? Incidentally, YUM China are not quite the novices in the coffee market that some might think. KFC sold over 90 million cups of freshly ground coffee and generated revenue of over RMB1 billion in 2018.

I am convinced Yum China is a very good company. I particularly like the fact that they can open a KFC restaurant and have all incremental expenditure needed to do that paid back within a couple of years. But successful investment is not just about sharemarket investors buying good companies. What investors need is to buy good companies at good value prices. I see Yum China last traded at $US45.24. Based on last years (2017) results, this represents an historical PE ratio of:

$45.24 / $1.52 = 29.8

This is very high. I would like to wait to see the full results from last year released, to see if such a lofty PE ratio could be justified. Right now, I won't be investing more money into Yum China.
If I was a new investor, I would be waiting for something negative to happen that caused the YUMC share price to fall a bit (bearing in mind YUMC is very strong at its core and the SP should bounce back), and allow a more favourable investment entry price. YUMC has had a series of mishaps outlined earlier on this thread, that dragged their reputation down, for a while at least. The next mishap could be next week. But it could be five years away. I feel right now that YUMC is a better measuring stick to hold up against 'Restaurant Brands' as a determiner of value, rather than a sure fire investment in its own right.

SNOOPY

discl: hold RBD, YUMC, YUM

Quote:

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Originally Posted by Snoopy

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018e
Operating Profit (excluding Impairments (1))	$384m	$354m	$488m	$640m	$785m	$941m
subtract Insurance Payouts		($25m)	($5m)	($3m)
adjust Corp Jet Disposal			$15m	($2m)
adjust Foreign Currency Adjustments		$5m	$4m	$3m	$0m	$?m
subtract Wuxi KFC equity revaluation						($98m)
add Duojia Intangible Write Off						$12m
add Interest Earned	$5m	$14m	$8m	$11m	$25m	$36m
Equals Adjusted Normalised EBT	$389m	$348m	$510m	$649m	$810m	$891m
subtract Tax at 27% (2)	$105m	$94m	$137m	$175m	$219m	($241m)
subtract Foreign unrepatriated earnings Tax (3)						($20m)
Equals Adjusted Normalised NPAT {A}	$284m	$254m	$372m	$474m	$591m	$630m
Shares on Issue EOFY {B}	363.758m	363.758m	363.758m	383.344m	388.860m	392m
eps {A}/{B} {C}	78.1c	69.8c	$1.02	$1.27	$1.52	$1.61
Share Price 31 March (following) {D}	NA	NA	NA	$27.20	$41.50	$40.52 (4)
PE Ratio (D)/(C)	NA	NA	NA	21.4	27.3	25.2

Notes

1/ Significant impairment write offs for the 'Little Sheep' casual dining concept occurred in 2013 and 2014. YUMC own the intellectual property of the 'Little Sheep' brand. 'Little Sheep' had its foundation in Inner Mongolia, China. It specialises in 'Hot Pot' cooking popular in in China, especially in the winter months. 'Little Sheep' has more than 280 restaurants operating. A wholly-owned business that sells seasoning to retail customers is part of the 'Little Sheep' operation. But total turnover at 'Little Sheep' is less than 1.5% of the turnover of YUMC.

2/ The US corporate tax rate up to 31st December 2017, for the last few years, has been 35%. Looking at Note 17 on Income Tax in AR2017, the actual tax paid by YUMC on operations has been less than this. For the years 2017, 2016 the 'Statutory rate differential attributable to foreign operations' was 8.4% and 7.5%. I have rounded this off to 8%, subtracted the 8% from the 35% US statutory rate and come up with 27%. This is still above the 25% Chinese Corporate Income tax rate, and I cannot explain the difference.

3/ The 'deemed repatriation of accumulated and distributed foreign earnings' tax saw a provision of $164m made in the YUMC accounts for FY2017. But this tax bill is to be spread out over eight years. Because it is in integral part of the Trump tax reforms, I do not feel that it should be recorded as a one off. Therefore I am recording a $20m charge every year from 2018 to 2025 inclusive.

4/ Share price at 5th February 2019. 31st March date still in the future when table was compiled.

Conclusion: Pass Test

---

I had to do a rush job of the 2018 results before the FY2018 Annual Report was released. That was to facilitate a comparison with 'Restaurant Brands' immediately post the 75% takeover offer from 'Finaccess'. Now that I have the actual YUMC report in my 'hot little paws', I can produce the 'definitive audited version' of these accounts.

Re-reading the accounts I notice something odd. 'Other Income' appears to have been subtracted from 'Operating Expenses' (AR2018 Form 10-k, p56). The 'Operating Expenses' that are used to calculate 'Operating Profit' ...

To use the terminology in the Annual Report

"Total Revenues" (p62) - "Total Cost & Expenses net" (p56) = "Operating Profit" (p62)

...have already been adjusted for! 'Minority Owned Equity Accounted Profit', 'the Wuxi KFC equity revaluation', 'Insurance payouts', 'Provision reversal for Aircraft Sales losses' and 'Foreign Currency Adjustments' etc. etc. have all been dealt with. Yet 'Decreasing Expenses' has the same effect as 'Increasing Profits'. So I still need to subtract 'Other Income' from 'Operating Income' to produce a 'Normalised Operating Income' with three exceptions.

1/'Other Income' does include equity accounted income, and I feel that should be included in the Normalised result. These equity accounted but unconsolidated affiliates are largely minority owned KFC restaurants. So I think it is appropriate not to 'subtract again' the equity accounted income component of 'Other Income', when I finally create my 'Normalised Operating Profit'. To give some idea of the scale of these profits, I have listed them below.

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018
Equity Income from Unconsolidated Affiliates	$26m	$30m	$41m	$54m	$65m	$65m

2/ 'Other Income' also includes 'Foreign Exchange Net Loss or Gains'. These losses or gains are generally on contractual arrangements not taken out as a form of money speculation. They are the result of money market events not foreseeable when the underlying contract was taken out. Consequently they should remain removed when considering normalised profits. To give some idea of the scale of these foreign exchange gains or losses , I have listed them below.

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018
Foreign Exchange Gains or (Losses)	($1m)	($4m)	($5m)	($3m)	$0m	($11m)

3/ The FY2016 result has been corrected to account for the fact that had the separation occurred prior to the actual October 2016 separation date, then there would have been an extra franchise fee due to the parent YUM Brands. However, since we are now interested in 'Yum China' as a separate entity this correction is realistic and the extra charge should not be removed.

				FY2016
Incremental adjustment to YUM licence fee expense				$17m

My 'Normalised Profit' calculation table appears below:

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018
Operating Profit (excluding Impairments (1))	$384m	$354m	$488m	$640m	$785m	$941m
less Poultry Supply Lost: Insurance Recovery		($25m)	($5m)	($3m)
add Provision for Losses on Aircraft sales			$15m
less Reversal of Aircraft Sale Provision				($2m)
less Business Combination Contingency Reversal					($3m)
less Equity Gain Consolidating Wuxi						($98m)
add Duojia Intangible Write Off						$12m
add Interest Earned	$5m	$14m	$8m	$11m	$25m	$36m
Equals Adjusted Normalised EBT	$389m	$343m	$506m	$646m	$807m	$891m
subtract Tax at 27% (2)	($105m)	($93m)	($137m)	($174m)	($218m)	($241m)
subtract Foreign unrepatriated earnings Tax (3)						($16m)
Equals Adjusted Normalised NPAT {A}	$284m	$250m	$369m	$472m	$589m	$634m
Shares on Issue EOFY {B}	363.758m	363.758m	363.758m	383.344m	388.860m	392m
eps {A}/{B} equals {C}	78.1c	68.7c	$1.01	$1.23	$1.51	$1.62
Share Price 31 March (following) {D}	NA	NA	NA	$27.20	$41.50	$44.91
PE Ratio (D)/(C)	NA	NA	NA	22.1	27.5	27.7

Notes

1/ Significant impairment write offs for the 'Little Sheep' casual dining concept occurred in 2013 and 2014. YUMC own the intellectual property of the 'Little Sheep' brand. 'Little Sheep' had its foundation in Inner Mongolia, China. It specialises in 'Hot Pot' cooking popular in in China, especially in the winter months. 'Little Sheep' has more than 280 restaurants operating. A wholly-owned business that sells seasoning to retail customers is part of the 'Little Sheep' operation. But total turnover at 'Little Sheep' was less than 1.5% of the turnover of YUMC.

2/ The US corporate tax rate up to 31st December 2017, for the last few years, has been 35%. Looking at Note 17 on Income Tax in AR2017, the actual tax paid by YUMC on operations has been less than this. For the years 2017, 2016 the 'Statutory rate differential attributable to foreign operations' was 8.4% and 7.5%. I have rounded this off to 8%, subtracted the 8% from the 35% US statutory rate and come up with 27%. This is still above the 25% Chinese Corporate Income tax rate, and I cannot explain the difference. Over FY2018, The US corporate tax rate reduced to 21%, Now that is 4 percentage points below the Chinese corporate tax rate. However if we look at the 'Consolidated and Combined Results of Operations' (p62 AR2018), after adjusting for 'Special Items', the actual corporate tax rate comes out at 27%.

3/ The 'deemed repatriation of accumulated and distributed foreign earnings' tax saw a provision of $164m made in the YUMC accounts for FY2017. After further consideration in FY2018, this provision was adjusted down by $36m to a total of $128m. But this tax bill is to be spread out over eight years (AR2017, p76). Because it is in integral part of the Trump tax reforms, I do not feel that it should be recorded as a one off. Therefore I am recording a $16m charge every year from 2018 to 2025 inclusive.


Conclusion: Pass Test

SNOOPY

Quote:

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Originally Posted by Snoopy

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018e
Adjusted Normalised NPAT {A}	$284m	$254m	$372m	$474m	$591m	$630m
Shareholder Equity EOFY {B}	$2,344m	$1,945m	$1.979m	$2,443m	$2,859m	$2,873m
ROE {A}/{B}	12.1%	13.1%	18.8%	19.4%	20.7%	21.9%

Conclusion: Pass Test

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	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018
Adjusted Normalised NPAT {A}	$284m	$250m	$369m	$472m	$589m	$634m
Shareholder Equity EOFY {B}	$2,344m	$1,945m	$1.979m	$2,443m	$2,859m	$2,976m
ROE {A}/{B}	12.1%	12.9%	18.6%	19.3%	20.6%	21.3%

Conclusion: Pass Test

SNOOPY

Quote:

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Originally Posted by Snoopy

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018e
Adjusted Normalised NPAT {A}	$284m	$254m	$372m	$474m	$591m	$630m
Revenue {B}	$6,905m	$6,934m	$6.909m	$6,752m	$7,144m	$7,774m
Net Profit Margin {A}/{B}	4.11%	3.66%	5.38%	7.02%	8.27%	8.10%

Inflation in China is around 2%. The smallest gain in margin has been from FY2016 to FY2017. 2% of 7.02% (margin for FY2016) is 0.14 percentage points. That means as long as the FY2017 margin is greater than 7.02% + 0.14% = 7.16%, then our requirement is satisfied. The actual margin is 8.27%, so our requirement is met, and has been met over the FY2017/FY2016, FY2016/FY2015 and FY2015/FY2014 'year on year' comparisons. The decrease in margin over the latest year does not invalidate this company's ability to increase margins for an extended period over the last five years.

Conclusion: Pass Test

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	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018
Adjusted Normalised NPAT {A}	$284m	$250m	$369m	$472m	$589m	$634m
Revenue {B}	$6,905m	$6,934m	$6.909m	$6,752m	$7,144m	$7,774m
Net Profit Margin {A}/{B}	4.11%	3.66%	5.38%	7.02%	8.27%	8.16%

There has been a change in the definition of 'Revenue' for FY2018. There are two additional categories being:

1/ 'Revenues from transactions with franchisees and unconsolidated affiliates'. YUMC operates a central procurement model. The company purchases centrally from suppliers all food and paper products, then on sells and delivers those to all restaurants, including franchisees and unconsolidated affiliates.
2/ 'Other Revenues': Primarily includes revenue generated from YUMC's mobile e-commerce platform

To preserve any statistical comparative worth with previous years, I have not added in these two additional revenue categories.

Inflation in China is around 2%. The smallest gain in margin (we are leaving out the drop in FY2018) has been from FY2016 to FY2017. 2% of 7.02% (margin for FY2016) is 0.14 percentage points. That means as long as the FY2017 margin is greater than 7.02% + 0.14% = 7.16%, then our requirement is satisfied. The actual margin is 8.27%, so our requirement is met, and has been met over the FY2017/FY2016, FY2016/FY2015 and FY2015/FY2014 'year on year' comparisons. The decrease in margin over the latest year does not invalidate this company's ability to increase margins for an extended period over the last five years.

Conclusion: Pass Test

SNOOPY

Quote:

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Originally Posted by Snoopy

All of the Buffett tests have been passed. This is a rare event for any share and some may think that this is an invitation to buy. This would be a wrong conclusion to draw. Passing the Buffett tests means that you get a seat at the table to fire up the Buffett growth model to see what comes out. The price an investor has to pay for YUMC will largely determine an investors return after ten years. A great company bought at a high price will likely end up an average investment proposition at best.

Total borrowing facilities are listed to be "Approximately $US261m." (from AR2017 p76), I further note that "As of December 31, 2017, the full amount of borrowings were available under each facility." I took that to mean that, despite these facilities being negotiated, nothing had yet been drawn down. There is no term debt listed on the balance sheet for FY2017. So that is consistent with my interpretation. If we now look at the 31st January preliminary release of the FY2018 results, the balance sheet there once again shows no term debt. The entry under which any current bank debt might be hiding ( 'Other Liabilities and Deferred Credits') is broken down into:

1/ Deferred and escalating minimum rents.
2/ Deferred Credits
2/ The 'Trump Tax' on deemed unrepatriated earnings.

This means there is no current bank debt nor term bank debt - still. If there is no bank debt, then we can't be worried about the repayment of something that doesn't exist. So it is time to take our seat at the 'Buffett Growth Model' table.

---

No change from my preliminary analysis. Each of the four Buffett screenings tests have been confirmed as passed. Some of the changes made between the 'Estimated 2018 results' and 'Audited 2018 Results' are because figures that I have had to estimate have now been altered. Other changes have been made because I have changed my mind on what I consider to be 'normalized earnings'. But the net result is that all the Buffett targets are still met.

There is one more hurdle to pass before we get to sit at the Buffett growth model table. High ROE can be contrived to be higher than intrinsic, if a company has a very high level of debt.

It is now time to look at a 'term debt' test. ROE can be manipulated higher by taking on more debt. We need to check that YUMC is not over leveraged.

Total borrowing facilities are listed to be "Approximately $US418m." (from AR2018 p75), This consists of Chinese credit facilities totaling $218m, which should be added to $200m of outside credit facilities in aggregate. I further note that "As of December 31, 2018, the full amount of borrowings were available under each facility." I took that to mean that, despite these facilities being negotiated, nothing had yet been drawn down. There is no term debt listed on the balance sheet for FY2019. So that is consistent with my interpretation.

If there is no bank debt, then we can't be worried about the repayment of something that doesn't exist. So it is time to take our seat at the 'Buffett Growth Model' table.

SNOOPY

Quote:

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Originally Posted by Snoopy

The objective of the Buffett growth model is to sum the gains of dividends and capital appreciation over an extended period, and calculate a compounding rate of annual return taking into account all tax liabilities incurred on the way.

The Buffett growth model operates by:

1/ Starting with shareholder equity at the start of Year 1,
2/ Working out a projected return on this equity using an averaged return on this equity from previous years.
3/ Apportioning this return between dividends, share buybacks and what remains to be reinvested within the company. New Capital raised outside of normal operations during the year must be taken into account.
4/ Recycling any retained earnings into subsequent year shareholder equity. Then using this new Shareholder equity total as the earnings base for the subsequent year. The subsequent year becomes the new starting point for this process to repeat.

YUMC is an 'overseas share', caught by NZ's FIF tax regime. FIF tax is paid on 5% of the opening balance of each share owned. At a tax rate of 30%, this works out at:

0.3 x 0.05 = 0.015, or 1.5% of the opening balance total, payable each year (actually FIF tax is charged on a whole of portfolio basis. But for the purpose of this exercise, we shall assume the entire FIF portfolio consists of YUMC shares only) For NZers, this FIF tax has to be separately accounted for in this calculation each year, and summed over the study period

We are looking at a study period, ten years into the future. The amount that must be paid for this FIF tax can be netted off against any overseas withholding tax paid on dividends. That is because, under the FIF regime, there is no separate tax on dividends. The withholding tax on dividends on NYSE listed YUMC and paid by YUMC on the investor's behalf is currently 15%.

Return On Shareholder Equity: Working Figure

Post 21 allows us to calculate an averaged five year ROE figure:

( 13.1% + 18.8% + 19.4% + 20.7% + 21.9 %) / 5 = 18.8%

Price Earnings Ratio: Working Figure

To value our share each year, we need to calculate an appropriate PE value to use. Despite operating for some thirty years, YUMC has only been separately listed for three. Using just three data points is not a very reliable way to calculate a representative average PE figure. This is particularly so when one of those figures was inflated by a since withdrawn takeover offer (Year 2017). I have taken 15% off the year 2017 PE figure to remove this takeover premium.

( 21.4 + 0.85x27.2 + 25.2 ) /3 = 23.2

The derivation of this PE figure has been calculated using a shallow data set. Nevertheless it is the best figure we can get, based on the possibly not representative three year sharemarket trading period we have to draw information from.

Dividends

Only one dividend of 10c per share has been declared over FY2017, the latest year in which an annual report was published. This relates to the period Q4 for FY2017. Over FY2018 there have been four quarterly dividends declared: 10cps, 10cps, 10cps and 12 cps. Given the growth path of the company, I am forecasting dividends for FY2021 to be 13cps, 13cps, 13cps and 13cps. Following an incremental pattern, I am going to model future dividend payments for the years in which we are studying to be as follows:

	Forecast Dividend
FY2018	42cps
FY2019	42cps
FY2020	46cps
FY2021	52cps
FY2022	58cps
FY2023	64cps
FY2024	70cps
FY2025	76cps
FY2026	82cps
FY2027	88cps
FY2028	94cps

Share Buybacks

On 4th October 2017, the board increased the aggregate quantum of shares to be repurchased to $550m. As of the end of FY2018, the aggregate of share repurchases had reached $455m. That leaves $95m worth of shares still authorized to be bought back. Yet counter intuitively, the number of shares on issue continues to go up year on year. What is the explanation for this?

As stated in AR2017 p37:

"The company's executive compensation program has three primary pay components: base salary, annual performance based cash bonuses and long term equity awards."

We learn on p119 of AR2017 that:

"The company has reserved for issuance under the "Yum China Holdings Inc. Long Term Incentive Plan" 45 million shares of our common stock. Under this plan, the excise price of stock options and SARs (Stock Appreciation Rights) granted must be equal to or greater than the fair market value of the company's stock on the date of the grant"

Options and SARs vest after three to five years and expire ten years after they were granted. Share based compensation is recognized in the "Consolidated and Combined Financial Statements" on a straight line basis over the service period based on their fair value on the date of the grant. When the options are redeemed, the company gets a cash injection based on the awarded price of the share options granted. But the employee gets to keep the difference between the price at the time the option was awarded and today's market price.

Again from p121 of AR2017, at the end of that year, 14.072m shares become exercisable at a weighted average excise price of $16.69. If all of these were exercised, this would represent a capital inflow to shareholders equity of:

14.072m x $16.69 = $235m

Actual new equity inflow over the period was $27m. That is equivalent to about 1.617m new ordinary shares created ( $16.69 x 1.617m = $27m)

The current authorized buy back limit of $95m would buy back 2.375m shares at $40 each. 2.375m shares to be redeemed is way short of the new 14.072m -1.617m = 12,455m shares that could be created at any time. it looks like the number of shares bought back will continue to be outweighed by the number of employee earned new shares vesting.

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The objective of the Buffett growth model is to sum the gains of dividends and capital appreciation over an extended period, and calculate a compounding rate of annual return taking into account all tax liabilities incurred on the way.

The Buffett growth model operates by:

1/ Starting with shareholder equity at the start of Year 1,
2/ Working out a projected return on this equity using an averaged return on this equity from previous years.
3/ Apportioning this return between dividends, share buybacks and what remains to be reinvested within the company. New Capital raised outside of normal operations during the year must be taken into account.
4/ Recycling any retained earnings into subsequent year shareholder equity. Then using this new Shareholder equity total as the earnings base for the subsequent year. The subsequent year becomes the new starting point for this process to repeat.

YUMC is an 'overseas share', caught by NZ's FIF tax regime. FIF tax is paid on 5% of the opening balance of each share owned. At a tax rate of 30%, this works out at:

0.3 x 0.05 = 0.015, or 1.5% of the opening balance total, payable each year (actually FIF tax is charged on a whole of portfolio basis. But for the purpose of this exercise, we shall assume the entire FIF portfolio consists of YUMC shares only) For NZers, this FIF tax has to be separately accounted for in this calculation each year, and summed over the study period

We are looking at a study period, ten years into the future. The amount that must be paid for this FIF tax can be netted off against any overseas withholding tax paid on dividends. That is because, under the FIF regime, there is no separate tax on dividends. The withholding tax on dividends on NYSE listed YUMC and paid by YUMC on the investor's behalf is currently 15%.

Return On Shareholder Equity: Working Figure

Post 35 allows us to calculate an averaged five year ROE figure:

( 12.9% + 18.6% + 19.3% + 20.6% + 21.3% ) / 5 = 18.5%

Price Earnings Ratio: Working Figure

To value our share each year, we need to calculate an appropriate PE value to use. Despite operating for some thirty years, YUMC has only been separately listed for three. Using just three data points is not a very reliable way to calculate a representative average PE figure. This is particularly so when one of those figures was inflated by a since withdrawn takeover offer (Year 2017). I have taken 15% off the year 2017 PE figure to remove this takeover premium.

( 22.1 + 0.85x27.5 + 27.7 ) /3 = 24.4

The derivation of this PE figure has been calculated using a shallow data set. Nevertheless it is the best figure we can get, based on the possibly not representative three year sharemarket trading period we have to draw information from.

Dividends

Over FY2018 there have been four quarterly dividends declared: 10cps, 10cps, 10cps and 12 cps. The first half of FY2019 has seen two dividends of 12cps being declared, an annualized rate of 48cps. Given the growth path of the company, I am forecasting dividends for FY2021 to be 13cps, 13cps, 13cps and 13cps. Following an incremental pattern, I am going to model future dividend payments for the years in which we are studying to be as follows:

	Forecast Dividend
FY2018 (actual)	42cps
FY2019	48cps
FY2020	48cps
FY2021	52cps
FY2022	58cps
FY2023	64cps
FY2024	70cps
FY2025	76cps
FY2026	82cps
FY2027	88cps
FY2028	94cps

Share Buybacks

On 4th October 2017, the board increased the aggregate quantum of shares to be repurchased to $550m. As of the end of FY2018, the aggregate of share repurchases had reached $455m. That leaves $95m worth of shares still authorized to be bought back. Yet counter intuitively, the number of shares on issue continues to go up year on year. What is the explanation for this?

As stated in AR2018 p40:

"The company's executive compensation program consists of three primary pay components: (i) base salary, (ii) annual performance based cash bonuses or short term incentives and (iii) long term equity awards."

We learn on p121 of AR2018 that:

"Effective 31st October 2016, the company has reserved for issuance under the "Yum China Holdings Inc. Long Term Incentive Plan" 45 million shares of our common stock. Under this plan, the excise price of stock options and SARs (Stock Appreciation Rights) granted must be equal to or greater than the fair market value of the company's stock on the date of the grant"

Over the remainder of FY2016, 25.274m of these long term incentive plan rewards were issued as part of the demerger process, 0.5m more were granted and 0.456m were forfeited or expired (AR2016 p115). So by the end of FY2016 the net plan shares issued were:

25.274m + 0.500m - 0.456m = 25.318m

We can record the change in rights issued in subsequent years as follows:

Employee Options Authorised Remaining
	Total (start of period)	less Options Granted during year	add Options Cancelled during year	equals Remaining Options to be Authorised (end of period)
At 31st October 2016	45m	(25.274m)		19.726m
FY2016	19.726m	(0.500m)	0.456m	19,682m
FY2017	19.682m	(2.234m)	1.199m	18.647m
FY2018	18.647m	(1.179m)	0.611m	18.079m

In 'number of option' terms, this means there are plenty still available to be issued.

Options and SARs vest after three to five years and expire ten years after they were granted. Share based compensation is recognized in the "Consolidated and Combined Financial Statements" on a straight line basis over the service period based on their fair value on the date of the grant. When the options are redeemed, the company gets a cash injection based on the awarded price of the share options granted. But the employee gets to keep the difference between the price at the time the option was awarded and today's market price.

Again from p123 of AR2018, at the end of that year, 12.407m shares become exercisable at a weighted average excise price of $18.64. If all of these were exercised, this would represent a capital inflow to shareholders equity of:

12.407m x $18.64 = $231m

Actual new equity inflow over the FY2018 period from share based compensation was $24m (AR2018 p91). That is equivalent to 3m new ordinary shares created (AR2018 p91).

During FY2018 (AR2018 p124), the company repurchased 9.0m shares during FY2018 (total cost $312m) and $960m remains available for purchase under current authorization. This remaining to purchase balance is up from the $422m available for future purchases a year earlier (AR2017 p122). So there doesn't seem to be any problem increasing the buy back authorization if management see fit to do so.

$960m would buy back 24m shares at $40 each. 24m shares exceeds the employee compensation package new equity that could now be created at any time.

12.407m shares x $18.64 per share = $231m (Potential employee new equity contribution EOFY2018)

So now the number of shares that could be bought back outweigh the number of employee earned new shares that could be redeemed.

Nevertheless warrant agreements with two strategic investors (AR2018 p115) could see 7.309m plus 0.891m = 8.2m new shares issued before October 31st 2021. Since these warrants are well 'in the money' I expect this will happen in due course. So I don't see the number of shares in YUMC decreasing over the next few years, despite the on market share buybacks.

SNOOPY

Quote:

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Originally Posted by Snoopy

The dollar figures in the table below are all on a 'per share' basis.

Note: To compile the table below, I have assumed:

1/ an ROE figure of 18.8%
2/ a PE ratio of 23.2.
3/ a constant dollar amount of shares being bought back every year amounting to $128m, The actual number of shares this buys back is determined by the modelled share price.
4/ $59m of new shares being subscribed to via the employee share scheme each year. These shares are assumed to be subscribed to at a redemption price of $16.69 each. This rate of subscription creates 3.542m new shares each year.

	Modelled No. Shares SOFY	Modelled Share Price SOFY {SP}	Equity SOFY	Net Income + Foreign Translation Gain {A}	Dividend Declared {B}	Share Buyback {C}	New Shares Subscribed + New Capital on Business Acquisitions {D}	New Retained Equity {A}+{B}+{C}+{D}	FIF Tax Liability {SP} x 0.015
2017	383.344m	$26.12	$6.37	$1.49	($0.16)	($0.33)	$0.09	$1.09
2018	388.860m	$40.02	$7.35	$1.56	($0.51)	($0.79)	$0.07	$0.33
2019	392m	$33.43	$7.62	$1.43	($0.58)	($0.33)	$0.15	$0.67	$0.50
2020	391.722m	$36.19	$8.29	$1.56	($0.58)	($0.33)	$0.15	$0.80	$0.54
2021	391.725m	$39.67	$9.09	$1.71	($0.64)	($0.33)	$0.15	$0.89	$0.60
2022	392.038m	$43.62	$9.98	$1.88	($0.72)	($0.33)	$0.15	$0.98	$0.65
2023	392.646m	$47.79	$10.96	$2.06	($0.80)	($0.33)	$0.15	$1.08	$0.72
2024	393.510m	$52.43	$12.01	$2.26	($0.88)	($0.33)	$0.15	$1.20	$0.79
2025	394.611m	$57.54	$13.17	$2.48	($0.96)	($0.32)	$0.15	$1.35	$0.86
2026	395.928m	$63.10	$14.47	$2.72	($1.04)	($0.32)	$0.15	$1.51	$0.95
2027	397.411m	$69.37	$15.92	$2.99	($1.12)	($0.32)	$0.15	$1.70	$1.04
2028	399.108m	$76.56	$17.55	$3.30	($1.20)	($0.32)	$0.15	$1.93	$1.15
2029	400.978m	$84.68	$19.39	$3.65
Sum 2019-2028					($8.52)				$7.80

Question/ On 1st March 2019, the YUMC share price closed at $41.40. What is the expected 10 year compounding rate of return for a New Zealand investor if you bought that share today, assuming exchange rates remain constant??

Answer/ 41.40 x (1+r)^10 = [ ($84.68+$8.52 - $7.80) ] => r = 0.075 = 7.5%

Question/ Warren Buffett likes to get a 15% compounding return on any share he invests in, What price would he need to pay for YUMC today to achieve that?

Answer/ P x (1.15)^10 = [ ($84.68+$8.52 - $7.80) ] => P = $21.10

Conclusion:

YumChina is a great company. But to purchase shares in it today would see you pay a high price. While a 7.5% after tax compounding return over ten years is OK, this is below the kind of return that Warren is seeking. I don't think Warren would be investing in YUMC, unless that acquisition price comes down.

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The dollar figures in the table below are all on a 'per share' basis.

Note: To compile the table below, I have assumed:

1/ An ROE figure of 18.5%
2/ A PE ratio of 24.4.
3/ A constant dollar amount of shares being bought back every year amounting to $128m.

YUMC has currently authorised share total buybacks up to a value of $1,400m (AR2018 p53), of which a balance of $960m now remains for further buybacks. This is less than the $1,280m of buybacks I am modelling over the next ten years. However, the YUMC board has a record of increasing the buyback limit over the years. So I don't believe that my modelling is unrealistic. The actual number of shares the money buys back each year in my model is determined by the modelled share price.

4/ $59m of new shares being subscribed to, via the employee share scheme each year. These shares are assumed to be subscribed to at a redemption price of $18.64 each (AR2018 p123). This rate of subscription creates 3.165m new shares each year.

	Modelled No. Shares SOFY	Modelled Share Price SOFY {SP}	Equity SOFY	Net Income + Foreign Translation Gain {A}	Dividend Declared {B}	Share Buyback {C}	New Shares Subscribed + New Capital on Business Acquisitions {D}	New Retained Equity {A}+{B}+{C}+{D}	FIF Tax Liability {SP} x 0.015
2017	383.344m	$26.12	$6.37	$1.49	($0.16)	($0.33)	$0.09	$1.09
2018	388.860m	$40.02	$7.31	$1.48	($0.49)	($0.80)	$0.16	$0.35
2019	392m	$33.53	$7.59	$1.40	($0.48 +$0.08)	($0.33)	$0.15	$0.66	$0.50
2020	391.348m	$37.33	$8.26	$1.53	($0.52+$0.08)	($0.33)	$0.15	$0.75	$0.56
2021	391.085m	$40.75	$9.02	$1.67	($0.56+$0.08)	($0.33)	$0.15	$0.85	$0.61
2022	391.109m	$44.65	$9.87	$1.83	($0.60+$0.08)	($0.33)	$0.15	$0.97	$0.67
2023	391.407m	$48.80	$10.83	$2.00	($0.64+$0.08)	($0.33)	$0.15	$1.10	$0.73
2024	391.959m	$53.68	$11.91	$2.20	($0.68+$0.08)	($0.33)	$0.15	$1.26	$0.81
2025	392.739m	$59.29	$13.14	$2.43	($0.76+$0.08)	($0.33)	$0.15	$1.41	$0.89
2026	393.745m	$65.39	$14.51	$2.68	($0.84+$0.08)	($0.33)	$0.15	$1.58	$0.98
2027	394.913m	$72.47	$16.04	$2.97	($0.92+$0.08)	($0.32)	$0.15	$1.80	$1.09
2028	396.312m	$80.28	$17.78	$3.29	($1.00+$0.08)	($0.32)	$0.15	$2.04	$1.20
2029	397.973m	$89.06	$19.74	$3.65
Sum 2019 to 2028					($7.00)				$8.04

Question/ On 12th August 2019, the YUMC share price closed at $43.02. What is the expected 10 year compounding rate of return for a New Zealand investor if you bought that share today, assuming exchange rates remain constant? (note the dividend figure included in the calculation below is the proportion of the dividend due to ordinary shareholders, which now excludes the dividend paid to the controlling interests of YUMC minority owned businesses).

Answer/ 43.02 x (1+r)^10 = [ ($89.06+$7.00 - $8.04) ] => r = 0.074 = 7.4%

Question/ Warren Buffett likes to get a 15% compounding return on any share he invests in, What price would he need to pay for YUMC today to achieve that?

Answer/ P x (1.15)^10 = [ ($89.06+$7.00 - $8.04) ] => P = $21.76

Conclusion:

YumChina is a great company. But to purchase shares in it today would see you pay a high price. While a 7.4% after tax compounding return over ten years is OK, this is below the kind of return that Warren is seeking. I don't think Warren would be investing in YUMC, unless that acquisition price comes down.


SNOOPY

Sometimes reading things through a second time can give you a different perspective. I have 'temporarily paused' my previous post 39 while I sort this matter out.

The YUMC 'Consolidated and Combined Statement of Cashflows' (AR2018 p89) show two kinds of dividends.

1/ Cash dividends paid on common stock
2/ Dividends paid to non-controlling interests

YUMC have a non-controlling 47% interest in each of the entities that operate the KFCs in Hangzhou (population 9.018m in 2015, 20 KFC Outlets {Googlemaps 2019}), Suzhou (population 4.330m in 2013, 20 KFC Outlets {Googlemaps 2019}). The now 83% owned Wuxi business (since an additional 36% of shares were added to the 47% percent of shares already held) is the entity that operates KFC in Wuxi (population 6.372m in 2010, 13 KFC outlets {Googlemaps 2019}) is now consolidated, as of the first quarter of FY2018.

From the annual results over the years, I have compiled a partial 'dividend table' below, based on the 'non-controlling interests' of YUMC, alongside the corresponding income.

	2014	2015	2016	2017	2018
Net Income (Non-controlling Shareholders)	($30m)	$5m	$12m	$26m	$28m
Dividends paid to Non-controlling Interests	($4m)	$0m	($7m)	($22m)	($36m)

There isn't much clear logic in this table that I can see. In 2014 a 'dividend' was paid out, despite multi-million dollar losses. The proportion of the dividend paid out doesn't seem to bear much relation to the earnings of any particular year. For the previous 'Buffett Growth Model Spreadsheet', I tried to estimate a 'normalised' non-controlling shareholder dividend. However, I now believe this was the wrong approach. These 'Dividends paid to Non-controlling Interests' can even be a reflection of one off earn out agreements. More details on 'Redeemable Noncontrolling Interests' can be found in AR2018 on p6 and p111. 'Unconsolidated affiliates' operated 14% of all YUMC KFC restaurants at the end of 2018 (p6 AR2018).

Specifically during FY2016, the founders of the 'Little Sheep Hot Pot' concept (a restaurant franchise business now entirely owned by YUMC) were bought out of a minority Little Sheep residual shareholding position.

"The difference between the purchase price of less than $1m, which was determined using a non-fair value based formula pursuant to the agreement governing the redemption rights, and the carrying value of their redeemable non-controlling interest was recorded as an $8m loss attributable to non-controlling interests during the year December 31 2016." (p111 AR2018)

Note that in the above table, the 'dividend' paid out for 2016 was the $1m price, less a fair value adjustment of $8m - for a total 'cash loss' to YUMC of $7m. So the fair value of goodwill adjustment was a cash flow item! This means the value of the goodwill attached to the residually owned 'Little Sheep' shares must have been previously agreed with the minority 'Little Sheep' shareholders as fixed. At least, I think that is the way it worked! I have found US regulated Form 10-K reports have less disclosure and are more difficult to follow than the typical NZX report. But maybe that is just me?

Today the 'non-consolidated entities' reflect certain minority holdings in:

1/ some flagship KFC stores AND
2/ a redeemable non-controlling interest in 'DAOJIA.com.cn' (Daojia)

Daojia is a specialist online takeaway food delivery company. Owning a majority interest of 90% in Daojia (AR2018 p92) is expected to enhance existing digital and delivery capabilities (AR2018 p26). Delivery contributed to 17% of Company Sales on 2018. (AR2018, p25) From what I can gather from the annual reports, 'revenue' from a takeaway food order is booked up front by either KFC or Pizza Hutt. But there seems to be some liabilities payable to the Daojia founders, and now minority shareholders, that are recorded in the YUMC cashflow statements as 'dividends'. Notwithstanding this Daojia lost money over FY2018 (AR2018 p70)

I intend to rework my Buffett Growth Model using my new reinterpreted knowledge.

SNOOPY

Quote:

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Originally Posted by Snoopy

The YUMC 'Consolidated and Combined Statement of Cashflows' (AR2018 p89) show

2/ Dividends paid to non-controlling interests

YUMC have a non-controlling 47% interest in each of the entities that operate the KFCs in Hangzhou (population 9.018m in 2015, 20 KFC Outlets {Googlemaps 2019}), Suzhou (population 4.330m in 2013, 20 KFC Outlets {Googlemaps 2019}). The now 83% owned Wuxi business (since an additional 36% of shares were added to the 47% percent of shares already held) is the entity that operates KFC in Wuxi (population 6.372m in 2010, 13 KFC outlets {Googlemaps 2019}) is now consolidated, as of the first quarter of FY2018.

More details on 'Redeemable Noncontrolling Interests' can be found in AR2018 on p6 and p111. 'Unconsolidated affiliates' operated 14% of all YUMC KFC restaurants at the end of 2018 (p6 AR2018).

I have found US regulated Form 10-K reports have less disclosure and are more difficult to follow than the typical NZX report. But maybe that is just me?

Today the 'non-consolidated entities' reflect certain minority holdings in:

1/ some flagship KFC stores AND
2/ a redeemable non-controlling interest in 'DAOJIA.com.cn' (Daojia)

Daojia is a specialist online takeaway food delivery company'. Notwithstanding this Daojia lost money over FY2018 (AR2018 p70)

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Time to test my theory that 'Dividends paid to non-controlling interests' are from the aggregated in the YUMC accounts 'majority stakes' - that YUMC doesn't own - in KFCs in Hangzhou (population 9.018m in 2015, 20 KFC Outlets {Googlemaps 2019}) and Suzhou (population 4.330m in 2013, 20 KFC Outlets {Googlemaps 2019}).

We can estimate these 'majority owned outside of YUMC' earnings from the price paid for the now 83% owned Wuxi business (since an additional 36% of shares were added by YUMC to the 47% percent of shares already held) in the entity that operates KFC in Wuxi (population 6.372m in 2010, 13 KFC outlets {Googlemaps 2019}). (Wuxi was consolidated, during the first quarter of FY2018). The valuation of the Wuxi restaurants is the clue where we can get at least some 'hard data' from which to make our valuation estimates for the Hangzhou and Suzhou KFC businesses.

AR2018 p92 tells us:

"The completed acquisition of an additional 36% equity interest in an unconsolidated affiliate that operates KFC stores in Wuxi China for a cash consideration of approximately $US98m increasing the company's equity to 83%."

This values the whole Wuxi KFC business at: $US98m/0.36 = $US270m

YUMC has been trading on EBIT multiples of around 20. Taking this measure as a baseline, this would imply an underlying EBIT for Wuxi of $US270m/ 20 = $US13.5m. Those earnings are spread over 13 outlets. But the remaining minority interests in the other two cities comprise 40 outlets. Assuming similar levels of profitability, that means the EBIT for KFCs in Hangzhou and Suzhou would be combined as an 'in the ballpark figure' of:

$US13.5m x 40/13 = $US42m

That breaks down to 0.47 x $US42m = $20m for YUMC shareholders, while the remaining $22m of EBIT belongs to the independent majority owners. YUMC has no term debt and would not withhold any tax payments to the majority shareholders. (In fact in the real world it is the other way around: the majority shareholders in KFC Hangzhou and KFC Suzhou would have to withhold Chinese tax before paying their dividend to minority shareholder YUMC). Yet from a YUMC accounts perspective -IMO-, all of the EBIT for KFC Hangzhou and KFC Suzhou in the YUMC accounts is available to pay the majority shareholders in KFC Hangzhou and KFC Suzhou. So how does that figure of $22m compare to the $36m dividend to non-controlling interests (AR2018 p89) that was paid? It is obviously less, although perhaps by co-incidence it does match the equivalent $22m figure from FY2017, (and that one would have included Wuxi as well).

I have made assumptions in this analysis, for example that the profitability of Wuxi is indicative of the profitability in other centres, that may be untrue. We don't know why the former majority shareholders in Wuxi agreed to sell down to YUMC. Perhaps those Wuxi restaurants were underperforming? While I would have liked to have seen my estimate of earnings at KFC Hangzhou and KFC Suzhou to be closer, it isn't far enough out in the circumstances to disprove my theory. Accordingly I am going to assume that $36m dividend to outside majority shareholders continues into the future. This is likely a high bound guess as it may include up to 1/4 of the Wuxi profits in the first quarter, before those profits were consolidated.

SNOOPY

You're doing a lot of fancy analysis on YUM, far more than I would ever consider on a stock if I were to buy it. For starters i'm not a fan of using EBITA

China's economy is on the down. Their currency is weakening to the USD. I would look at these factors because they would have a more relevant hit against their balance sheet than to assess by how much dividends they pay.

Quote:

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Originally Posted by SBQ

You're doing a lot of fancy analysis on YUM,

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Too much speed reading on your behalf SBQ? We are talking about YUMC here, which is an entirely different company from YUM now. YUM is the master franchise holder for KFC, Pizza Hutt and Taco Bell globally. YUMC is the operator of KFC, Pizza Hutt and Taco Bell restaurants within mainland China. YUMC is the Chinese equivalent as 'Restaurant Brands' here in New Zealand.

Quote:

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far more than I would ever consider on a stock if I were to buy it.

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Possibly, although maybe not more than if you owned the stock already?

Of course, I am not looking into YUMC just for its own sake. I am interested in it as a 'comparative stick' against which to measure my own holding in 'Restaurant Brands' here in NZ. I am also interested in it as a long term success story on developing a 'western' business in the Chinese market. Because NZ has such a deep trade relationship with China, I think YUMC is a worthwhile case study for those companies in NZ looking to develop their business in China.

Quote:

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For starters i'm not a fan of using EBITA

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I was using EBIT (not EBITA) for business unit valuation purposes. That is how business units are valued in most takeover circumstances. Nothing radical about doing that I would have thought.

SNOOPY

Quote:

---

Originally Posted by SBQ

China's economy is on the down. Their currency is weakening to the USD. I would look at these factors because they would have a more relevant hit against their balance sheet than to assess by how much dividends they pay.

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I find it an interesting feature of the 'United States Securities and Exchange Commission' FORM 10-K annual reports that they are forced to disclose risks to an almost absurd degree. Nevertheless, not living in the USA, I find these disclosures useful. Here is what the report says on the current USA vs China trade wars (p34 AR2018).

"The adoption and expansion of trade restrictions and tariffs, quotas and embargoes, the occurrence of a trade war or other governmental action related to tariffs or trade agreements or policies has the potential to adversely impact costs."

I am sure that if this was an NZX report, they would go on to supply some quantitative estimate of these costs. But none was forthcoming. Yet almost all the YUMC restaurant inputs are sourced within China anyway, so I am not too worried.

"In addition changes in trade relations between the United States and China may trigger negative customer sentiment towards western brands in China, potentially resulting in negative impact on our results of operations and financial conditions."

This has happened before, but after two to three years YUMC recovered.

From AR2018 p32

"For example, our results of operations in the third quarter of 2016 ( sales $1,848m) were adversely impacted by an international court ruling in July 2016 regarding claims to sovereignty over the South Chia Sea, which triggered a series of regional protests and boycotts in China, intensified by social media, against a few international companies with well known Western brands."

As far as the currency is concerned, the RMB has been -largely- depreciating against the USD for a long time. So the more recent depreciation over the last few months is nothing new.

In my spreadsheet projected profits, I use the term 'Net Income + Foreign Translation Gain'. Over the past five years these adjustments have been as follows:

	2014	2015	2016	2017	2018
Foreign Currency Translation Adjustment	($51m)	($91m)	($134m)	$142m	($160m)

My base earnings figures on the spreadsheet include these adjustments. Also bear in mind that the number of YUMC outlets grew from 7,983 to 8,484 (+6.3%) over FY2018, and underlying profitability has increased much more than that. That kind of growth is outweighing any currency losses.

SNOOPY

Best of luck on your YUMC ventures. Personally I would rather pick YUM because of the cultural (anti-western) shift we're seeing in China. Also not touching any NZ listed companies at all. Not when corporate taxes are at 28% + a small market size of 4.5M population in NZ.

SEC reporting is strict as Elon Musk has continuous battles with their regulations. Is it a good thing? IMO overall yes. While you get the odd case like Enron frauds, I would say they are far fewer than the amount of fraud / unethical actions we've seen on listed NZX companies in the past century. In fact, it's a primary reason why so many NZ people shun at sharemarket investing because they remember the past of so many corrupted NZ corporations that have 'fleeced investors'.

As for China reporting... I only take it with a grain of salt. No one is blowing the whistle on China's mass corporate debt.

Quote:

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Originally Posted by SBQ

Best of luck on your YUMC ventures. Personally I would rather pick YUM because of the cultural (anti-western) shift we're seeing in China.

---

I own shares in YUM as well. No reason why you can't ride more than one horse. In fact that is how I got my shares in YUMC. The shares split from my YUM holding.

Quote:

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Originally Posted by SBQ

As for China reporting... I only take it with a grain of salt. No one is blowing the whistle on China's mass corporate debt.

---

YUMC has no term debt, which is another appealing factor.

SNOOPY

Quote:

---

Originally Posted by Snoopy

The most striking thing I found from looking at the YUMC results is how well profits are growing with respect to revenues. This is great for shareholders. But ultimately a company will run into the 'squeeze the orange' argument. Put simply, you can squeeze an orange harder and harder, but ultimately there will be no more juice that you can get out of it. 'Squeezing the orange' that is the fast food restaurant market and eventually your 'profit growth' dries up unless revenues grow. Over the last five years reported, revenues have grown:

US$6,905m x (1+g)^5= US$7,144m => g= 0.683% (compounding)

But profit growth has been

US$284 x (1+g)^5= US$591 => g=15.8% (compounding)

It is hard to imagine that profit growth could outstrip revenue growth like that going forwards. However, there is another angle that needs investigating. The functional currency of YUMC is the RMB, not the USD. So what happens if the revenue is converted to RMB?

	FY2013	FY2014	FY2015	FY2016	FY2017
Adjusted Normalised NPAT {A}	$284m	$254m	$372m	$474m	$591m
Revenue {B}	$6,905m	$6,934m	$6.909m	$6,752m	$7,144m
RMB/USD Exchange Rate	6.1932	6.1428	6.2284	6.6423	6.7518
Revenue	RMB42.764	RMB42.594	RMB43.032	RMB44.849	RMB48.235
Net Profit Margin {A}/{B}	4.11%	3.66%	5.38%	7.02%	8.27%

The revenue growth rate in local currency was

RMB42.764 x (1+g)^5 = RMB48.235 => g=2.44% (compounding)

This is not great when you consider:

1/ local inflation is around 2%
2/ there has been a substantial number of new outlets created over the study period.

But it does show that the revenue is growing above inflation, albeit modestly. This was not apparent when the results were presented in USD.

---

The functional currency of YUMC is the RMB, not the USD. So what happens if the revenue is converted to RMB?

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018
Adjusted Normalised NPAT {A}	$284m	$254m	$372m	$474m	$591m	$634m
Revenue {B}	$6,905m	$6,934m	$6.909m	$6,752m	$7,144m	$7,774m
RMB/USD Exchange Rate	6.1932	6.1428	6.2284	6.6423	6.7518	6.6174
Revenue	RMB42.764	RMB42.594	RMB43.032	RMB44.849	RMB48.235	RMB51.444
Net Profit Margin {A}/{B}	4.11%	3.66%	5.38%	7.02%	8.27%	8.16%

The revenue growth rate in local currency per annum was:

RMB42.764 x (1+g)^5 = RMB51.444 => g=3.77% (compounding)

This is not great when you consider:

1/ local inflation is around 2%
2/ there has been a substantial number of new outlets created over the study period.

But it does show that the revenue is growing above inflation, albeit modestly. This was not apparent when the results were presented in USD.

SNOOPY

Quote:

---

Originally Posted by Snoopy

Return on Equity

In the 'Buffett Growth Model', it is 'Return on Equity' that is the most important factor in determining earnings for the year. I am happy with assuming a return on equity for Yum China of 18.8% (edit now updated to 18.5%) . In absolute terms, this will be a high number to roll over on itself for the next ten years. Yet the actual ROE over the last three years (the time since YUMC has been listed as a separate entity) have been noticeably higher than this. I am not expecting the high ROE figures from the last three years to continue. Profits have been growing a lot faster than sales. And I expect some re-balancing of costs upwards. Indeed, over FY2018, the 'Net Profit Margin' was, apparently, already shrinking.

---

I have mentioned before that YUMC came into being as a 'stock split' for the parent YUM corporation. This is a slight simplification of the truth. In fact at the time of the split, YUMC received an outside capital injection of $460m (AR2018 p115). This is as the result of two strategic investors being brought on board the share register:

1/ An affiliate of the 'Primavera Financial Group' called 'Pollis Investment L.P.' invested $410m.
2/ An affiliate of ''Zhejiang Ant Small and Micro Financial Services Co. Limited" called 'API Hong Kong Investment Limited" invested $50m.

The net effect of these transactions was to add 19.145m shares (along with the $460m) to the 363.758m shares that came into existence at the time of separation. These shares were added in the very last quarter of 2016 and so already appear on the FY2016 balance sheet information as presented in the table below.

	EOFY2016	Change	EOFY2018
Normalised Earnings {A}	$472m		$634m
No. of Shares {B}	383m		392m
eps {A}/{B}	$1.23c	+39c {D}	$1.62
Owner Equity {C}	$2,443m		$2,976m
Owner Equity per share {C}/{B}	$6.38	+$1.21 {E}	$7.59
Return on Incremental Equity / Share {D}/{E}		+32%

It is likely that the net effect of this earlier $460m investment was not felt immediately. So much of the profitability gain apparent from subsequent net capital injection into YUMC (mainly from senior employees cashing in their stock options) is 'piggy backing' on the earlier $460m cash injection not shown in the above table. Thus in my opinion a more meaningful comparison table is this second one:

	31/10/2016 (spin off date)	Change	EOFY2018
Normalised Earnings {A}	$472m (for all of FY2016)		$634m
No. of Shares {B}	364m		392m
eps {A}/{B}	$1.30c	+32c {D}	$1.62
Owner Equity {C}	($2,443m-$460m)		$2,976m
Owner Equity per share {C}/{B}	$5.45	+$2.14 {E}	$7.59
Return on Incremental Equity / Share {D}/{E}		+15%

Note that 15% is well below the overall ROE figure of 21.3% achieved over FY2018 and also below the ROE figure of 18.5% over the last five years. 15% return on 'incremental equity' is nevertheless a good figure, the kind of figure that a Warren Buffett would be happy with.

SNOOPY

Quote:

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Originally Posted by Cricketfan

So Snoopy, after all this analysis, have you invested? I've opened an account with Hatch, might buy a few YUMC to get started.

---

Quote:

---

Originally Posted by Snoopy

I am convinced Yum China is a very good company. I particularly like the fact that they can open a KFC restaurant and have all incremental expenditure needed to do that paid back within a couple of years. But successful investment is not just about sharemarket investors buying good companies. What investors need is to buy good companies at good value prices. I see Yum China last traded at $US45.24. Based on last years (2017) results, this represents an historical PE ratio of:

$45.24 / $1.52 = 29.8

This is very high. I would like to wait to see the full results from last year released, to see if such a lofty PE ratio could be justified. Right now, I won't be investing more money into Yum China.

If I was a new investor, I would be waiting for something negative to happen that caused the YUMC share price to fall a bit (bearing in mind YUMC is very strong at its core and the SP should bounce back), and allow a more favourable investment entry price. YUMC has had a series of mishaps outlined earlier on this thread, that dragged their reputation down, for a while at least. The next mishap could be next week. But it could be five years away.

---

Cricketfan, YUMC fell 3.49% on Friday down to $42.57. That is more than any of the underlying US indices fell and all were down. This stoush between Trump and Chinese President Xi is exactly the kind of event that we investors look for to bring share prices down to more reasonable levels.

Many here will see YUMC as just another US corporation liable to feel the backlash, if not from tariffs, then from an anti-US feeling from the loyal Chinese citizen consumers against the USA. But as you can see below, it isn't.

Quote:

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Originally Posted by Snoopy

If we look at YumChina, their success seems due to their ability to be seen as a Chinese company (the senior executive team is Chinese, they sell franchises to local Chinese) that provide tangible benefits for Chinese workers. Raising the standard of living of the Chinese people is something the Chinese government have been very successful at. And I would say any China based business that produce for all stakeholders benefits in line with the Chinese government's vision will continue to do well.

---

Watch the misguided masses sell this one down. Then be ready to pounce. But will the share price go low enough to make this a deal that new investor's can't turn down? That remains to be seen.

SNOOPY

It is interesting to take note of the year to date profitability for HY2019 verses the previous year HY2018. (From 30th July 2019 Yum China Profit Release)

A significant contributor to the profit in HY2019 was the 'mark to market' gain from YUMC's equity investment in Meituan Dianping (a $27m gain in the half).

Meituan and Dianping were originally two separate companies that merged in 2015. They made their merged public debut on the Hong Kong stock exchange (HKEX) in September 2018. Meituan Dianping operates two complimentary website businesses in China. Meituan.com is a group-discount website which sells vouchers from merchants for deals. Meituan.com generates most of its revenue from mobile application services. Dianping.com hosts consumer reviews of restaurants, and also offers group buying.

Adjusted 'Net Profit after Tax' for YUMC attributable to shareholders is as follows:

HY2019 Revenue: $1,048m
HY2019 NPAT: $553m - $139m -$27m -$14m = $373m
HY2019 eps: $373m/ 394m = 94.7c
Exchange Rate 31-07-2019: USD1 = 6.885yuan

HY2018 Revenue: $1,092m
HY2018 NPAT: $606m - $160m - $15m = $431m
HY2018 eps: $431m/ 377m = $1.14
Exchange Rate 31-07-2018: USD1 = 6.813yuan

Against the underlying growth narrative, core earnings are down. That is still the case, even if we add in the Meituan Dianping shareholding gain.

$27m/ 394m = an incremental 6.9c for HY2019.

We know that extra $27m of investment capital gain was not planned for, because YUMC management do not go about guessing the short term performance, as reflected by markets, of their long term investments. So this earnings drop is not consistent with the stated plan of growing earnings over FY2019 as referenced below.

From

https://www.fool.com/investing/2019/...high-note.aspx

"Management still thinks it can grow overall sales in high single digits and operating profits by double digits."

One thing management cannot control is the relationship between the US Dollar (the reporting currency for YUMC) and the Chinese Yuan (the function currency of YUMC). Yet if we translate the revenue figures into yuan:

HY2019 Revenue: 7,215m yuan
HY2018 Revenue: 7,340m yuan

there is still no growth.

At EOFY2018, YUMC was looking to open 600-650 new restaurants in the FY2019 financial year.
At EOHY2019 this target has been upped to 800-850 units, with the majority of the incremental new units coming from KFC and the new inclusion of COFFii & JOY.

Special opening promotions for new stores can affect profits in the short term. In addition, bringing forward store remodelling can have a profound negative effect on operating profit and sales, during the period of refurbishment.

During FY2018 and into FY2019 the overall Chinese economy slowed. Yet digital ordering and increased delivery options are key areas of focus to cater to the busy Chinese diner. Digital and delivery initiatives have helped keep costs in check over the year.

Snoopy..

How's that CoronaVirus doing to YumChina? It's ok i'll post the new for you:

https://edition.cnn.com/2020/02/05/b...rus/index.html

"Yum China, which operates KFC, Taco Bell and Pizza Hut in the country, warned that the deadly coronavirus will hurt its business this year. "As a result of the outbreak, the company may experience operating losses for the first quarter of 2020," the company said in a statement discussing 2019 financial results."

Are you buying more?

Quote:

---

Originally Posted by SBQ

Snoopy..

How's that CoronaVirus doing to YumChina? It's ok i'll post the new for you:

https://edition.cnn.com/2020/02/05/b...rus/index.html

"Yum China, which operates KFC, Taco Bell and Pizza Hut in the country, warned that the deadly coronavirus will hurt its business this year. "As a result of the outbreak, the company may experience operating losses for the first quarter of 2020," the company said in a statement discussing 2019 financial results."

Are you buying more?

---

Share price closed at $42.71 down over a dollar almost exactly line ball with a year ago! Not great news but hardly a collapse. Google is showing a PE of 23. I have a decent helping of these so not going out of my way to buy more. However, after problems trying to cash my US dividend cheques in NZ I have joined the YUMC Dividend Reinvestment Plan. So the answer to your question is 'yes' as a result of that. I am not buying in a significant way though.

SNOOPY

Quote:

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Originally Posted by Snoopy

Share price closed at $42.71 down over a dollar almost exactly line ball with a year ago! Not great news but hardly a collapse. Google is showing a PE of 23. I have a decent helping of these so not going out of my way to buy more. However, after problems trying to cash my US dividend cheques in NZ I have joined the YUMC Dividend Reinvestment Plan. So the answer to your question is 'yes' as a result of that. I am not buying in a significant way though.

SNOOPY

---

Have had similar problems with all foreign cheques recently. Now only invest in overseas stocks that have a dividend reinvestment plan, as otherwise the hassle is just too much.

With my Australian shares I go for drp where avaliable.Cheques go into my Craigs Australian cash management a/c.I do have a lot of problems with the companies that no longer issue cheques.Usually takes 3 or 4 emails and often a phone call before they get the right numbers for my NZ bank a/c.Takes about a month.Those companies I am selling out of, because I can't be bothered with the hassles.
With my recent UK investment I have the shares in Craigs' Custodial a/c to save problems.

From the Forager funds International shares fund January report.

"Unsurprisingly the quarantine measures are hurting our investment in Yum China (NYSE:YUMC), the owner of KFC and Pizza Hut stores in China. More than 30% of their restaurants have been temporarily closed. For those open, sales per store have halved versus the prior comparable period. It’s a painful and substantial test of the business and management, at the very least temporarily. Having first opened in China in 1987, Yum China has built scale and processes that have been able to absorb shocks. The SARS outbreak in 2003 is a case in point. Revenues have grown ten-fold since. There have been food safety incidents that forced a rejigging of supply chain processes. More recently, the company has navigated through the rapid spike in food cost caused by the African Swine Flu. But this is clearly the biggest test yet. Prior to the emergence of the virus, the recent fourth quarter result was strong, beating market expectations for the ninth consecutive quarter. The company has executed well on factors within its control—growing its store network, improving its digital strategy and launching several new menu offerings. In a year where food costs were rising, the company still managed to expand margins. The balance sheet is strong, with more than US$1.6bn in cash and no debt. Few competitors have such meaningful ‘rainy day’ reserves. This should see Yum China through the current challenges. "

Any idea why this hasn't dropped much?

Quote:

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Originally Posted by Arthur

Any idea why this hasn't dropped much?

---

This is a surprise to me as well Arthur. I don't know the answer, but I can offer the following observations:

1/ YUMC is very will capitalised (no term debt), so is well placed to ride out any short term downturn. The strength of the underlying business model has not changed.
2/ YUMC is fundamentally a domestic company with most food ingredients grown and supplied from within China. So there is unlikely to be any shortage of product for sale from international trade restrictions.
3/ People still have to eat and one of YUMC's very strong points of difference is food hygiene standards. By that I mean they have a standard (not that it is necessarily world class by western standards) whereas most local food restaurant businesses have no quality control standard at all. This means local people may be more inclined to eat at a YUMC restaurant than 'Chin's Diner'.

SNOOPY

Quote:

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Originally Posted by PLYNCH

From the Forager funds International shares fund January report.

"Unsurprisingly the quarantine measures are hurting our investment in Yum China (NYSE:YUMC), the owner of KFC and Pizza Hut stores in China. More than 30% of their restaurants have been temporarily closed. For those open, sales per store have halved versus the prior comparable period. It’s a painful and substantial test of the business and management, at the very least temporarily."

---

It was good to hear YUMC CEO Joey Wat, on the RNZ airwaves this morning. She said that every YUMC customer was given a ticket with the name and temperature of the person who served them on it. When the order was delivered, a similar ticket was added for the delivery person. This provides confidence and traceability for their customers.

More information on what YUMC are doing with their COVID-19 risk control program can be found here.

http://ir.yumchina.com/news-releases...ht-coronavirus

"Since January 30th, the KFC and Pizza Hut brands in China have rolled out contactless delivery services nationwide and contactless in store pick-up services at selected locations in China. These services help reduce the risk of person-to-person transmission of the coronavirus and have been well received by customers."

An unlikely growth opportunity has opened up in the area of corporate meals

"helping employers to offer healthy and reliable dining options to their staff."

YUMC have been helping health workers too.

"Since January 27, the KFC and Pizza Hut brands have been providing up to 1,500 free meals every day to medical workers in hospitals across Wuhan. The initiative has since been expanded, resulting in the delivery of over 70,000 free meals to nearly 500 hospitals and community health centres across mainland China."

Then there is a picture of a full body suited medical worker carrying in three buckets of healthy KFC into the hospital - classic!

SNOOPY

Investors are diving into consumer staples now.

https://finance.yahoo.com/news/yum-c...015400397.html

Quote:

---

Originally Posted by Snoopy

I can offer the following observations:

1/ YUMC is very will capitalised (no term debt), so is well placed to ride out any short term downturn. The strength of the underlying business model has not changed.
2/ YUMC is fundamentally a domestic company with most food ingredients grown and supplied from within China. So there is unlikely to be any shortage of product for sale from international trade restrictions.
3/ People still have to eat and one of YUMC's very strong points of difference is food hygiene standards. By that I mean they have a standard (not that it is necessarily world class by western standards) whereas most local food restaurant businesses have no quality control standard at all. This means local people may be more inclined to eat at a YUMC restaurant than 'Chin's Diner'.

---

Quote:

---

Originally Posted by Valuegrowth

https://finance.yahoo.com/news/yum-c...015400397.html

---

So VG, you have posted a link which is a regurgitation of a link I posted nine days earlier? I am not quite sure the point you are thinking readers should deduce from this, since your post did not contain your own take on this matter.

What I can say is that whether you consider YUMC is a 'consumer staple' or not (I am not clear on this point), it has been a good place to hide from 'market turmoil' over the last month. As I write this, the YUMC share price is still higher than it was a month ago ($42.41 on 10th February to $43.92 today, a gain of 3.6%) and there is an exchange rate gain for NZ based holders as well ($NZ1 = $US64 at start of period vs $NZ1 = $US63, a gain of 1.6%). Over the same period the DOW (note YUMC is NYSE listed) has declined from 29,276 to 23,851, a drop of more than 18%.

I didn't pick any of this in advance, although my subsequent 'observations', quoted above, may explain what happened 'with the benefit of hindsight'. This is one reason that I prefer to have a few global investments that are not available on the NZX so that I can participate in markets and sectors that are not easily accessible here. One could argue that ATM is an equivalent 'local opportunity' to gain exposure to the consumer food market in China. The ATM share price has risen from $NZ15.75 to $NZ16.10 over the same period, a gain of 2.2%. So ATM has underperformed YUMC over the last month. The historical PE ratio of ATM is now 37 verses only 24 for YUMC. There are other similarities like both companies having no term debt. I like both companies, but the value proposition of YUMC is clearly superior. So YUMC is where my 'China market' money will be staying.

SNOOPY

Sorry I have posted it by mistake instead of other link. I found somewhere Yum China has been recognized as one of the world's most innovative companies for 2020, and is one of only a few restaurant holding companies in the world to be included. Its innovation is the major force behind Yum China's growth strategy. With this coronavirus drama, I believe there will be some great opportunities.

Quote:

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Originally Posted by Snoopy

I had to do a rush job of the 2018 results before the FY2018 Annual Report was released. That was to facilitate a comparison with 'Restaurant Brands' immediately post the 75% takeover offer from 'Finaccess'. Now that I have the actual YUMC report in my 'hot little paws', I can produce the 'definitive audited version' of these accounts.

Re-reading the accounts I notice something odd. 'Other Income' appears to have been subtracted from 'Operating Expenses' (AR2018 Form 10-k, p56). The 'Operating Expenses' that are used to calculate 'Operating Profit' ...

-------------

To use the terminology in the Annual Report

"Total Revenues" (p62) - "Total Cost & Expenses net" (p56) = "Operating Profit" (p62)

-------------

...have already been adjusted for! 'Minority Owned Equity Accounted Profit', 'the Wuxi KFC equity revaluation', 'Insurance payouts', 'Provision reversal for Aircraft Sales losses' and 'Foreign Currency Adjustments' etc. etc. have all been dealt with. Yet 'Decreasing Expenses' has the same effect as 'Increasing Profits'. So I still need to subtract 'Other Income' from 'Operating Income' to produce a 'Normalised Operating Income' with three exceptions.

1/'Other Income' does include equity accounted income, and I feel that should be included in the Normalised result. These equity accounted but unconsolidated affiliates are largely minority owned KFC restaurants. So I think it is appropriate not to 'subtract again' the equity accounted income component of 'Other Income', when I finally create my 'Normalised Operating Profit'. To give some idea of the scale of these profits, I have listed them below.

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018
Equity Income from Unconsolidated Affiliates	$26m	$30m	$41m	$54m	$65m	$65m

2/ 'Other Income' also includes 'Foreign Exchange Net Loss or Gains'. These losses or gains are generally on contractual arrangements not taken out as a form of money speculation. They are the result of money market events not foreseeable when the underlying contract was taken out. Consequently they should remain removed when considering normalised profits. To give some idea of the scale of these foreign exchange gains or losses , I have listed them below.

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018
Foreign Exchange Gains or (Losses)	($1m)	($4m)	($5m)	($3m)	$0m	($11m)

3/ The FY2016 result has been corrected to account for the fact that had the separation occurred prior to the actual October 2016 separation date, then there would have been an extra franchise fee due to the parent YUM Brands. However, since we are now interested in 'Yum China' as a separate entity this correction is realistic and the extra charge should not be removed.

				FY2016
Incremental adjustment to YUM licence fee expense				$17m

My 'Normalised Profit' calculation table appears below:

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018
Operating Profit (excluding Impairments (1))	$384m	$354m	$488m	$640m	$785m	$941m
less Poultry Supply Lost: Insurance Recovery		($25m)	($5m)	($3m)
add Provision for Losses on Aircraft sales			$15m
less Reversal of Aircraft Sale Provision				($2m)
less Business Combination Contingency Reversal					($3m)
less Equity Gain Consolidating Wuxi						($98m)
add Daojia Intangible Write Off						$12m
add Interest Earned	$5m	$14m	$8m	$11m	$25m	$36m
Equals Adjusted Normalised EBT	$389m	$343m	$506m	$646m	$807m	$891m
subtract Tax at 27% (2)	($105m)	($93m)	($137m)	($174m)	($218m)	($241m)
subtract Foreign unrepatriated earnings Tax (3)						($16m)
Equals Adjusted Normalised NPAT {A}	$284m	$250m	$369m	$472m	$589m	$634m
Shares on Issue EOFY {B}	363.758m	363.758m	363.758m	383.344m	388.860m	392m
eps {A}/{B} equals {C}	78.1c	68.7c	$1.01	$1.23	$1.51	$1.62
Share Price 31 March (following) {D}	NA	NA	NA	$27.20	$41.50	$44.91
PE Ratio (D)/(C)	NA	NA	NA	22.1	27.5	27.7

Notes

1/ Significant impairment write offs for the 'Little Sheep' casual dining concept occurred in 2013 and 2014. YUMC own the intellectual property of the 'Little Sheep' brand. 'Little Sheep' had its foundation in Inner Mongolia, China. It specialises in 'Hot Pot' cooking popular in in China, especially in the winter months. 'Little Sheep' has more than 280 restaurants operating. A wholly-owned business that sells seasoning to retail customers is part of the 'Little Sheep' operation. But total turnover at 'Little Sheep' was less than 1.5% of the turnover of YUMC.

2/ The US corporate tax rate up to 31st December 2017, for the last few years, has been 35%. Looking at Note 17 on Income Tax in AR2017, the actual tax paid by YUMC on operations has been less than this. For the years 2017, 2016 the 'Statutory rate differential attributable to foreign operations' was 8.4% and 7.5%. I have rounded this off to 8%, subtracted the 8% from the 35% US statutory rate and come up with 27%. This is still above the 25% Chinese Corporate Income tax rate, and I cannot explain the difference. Over FY2018, The US corporate tax rate reduced to 21%, Now that is 4 percentage points below the Chinese corporate tax rate. However if we look at the 'Consolidated and Combined Results of Operations' (p62 AR2018), after adjusting for 'Special Items', the actual corporate tax rate comes out at 27%.

3/ The 'deemed repatriation of accumulated and distributed foreign earnings' tax saw a provision of $164m made in the YUMC accounts for FY2017. After further consideration in FY2018, this provision was adjusted down by $36m to a total of $128m. But this tax bill is to be spread out over eight years (AR2017, p76). Because it is in integral part of the Trump tax reforms, I do not feel that it should be recorded as a one off. Therefore I am recording a $16m charge every year from 2018 to 2025 inclusive.


Conclusion: Pass Test

---

I have the 2019 YUMC report in my 'hot little paws'. So time to update the 'earnings per share' trend. Re-reading the accounts I notice something odd. 'Other Income' has been subtracted from 'Operating Expenses' (AR2019 Form 10-k, p55).

These are the same 'Operating Expenses' that are used as a key component in the calculation of 'Operating Profit' (AR2019 Form 10-k, p55)....

---------------

To use the terminology in the Annual Report

"Operating Profit" ($901m, p55,p60) = "Total Revenues" ($8,776m, p55,p60) - "Total Cost & Expenses net (that means Other Income already subtracted from expenses)" ($7,875m, p55)

----------------

'Other Income' has been recorded as a 'negative expense', which includes a series of 'one offs' not reflective of normal trading:

1/ 'Minority Owned Equity Accounted Profit', (Note 6, AR2019; Note 7 AR2016-AR2018)
2/ 'the Wuxi KFC equity revaluation', (Note 7, AR2018)
3/ 'Insurance payouts', (Note 7, AR2016)
4/ 'Provision reversal for Aircraft Sales losses' (Note 7, AR2016) and
5/ 'Foreign Currency Adjustments' (Note 6, AR2019; Note 7 AR2016-AR2018) etc. etc.

These one off and/or non-operational adjustments have all been dealt with. Yet 'Decreasing Expenses' has the same effect as 'Increasing Profits'. This means, in general, I do need to subtract 'Other Income' from 'Operating Income' to produce a 'Normalised Operating Income'.

But there are three exceptions.

1/'Other Income' does include equity accounted income, and I feel that should be included in the Normalised result. These equity accounted -but unconsolidated- affiliates are largely minority owned KFC restaurants. So I think it is appropriate not to subtract the equity accounted income component of 'Other Income', when I finally create my 'Normalised Operating Profit'. To give some idea of the scale of these profits, I have listed them below.

	FY2015	FY2016	FY2017	FY2018	FY2019
Equity Income from Unconsolidated Affiliates	$41m	$54m	$65m	$65m	$69m
Unconsolidated Affiliates %ge of Adjusted Normalised EBT	8.1%	8.4%	8.1%	7.3%	7.3%
Reference	AR2016 Note7	AR Note 7	AR Note 7	AR Note 7	AR Note 6

2/ 'Other Income' also includes 'Foreign Exchange Net Loss or Gains'. These losses or gains are generally on contractual arrangements not taken out as a form of money speculation. They are the result of money market events not foreseeable when the underlying contract was taken out. Consequently they should remain removed when considering normalised profits. To give some idea of the scale of these foreign exchange gains or losses , I have listed them below.

	FY2015	FY2016	FY2017	FY2018	FY2019
Foreign Exchange Gains or (Losses)	($5m)	($3m)	$0m	($11m)	($9m)
Reference	AR2016 Note7	AR Note 7	AR Note 7	AR Note 7	AR Note 6

3/ The FY2016 result has been corrected to account for the fact that had the separation occurred prior to the actual October 2016 separation date, then there would have been an extra franchise fee due to the parent YUM Brands. However, since we are now interested in 'Yum China' as a separate entity this correction is realistic and the extra franchise fee charge should not be removed.

				FY2016
Incremental adjustment to YUM licence fee expense				$17m

My 'Normalised Profit' calculation table appears below:

	FY2015	FY2016	FY2017	FY2018	FY2019	Reference
Operating Profit	$488m	$640m	$785m	$941m	$901m	Consolidated and Combined Statements of Income Data
less Poultry Supply Lost: Insurance Recovery	($5m)	($3m)				AR2016 Note 7 'Other Income'
add Provision for Losses on Aircraft sales	$15m					AR2016 Note 7 'Other Income'
less Reversal of Aircraft Sale Provision		($2m)				AR2016 Note 7 'Other Income'
less Business Combination Contingency Reversal			($3m)			AR2017 Note 7 'Other Income'
less Equity Gain Consolidating Wuxi				($98m)		AR2018 Note 7 'Other Income'
add Daojia Intangible Write Off				$12m	$11m	AR2019 p27, p61
add Interest Earned (net)	$8m	$11m	$25m	$36m	$39m	Consolidated Statement of Income
Equals Adjusted Normalised EBT	$506m	$646m	$807m	$891m	$951m
subtract Tax at 27% /26% (1)	($137m)	($174m)	($218m)	($241m)	($247m)
subtract Foreign unrepatriated earnings Tax (2)				($17m)	($17m)
Equals Adjusted Normalised NPAT {A}	$369m	$472m	$589m	$633m	$687m
Shares on Issue EOFY {B}	363.758m	383.344m	388.860m	392m	395m
eps {A}/{B} equals {C}	$1.01	$1.23	$1.51	$1.61	$1.74
Share Price 31 March (following) {D}	NA	$27.20	$41.50	$44.91	$42.63
PE Ratio (D)/(C)	NA	22.1	27.5	27.9	24.5

Notes

1/ The US corporate tax rate up to 31st December 2017, for the previous few years, had been 35%. Looking at Note 17 on Income Tax in AR2017, the actual tax paid by YUMC on operations has been less than this. For the years 2017, 2016 the 'Statutory rate differential attributable to foreign operations' was 8.4% and 7.5%. I have rounded this off to 8%, subtracted the 8% from the 35% US statutory rate and come up with 27%. This is still above the 25% Chinese Corporate Income tax rate. The difference is explained under the 'Income taxes' note (Note 16 AR2019, Note 17 AR2018).

Over FY2018, The US corporate tax rate reduced to 21%, Now that is 4 percentage points below the Chinese corporate tax rate. However if we look at the 'Consolidated and Combined Results of Operations' (p62,63 AR2018), after adjusting for 'Special Items', the actual corporate tax rate comes out at 27%.

For FY2019 I have used the 'Statutory rate differential attributable to foreign operations' of 5.3%, added to the US Federal Statutory rate of 21% to obtain a 'round figure' tax rate of 26%. This figure does not include extra tax from 'Foreign repatriated earnings'.

2/ The 'deemed repatriation of accumulated and distributed foreign earnings' tax saw a provision of $164m made in the YUMC accounts for FY2017. After further consideration in FY2018, this provision was adjusted down by $36m to a total of $128m. The IRS released the final transition tax regulations in Q1 2019. This resulted in an additional $8m in transition tax expense being required (AR2019 p62). The final transition tax bill, now $136m, is to be spread out over eight years (AR2017, p76). Because it is in integral part of the Trump tax reforms, I do not feel that it should be recorded as a one off. Therefore I am recording a $136m/8=$17m charge every year from 2018 to 2025 inclusive.

3/ In September 2018 YUMC made a $74m investment in a Hong Kong Stock Exchange floated e-commerce platform for services in China, 'Meituan' (AR2019 p107). YUMC bought 8 million 'Meituan' shares, or less than 1% of the shares on issue. The fair value of YUMC's stake is determined by the closing market price at the end of each reporting period. Gains or losses each year flow through to YUMC's accounts. These gains and losses are not reflected in 'normalised earnings', because they are recorded as gains or losses under the heading 'Investment Gain (Loss)' which falls outside of this envelope (AR2019 p55).

Conclusion: Pass Test

SNOOPY

Quote:

---

Originally Posted by Snoopy

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018
Adjusted Normalised NPAT {A}	$284m	$250m	$369m	$472m	$589m	$634m
Shareholder Equity EOFY {B}	$2,344m	$1,945m	$1.979m	$2,443m	$2,859m	$2,976m
ROE {A}/{B}	12.1%	12.9%	18.6%	19.3%	20.6%	21.3%

Conclusion: Pass Test

---

	FY2015	FY2016	FY2017	FY2018	FY2019
Adjusted Normalised NPAT {A}	$369m	$472m	$589m	$633m	$687m
Shareholder Equity EOFY {B}	$1.979m	$2,443m	$2,859m	$2,976m	$3,175m
ROE {A}/{B}	18.6%	19.3%	20.6%	21.3%	21.6%

Conclusion: Pass Test

SNOOPY

Quote:

---

Originally Posted by Snoopy

There has been a change in the definition of 'Revenue' for FY2018. There are two additional categories being:

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018
Adjusted Normalised NPAT {A}	$284m	$250m	$369m	$472m	$589m	$634m
Revenue {B}	$6,905m	$6,934m	$6.909m	$6,752m	$7,144m	$7,774m
Net Profit Margin {A}/{B}	4.11%	3.66%	5.38%	7.02%	8.27%	8.16%

1/ 'Revenues from transactions with franchisees and unconsolidated affiliates'. YUMC operates a central procurement model. The company purchases centrally from suppliers all food and paper products, then on sells and delivers those to all restaurants, including franchisees and unconsolidated affiliates.
2/ 'Other Revenues': Primarily includes revenue generated from YUMC's mobile e-commerce platform

To preserve any statistical comparative worth with previous years, I have not added in these two additional revenue categories.

Inflation in China is around 2%. The smallest gain in margin (we are leaving out the drop in FY2018) has been from FY2016 to FY2017. 2% of 7.02% (margin for FY2016) is 0.14 percentage points. That means as long as the FY2017 margin is greater than 7.02% + 0.14% = 7.16%, then our requirement is satisfied. The actual margin is 8.27%, so our requirement is met, and has been met over the FY2017/FY2016, FY2016/FY2015 and FY2015/FY2014 'year on year' comparisons. The decrease in margin over the latest year does not invalidate this company's ability to increase margins for an extended period over the last five years.

Conclusion: Pass Test

---

	FY2015	FY2016	FY2017	FY2018	FY2019
Adjusted Normalised NPAT {A}	$369m	$472m	$589m	$633m	$687m
Revenue {B}	$7,233m	$7,075m	$7,769m	$8,415m	$8,776m
Net Profit Margin {A}/{B}	5.10%	6.67%	7.58%	7.52%	7.83%
Inflation rate for China	1.4%	2.0%	1.6%	2.1%	2.9%

If you compare this table with my previous year's work, you will see that I have altered the definition of 'revenue' for all years to the updated way that YUMC looks at things today. 'Revenue' now includes:

1/ Normal company sales.
2/ Franchise fees and income.
3/ Revenues from transactions with franchisees and unconsolidated affiliates.
4/ Other revenues.

I grabbed the CPI inflation rate for China from here:

https://www.focus-economics.com/coun...hina/inflation

Inflation in China is generally subdued and profit margins are not being eroded (FY2018 excepted) as inflation rises.

Conclusion: Pass Test

SNOOPY

Quote:

---

Originally Posted by Snoopy

No change from my preliminary analysis. Each of the four Buffett screenings tests have been confirmed as passed. Some of the changes made between the 'Estimated 2018 results' and 'Audited 2018 Results' are because figures that I have had to estimate have now been altered. Other changes have been made because I have changed my mind on what I consider to be 'normalized earnings'. But the net result is that all the Buffett targets are still met.

There is one more hurdle to pass before we get to sit at the Buffett growth model table. ROE can be contrived to be higher than intrinsic, if a company has a very high level of debt.

It is now time to look at a 'term debt' test. ROE can be manipulated higher by taking on more debt. We need to check that YUMC is not over leveraged.

Total borrowing facilities are listed to be "Approximately $US418m." (from AR2018 p75), This consists of Chinese credit facilities totaling $218m, which should be added to $200m of outside credit facilities in aggregate. I further note that "As of December 31, 2018, the full amount of borrowings were available under each facility." I took that to mean that, despite these facilities being negotiated, nothing had yet been drawn down. There is no term debt listed on the balance sheet for FY2019. So that is consistent with my interpretation.

If there is no bank debt, then we can't be worried about the repayment of something that doesn't exist. So it is time to take our seat at the 'Buffett Growth Model' table.

---

There hasn't been sufficient change in the Chinese market to revise by 'Buffett Test 1' post, the second on this thread. I have revised the second third and fouth Buffett tests over the last few days. Suffice to say the company passes all of these tests over FY2019, as was the case last year. However, I do note that FY2019 ended on 31st December 2019. So these results do not cover the Covid-19 period. The FY2020 annual report has not been released, although if you judge by the share price, up around 40% for the year, the company has recovered well.

There is one more hurdle to pass before we get to sit at the Buffett growth model table. High ROE can be contrived to be higher than intrinsic, if a company has a very high level of debt.

It is now time to look at a 'term debt' test. ROE can be manipulated higher by taking on more debt. We need to check that YUMC is not over leveraged.

Total borrowing facilities are listed to be "Approximately $US415m." (from AR2019 p72), This consists of Chinese credit facilities totalling $215m, which should be added to $200m of outside credit facilities in aggregate. I further note that "As of December 31, 2019, there were no borrowings outstanding" under each facility." I took that to mean that, despite these facilities being negotiated, nothing had yet been drawn down. There is no term debt listed on the balance sheet for FY2019. So that is consistent with my interpretation.

If there is no bank debt, then we can't be worried about the repayment of something that doesn't exist. So it is time to, once again, take our seat at the 'Buffett Growth Model' table.

SNOOPY

Quote:

---

Originally Posted by Snoopy

Continuing to quote from the listing prospectus:

"The development and growth of our business has benefited from China's rapidly growing middle class and increasing urbanization. The size of the middle class is expected to continue to grow significantly. According to a 2012 McKinsey study, between 2002 and 2022, the number of middle class and affluent households is expected to increase by 283 million. A significant portion of this growth will be driven by upper middle class households, which are expected to increase from 2% of total households in 2002 to 54% by 2022, or an increase of 188 million households. The Company will continue to focus on this core consumer segment and on serving China's growing middle class."

What the McKinsey report says about the distribution of middle class households is equally interesting:

"According to the McKinsey study referenced above, in 2002 87% of the middle class lived in coastal China and only 13% of the middle class lived in inland provinces. By 2022 it is expected that only 61% of the middle class will live in coastal cities as the middle class expands more rapidly in inland cities. Likewise, according to the same study, by 2022 it is expected that 39% of the middle class will live in cities with a population of more than one million."

The response from Yum China, is to target new trade zones and build more new restaurants further inland. This includes targeting those 'small' (sic) cities with a population of 'only a million'.

There are interesting parallels with the development of quick service restaurants in China, and China's milk market.

https://www.theguardian.com/environm...hirst-for-milk

---

The battle that YUMC has had in managing their Covid-19 response in China, provides an interesting insight into what happened with consumer food markets in general over FY2020 in China. The following are quotes from the three quarterly reports form FY2020 issued to date.

--------------------------

Q1 2020

First quarter operations were significantly affected by the outbreak. Working closely with local health authorities to safeguard the public, the Company began temporary store closures in late January where appropriate. Approximately 35% of stores were closed by mid-February at the peak of the outbreak, with significant regional differences. As of the date of this release (28-04-2020), approximately 99% of stores in China are either partially or fully open.

For restaurants that remained open, same-store sales declined due to shortened operating hours and reduced traffic, with a significant portion of stores providing only delivery and takeaway services. Our results were strong for the first three weeks of January, but then the outbreak led to subsequent same-store sales declines of 40-50% compared to the comparable Chinese New Year holiday period in 2019. As the first quarter progressed, sales performance recovered gradually, with same-store sales down approximately 20% in late March. The pace of recovery is uneven with recent sales and traffic still below pre-outbreak levels as people continue to avoid going out and practice social distancing. Same-stores sales were still down by more than 10% month-to-date.

Yum China pioneered contactless delivery and contactless takeaway in late January to enhance preventative health measures. Those services proved popular with customers and have supported the businesses during this period of reduced dine-in traffic.

Q2 2020

Sales improved sequentially in April and May but softened in June. Sales were primarily impacted by significantly reduced traffic at transportation and tourist locations, delayed and shortened school holidays and resurging regional infections. These factors and the lingering effect of COVID-19 continue to impact operations in July.

The unevenness in recovery was most pronounced in the differences between regions and trade zones. Eastern China recovered faster than other regions. Northern China's recovery was notably slower, primarily due to more stringent public health measures. Transportation and tourist locations, which accounted for high single digits of sales, continue to experience significant year over year traffic declines. The pace of recovery also varies across days of the week. Weekdays recovered the fastest as people returned to work and school, followed by weekends, with holidays lagging behind.

Q3 FY2020

Third quarter operations improved, although still impacted by reduced traffic at transportation and tourist locations, the delayed and shortened school holiday and the other lingering effects of the COVID-19 outbreak. Dine-in volume has been recovering, while delivery and takeaway remained popular options. The Company's primary focus continues to be safety, efficiency and driving traffic. We launched attractive digital and membership campaigns with strong value propositions to drive sales recovery.

Q4 FY2020

Fourth quarter operations improved sequentially from the third quarter. The Company's primary focus continues to be safety, efficiency and sales recovery. To counter the pandemic impact, we ran strong value and digital campaigns to drive traffic. Delivery and takeaway remained popular, while dine-in recovered sequentially. Proactive cost structure realignment, productivity improvements and one-off cost savings helped us achieve year-over-year expansion of restaurant margins and operating profit. However, the pace of recovery was uneven and non-linear, impacted by regional resurgences of COVID-19 in Qingdao, Xinjiang, Beijing, Dalian and elsewhere. October sales benefited from the National Day long holiday, but November and December sales were pressured by the regional outbreaks. Traffic at transportation hubs remained significantly below the prior year due to reduced travel.

------------------

The latest Chinese Covid-19 outbreak (24th January 2021 report) is in the Hebei province, just outside of Beijing. The provincial capital Shijiazhung and the city of Xingtai, which encompasses Nangong, have been largely sealed off from the rest of the country. Community isolation and large-scale testing have also been enforced.

Nearby Beijing, where around 2 million residents have been ordered to undergo new testing, and has reported two new confirmed cases. This is potentially serious for consumer confidence in 'Northern China'.

SNOOPY

Quote:

---

Originally Posted by Snoopy

The objective of the Buffett growth model is to sum the gains of dividends and capital appreciation over an extended period, and calculate a compounding rate of annual return taking into account all tax liabilities incurred on the way.

-----------------------

The Buffett growth model operates by:

1/ Starting with shareholder equity at the start of Year 1,
2/ Working out a projected return on this equity using an averaged return on this equity from previous years.
3/ Apportioning this return between dividends, share buybacks and what remains to be reinvested within the company. Note: New Capital raised outside of normal operations during the year must be taken into account!
4/ Recycling any retained earnings into subsequent year shareholder equity. Then using this new Shareholder equity total as the earnings base for the subsequent year. The subsequent year becomes the new starting point for this process to repeat. Go back to step 1.

---------------------

YUMC is an 'overseas share', caught by NZ's FIF tax regime. FIF tax is paid on 5% of the opening balance of each share owned. At a tax rate of 30%, this works out at:

0.3 x 0.05 = 0.015, or 1.5% of the opening balance total, payable each year (actually FIF tax is charged on a whole of portfolio basis. But for the purpose of this exercise, we shall assume the entire FIF portfolio consists of YUMC shares only) For NZers, this FIF tax has to be separately accounted for in this calculation each year, and summed over the study period.

We are looking at a study period, ten years into the future. The amount that must be paid for this FIF tax can be netted off against any overseas withholding tax paid on dividends. That is because, under the FIF regime, there is no separate tax on dividends. The withholding tax on dividends on NYSE listed YUMC and paid by YUMC on the investor's behalf is currently 15%.

Return On Shareholder Equity: Working Figure

Post 35 allows us to calculate an averaged five year ROE figure:

( 12.9% + 18.6% + 19.3% + 20.6% + 21.3% ) / 5 = 18.5%

Price Earnings Ratio: Working Figure

To value our share each year, we need to calculate an appropriate PE value to use. Despite operating for some thirty years, YUMC has only been separately listed for three. Using just three data points is not a very reliable way to calculate a representative average PE figure. This is particularly so when one of those figures was inflated by a since withdrawn takeover offer (Year 2017). I have taken 15% off the year 2017 PE figure to remove this takeover premium.

( 22.1 + 0.85x27.5 + 27.7 ) /3 = 24.4

The derivation of this PE figure has been calculated using a shallow data set. Nevertheless it is the best figure we can get, based on the possibly not representative three year sharemarket trading period we have to draw information from.

Dividends

Over FY2018 there have been four quarterly dividends declared: 10cps, 10cps, 10cps and 12 cps. The first half of FY2019 has seen two dividends of 12cps being declared, an annualized rate of 48cps. Given the growth path of the company, I am forecasting dividends for FY2021 to be 13cps, 13cps, 13cps and 13cps. Following an incremental pattern, I am going to model future dividend payments for the years in which we are studying to be as follows:

	Forecast Dividend
FY2018 (actual)	42cps
FY2019	48cps
FY2020	48cps
FY2021	52cps
FY2022	58cps
FY2023	64cps
FY2024	70cps
FY2025	76cps
FY2026	82cps
FY2027	88cps
FY2028	94cps

Share Buybacks

On 4th October 2017, the board increased the aggregate quantum of shares to be repurchased to $550m. As of the end of FY2018, the aggregate of share repurchases had reached $455m. That leaves $95m worth of shares still authorized to be bought back. Yet counter intuitively, the number of shares on issue continues to go up year on year. What is the explanation for this?

As stated in AR2018 p40:

"The company's executive compensation program consists of three primary pay components: (i) base salary, (ii) annual performance based cash bonuses or short term incentives and (iii) long term equity awards."

We learn on p121 of AR2018 that:

"Effective 31st October 2016, the company has reserved for issuance under the "Yum China Holdings Inc. Long Term Incentive Plan" 45 million shares of our common stock. Under this plan, the excise price of stock options and SARs (Stock Appreciation Rights) granted must be equal to or greater than the fair market value of the company's stock on the date of the grant"

Over the remainder of FY2016, 25.274m of these long term incentive plan rewards were issued as part of the demerger process, 0.5m more were granted and 0.456m were forfeited or expired (AR2016 p115). So by the end of FY2016 the net plan shares issued were:

25.274m + 0.500m - 0.456m = 25.318m

We can record the change in rights issued in subsequent years as follows:

Employee Options Authorised Remaining
	Total (start of period)	less Options Granted during year	add Options Cancelled during year	equals Remaining Options to be Authorised (end of period)
At 31st October 2016	45m	(25.274m)		19.726m
FY2016	19.726m	(0.500m)	0.456m	19,682m
FY2017	19.682m	(2.234m)	1.199m	18.647m
FY2018	18.647m	(1.179m)	0.611m	18.079m

In 'number of option' terms, this means there are plenty still available to be issued.

Options and SARs vest after three to five years and expire ten years after they were granted. Share based compensation is recognized in the "Consolidated and Combined Financial Statements" on a straight line basis over the service period based on their fair value on the date of the grant. When the options are redeemed, the company gets a cash injection based on the awarded price of the share options granted. But the employee gets to keep the difference between the price at the time the option was awarded and today's market price.

Again from p123 of AR2018, at the end of that year, 12.407m shares become exercisable at a weighted average excise price of $18.64. If all of these were exercised, this would represent a capital inflow to shareholders equity of:

12.407m x $18.64 = $231m

Actual new equity inflow over the FY2018 period from share based compensation was $24m (AR2018 p91). That is equivalent to 3m new ordinary shares created (AR2018 p91).

During FY2018 (AR2018 p124), the company repurchased 9.0m shares during FY2018 (total cost $312m) and $960m remains available for purchase under current authorization. This remaining to purchase balance is up from the $422m available for future purchases a year earlier (AR2017 p122). So there doesn't seem to be any problem increasing the buy back authorization if management see fit to do so.

$960m would buy back 24m shares at $40 each. 24m shares exceeds the employee compensation package new equity that could now be created at any time.

12.407m shares x $18.64 per share = $231m (Potential employee new equity contribution EOFY2018)

So now the number of shares that could be bought back outweigh the number of employee earned new shares that could be redeemed.

Nevertheless warrant agreements with two strategic investors (AR2018 p115) could see 7.309m plus 0.891m = 8.2m new shares issued before October 31st 2021. Since these wanrrants are well 'in the money' I expect this will happen in due course. So I don't see the number of shares in YUMC decreasing over the next few years, despite the on market share buybacks.

---

The objective of the Buffett growth model is to sum the gains of dividends and capital appreciation over an extended period, and calculate a compounding rate of annual return taking into account all tax liabilities incurred on the way.

-----------------------

The Buffett growth model operates by:

1/ Starting with shareholder equity at the start of Year 1,
2/ Working out a projected return on this equity using an averaged return on this equity from previous years.
3/ Apportioning this return between dividends, share buybacks and what remains to be reinvested within the company. Note: New Capital raised outside of normal operations during the year must be taken into account!
4/ Recycling any retained earnings into subsequent year shareholder equity. Then using this new Shareholder equity total as the earnings base for the subsequent year. The subsequent year becomes the new starting point for this process to repeat. Go Back to Step 1.

---------------------

Tax

YUMC is an 'overseas share', caught by NZ's FIF tax regime. FIF tax is paid on 5% of the opening balance of each taxpayer's FIF share portfolio owned at the start of each financial year (Fair Dividend Rate method). At a tax rate of 30%, this works out at:

0.3 x 0.05 = 0.015, or 1.5% of the opening balance total, payable each year (FIF tax is charged on a whole of portfolio basis. But for the purpose of this exercise, we shall assume the entire FIF portfolio consists of YUMC shares only) For NZ investors in YUMC, this FIF tax has to be separately accounted for in the spreadsheet calculation each year, and summed over the future forecast study period.

We are looking at a study period, ten years into the future. The amount that must be handed over to the IRD under this FIF tax regime can be netted off against any overseas withholding tax paid on dividends. That is because, under the FIF regime, there is no separate tax on dividends. The withholding tax on dividends on NYSE listed YUMC and paid by YUMC on the investor's behalf is currently 15%. However, as previously explained, this withholding tax is netted off against the FIF tax and does not directly come into the Buffett spreadsheet calculation that follows in the ensuing 'spreadsheet' post.

Return On Shareholder Equity: Working Figure

Post 64 allows us to calculate an averaged five year ROE figure:

( 18.6% + 19.3% + 20.6% + 21.3% + 21.6% ) / 5 = 20.3%

Price Earnings Ratio: Working Figure

To value our share each year, we need to calculate an appropriate PE value to use. Despite operating for some thirty years, YUMC has only been separately listed for four. Using just four data points is not a very reliable way to calculate a representative average PE figure. This is particularly so when one of those figures was inflated by a since withdrawn takeover offer (Year 2017). I have taken 15% off the year 2017 PE figure to remove this takeover premium.

( 22.1 + 0.85x27.5 + 27.9 + 24.5 ) /4 = 24.5

The derivation of this PE figure has been calculated using a shallow data set. Nevertheless it is the best figure we can get, based on the possibly not representative four year sharemarket trading period we have to draw information from.

Dividends

Over FY2018 there were four quarterly dividends paid: 10cps, 10cps, 10cps and 10 cps (the first of these was the fourth quarter dividend of FY2017, paid in the FY2018 year). FY2019 saw four quarterly dividends of 12cps being paid, an annualized rate of 48cps. Given the growth path of the company, I am forecasting dividends for FY2021 to be 13cps, 13cps, 13cps and 13cps. Following an incremental pattern, I am going to model future dividend payments for the years in which we are studying to be as follows:

	Forecast Dividend (AR2020 p120)
FY2018 (actual)	40cps
FY2019 (actual)	48cps
FY2020 (estimate)	48cps
FY2021	52cps
FY2022	58cps
FY2023	64cps
FY2024	70cps
FY2025	76cps
FY2026	82cps
FY2027	88cps
FY2028	94cps
FY2029	100cps

Share Buybacks

The board has authorised a quantum of shares to be repurchased, topping out at a total value of $1.4billion (AR2019 p53), including the latest approved authorisation on 31st October 2018. As of the end of FY2019, the aggregate of share repurchases for cash had reached $700m (AR2019 Form10k, Cashflow Statement, p87 summing three retrospective years). In numerical terms that adds up to, at least, a documented 9 million shares over three years (AR2017-AR2019 Form10k Item 5). In fact, the dollar amount, purchased as declared in the cashflow statements, would suggest that the actual number of shares bought back for all reasons was nearer 20 million. (This is confirmed on p120 of AR2019 Form 10k to be 6.2m + 9.0m + 3.4m = 18.6m.) There are still $700m worth of shares authorized to be bought back. Yet, counter intuitively, the number of shares on issue continues to go up year on year. What is the explanation for this?

Why do the number of YUMC shares seemingly keep increasing in spite of the share buyback?

There are at least a couple of reasons

1/ Exercise of Warrants As part of the YUMC demerger,

a/ a subsidiary of Primavera Capital - the Hong Kong based investment group - AND
b/ an affiliate of 'Zhejiang Ant Small and Micro Financial Services Group' ('Ant Financial')

were in combination issued warrants to purchase shares representing 4% of the YUMC share capital at the time of the separation agreement (AR2019 p48). This amounted to some:

0.04 x 364m = 14.5m shares

As of 31st December 2019 warrants to purchase 1.5 percentage points of the original 4 percentage point warrant offer had been exercised (AR2019 Form 10k p49). This has created.

0.015 x 364m = 5.5m new YUMC shares

Furthermore in the last quarter of FY2019, these investors entered into pre-paid forward sale transactions which obliges them to deliver a portion of their remaining warrants to third parties in the future. In the foreseeable future, this should result in yet more - 14.5m-5.5m=9.0m - new YUMC shares coming into existence.

2/ Exercise of Long Term Equity Awards As stated in the opening pages of AR2019 p41:

"The company's executive compensation program consists of three primary pay components: (i) base salary, (ii) annual performance based cash bonuses or short term incentives and (iii) long term equity awards."

We learn on p117 of AR2019 that:

"Effective 31st October 2016, the company has reserved for issuance under the 2016 "Yum China Holdings Inc. Long Term Incentive Plan" 45 million shares of our common stock. Under this plan, the excise price of stock options and SARs (Stock Appreciation Rights) granted must be equal to or greater than the fair market value of the company's stock on the date of the grant"

Over the remainder of FY2016, 25.274m of these long term incentive plan rewards were issued as part of the demerger process, 0.5m more were granted and 0.456m were forfeited or expired (AR2016 p115). So by the end of FY2016 the net Long Term Incentive Plan shares issued were:

25.274m + 0.500m - 0.456m = 25.318m

We can record the change in rights issued above, and equivalent changes in subsequent years, in a table as follows:

Employee Options Authorised Remaining
	Total (start of period)	less Options Granted during year	add Options Cancelled during year	equals Remaining Options to be Authorised (end of period)
At 31st October 2016	45m	(25.274m)		19.726m
FY2016	19.726m	(0.500m)	0.456m	19.682m
FY2017	19.682m	(2.234m)	1.199m	18.647m
FY2018	18.647m	(1.179m)	0.611m	18.079m
FY2019	18.079m	(1.469m)	0.532m	17.142m

In 'number of option' terms, this means there are plenty still available to be issued.

Options and SARs (Stock Appreciation Rights) vest after three to five years and expire ten years after they were granted. When and if options are redeemed, the company gets a cash injection based on the awarded price of the share options granted. But the employee gets to keep the difference between the price at the time the option was awarded and the market price on the day the options are exercised. The employee settlement payment is made in a dollar equivalent value of shares (AR2019 p61). Other shares based payments to NEOs (Named Executive Officers) are in the form of PSUs (Performance Stock Units) and RSUs (Restricted Stock Units). The latter are time based.

From the 'Share Based Compensation' Notes (p119 of AR2019) at the end of that year, 10.583m shares remained ultimately exercisable at a weighted average excise price of $20.92. Add that total to the options 17.142m yet to be issued and I get a maximum approved number of options that could possibly be redeemed to be 27.725m. If all of these 10.583m of stock options that exist now were to be exercised in the years FY2020 and beyond, this would represent a capital inflow to shareholders equity of:

10.583m shares x $20.92 per share = $221m (Potential employee new equity contribution following EOFY2019)

Actual new equity inflow over the FY2019 period from share based compensation was $26m (AR2019 p89). That is equivalent to $26m/$16.58 per share = 1.57m new ordinary shares created (AR2019 p119).

Employee Options Exercised
	Number of Options Exercised	times Weighted Average Excise Price	equals Option Supplied Capital
FY2016	0.590m	$9.90	$5.800m
FY2017	4.168m	$15.50	$64.600m
FY2018	4.493m	$15.12	$67.900m
FY2019	4.234m	$16.58	$70.200m
Total	13.485m		$208.50m

During FY2019 (AR2019 p120), the company repurchased 6.2m shares (total cost $261m). $699m remains available for purchase under current authorization. This remaining 'to purchase balance' is down from the $960m available for future purchases a year earlier (AR2018 p120).

$699m would buy back 11.7m shares at $60 each (the market price as I write this). 11.7m shares is now less than the employee compensation package related new equity (14.373m) that is eligible to ultimately be created (AR2019 p119).

14.373m shares x $24.22 per share = $348m (Potential eventual employee new equity contribution EOFY2019)

Right now the number of shares that could be bought back (11.7m) are near to balancing the number of employee earned 10.583m of new shares that could be redeemed right now (AR2019 119), and less than the number of employee earned shares that will likely ultimately be redeemed (14.373m).

Conclusion for a long and rambling discussion on Share Buybacks

So far I have looked at:

1/ What has documented to have happened AND
2/ What could happen in the future

regarding the changing number of YUMC shares, and the associated dollar amounts changing hands.

What might happen is speculative, in the sense that:

1/ the rate of buying back shares can change at any time, (ultimately it is entirely under the control of the board) AS CAN
2/ the number of shares issued to employees and investors (also under board control).

Nevertheless looking at what 'might happen' from existing declared positions does provide a window of where management think the number of shares will head. It is a window into current board headspace. However, for the purposes of this discussion, it is more important to look at what 'has happened'. That is why I have put 'in bold' figures relating to the actual change in the number of shares on issue since YUMC float time. The one sentence summary of the documented number of share changes is as follows:

Since the demerger,

1/ 18.6 million YUMC shares have been bought back AND
2/ 13.5 +5.5 = 19.0m new YUMC shares have been created.

That is a gain of 0.4m shares over the period since YUMC was separately quoted. By contrast, Balance Sheet disclosed information would suggest the number of shares has increased from 364m to 392m over the same period -a rise of 28m shares. There is no doubt that, despite the buybacks, the number of YUMC shares has gone up. But why the documented increase is only 0.4m, while the balance sheet information indicates the increase is 28m, is a discrepancy that I cannot satisfactorily explain. There is much talk in the annual report about 'basic earnings per share' and 'diluted earnings per share'. It is possible that 'diluted earnings' include options issued to employees and investors that have not yet been paid up, while excluding future share buybacks that have been authorised by the board but not yet actioned.

Whatever the actual reasoning behind the share numbers, there is irrefutable documentation that the number of YUMC shares is not decreasing over time. The total number of new shares issued

1/ in the form of warrants at float time AND
2/ employee performance incentives

exceeds those removed from circulation by the program of on market share buybacks.

SNOOPY

Quote:

---

Originally Posted by Snoopy

The dollar figures in the table below are all on a 'per share' basis.

Note: To compile the table below, I have assumed:

1/ An ROE figure of 18.5%
2/ A PE ratio of 24.4.
3/ A constant dollar amount of shares being bought back every year amounting to $128m.

YUMC has currently authorised share total buybacks up to a value of $1,400m (AR2018 p53,p124), of which a balance of $960m now remains for further buybacks. This is less than the $2,340m of buybacks I am modelling over the next ten years. However, the YUMC board has a record of increasing the buyback limit over the years. So I don't believe that my modelling is unrealistic. The actual number of shares the money buys back each year in my model is determined by the modelled share price.

4/ $59m of new shares being subscribed to, via the employee share scheme each year. These shares are assumed to be subscribed to at a redemption price of $18.64 each (AR2018 p123). This rate of subscription creates 3.165m new shares each year.

	Modelled No. Shares SOFY	Modelled Share Price SOFY {SP}	Equity SOFY	Net Income + Foreign Translation Gain {A}	Dividend Declared {B}	Share Buyback {C}	New Shares Subscribed + New Capital on Business Acquisitions {D}	New Retained Equity {A}+{B}+{C}+{D}	FIF Tax Liability {SP} x 0.015
2017	383.344m	$26.12	$6.37	$1.49	($0.16)	($0.33)	$0.09	$1.09
2018	388.860m	$40.02	$7.31	$1.48	($0.49)	($0.80)	$0.16	$0.35
2019	392m	$33.53	$7.59	$1.40	($0.48 +$0.08)	($0.33)	$0.15	$0.66	$0.50
2020	391.348m	$37.33	$8.26	$1.53	($0.52+$0.08)	($0.33)	$0.15	$0.75	$0.56
2021	391.085m	$40.75	$9.02	$1.67	($0.56+$0.08)	($0.33)	$0.15	$0.85	$0.61
2022	391.109m	$44.65	$9.87	$1.83	($0.60+$0.08)	($0.33)	$0.15	$0.97	$0.67
2023	391.407m	$48.80	$10.83	$2.00	($0.64+$0.08)	($0.33)	$0.15	$1.10	$0.73
2024	391.959m	$53.68	$11.91	$2.20	($0.68+$0.08)	($0.33)	$0.15	$1.26	$0.81
2025	392.739m	$59.29	$13.14	$2.43	($0.76+$0.08)	($0.33)	$0.15	$1.41	$0.89
2026	393.745m	$65.39	$14.51	$2.68	($0.84+$0.08)	($0.33)	$0.15	$1.58	$0.98
2027	394.913m	$72.47	$16.04	$2.97	($0.92+$0.08)	($0.32)	$0.15	$1.80	$1.09
2028	396.312m	$80.28	$17.78	$3.29	($1.00+$0.08)	($0.32)	$0.15	$2.04	$1.20
2029	397.973m	$89.06	$19.74	$3.65
Sum 2019 to 2028					($7.00)				$8.04

Question/ On 12th August 2019, the YUMC share price closed at $43.02. What is the expected 10 year compounding rate of return for a New Zealand investor if you bought that share today, assuming exchange rates remain constant? (note the dividend figure included in the calculation below is the proportion of the dividend due to ordinary shareholders, which now excludes the dividend paid to the controlling interests of YUMC minority owned businesses).

Answer/ 43.02 x (1+r)^10 = [ ($89.06+$7.00 - $8.04) ] => r = 0.074 = 7.4%

Question/ Warren Buffett likes to get a 15% compounding return on any share he invests in, What price would he need to pay for YUMC today to achieve that?

Answer/ P x (1.15)^10 = [ ($89.06+$7.00 - $8.04) ] => P = $21.76

Conclusion:

YumChina is a great company. But to purchase shares in it today would see you pay a high price. While a 7.4% after tax compounding return over ten years is OK, this is below the kind of return that Warren is seeking. I don't think Warren would be investing in YUMC, unless that acquisition price comes down.

---

The dollar figures in the table below are all on a 'per share' basis.

Note: To compile the table below, I have assumed:

1/ An ROE figure of 20.3%
2/ A PE ratio of 24.5.
3/ A constant dollar amount of shares being bought back every year. Since listing, the dollar value of shares bought back amounted to $128m (FY2017), $312m (FY2018) and $261m (FY2019). For modelling purposes I intend to assume the average amount of these three, $234m worth of shares is bought back every year for ten years. That equates to a total ten year buyback commitment of $2,340m.

YUMC has currently authorised share total buybacks up to a value of $1,400m, of which a balance of $699m now remains for further buybacks (AR2019 p120). This is less than the $1,280m of buybacks I am modelling over the next ten years. However, the YUMC board has a record of increasing the buyback limit over the years. So I don't believe that my modelling is unrealistic. The actual number of shares the money buys back each year in my model is determined by the modelled share price.

4/ $86m of new shares being subscribed to, via the employee share scheme each year (Estimate, see my post 70). These shares are assumed to be subscribed to at a redemption price of $20.92 each (AR2019 p119). This rate of subscription creates 4.111m new shares each year. $86m/395m shares = 22cps.

	Modelled No. Shares SOFY	Modelled Share Price SOFY {SP}	Equity SOFY	Net Income + Foreign Translation Gain {A}	Dividend Declared {B}	Share Buyback {C}	New Shares Subscribed + New Capital on Business Acquisitions {D}	New Retained Equity {A}+{B}+{C}+{D}	NZ Shareholder FIF Tax Liability {SP} x 0.015
2017	383.344m	$26.12	$6.37	$1.49	($0.16)	($0.33)	$0.09	$1.09
2018	388.860m	$40.02	$7.31	$1.48	($0.49)	($0.80)	$0.16	$0.35
2019 (1)	392m	$33.53	$7.59	$1.82	($0.46+$0.09)	($0.67)	$0.06	$0.66
2020	395m	$48.01	$8.04	$1.63	($0.48+$0.09)	($0.59)	$0.22	$0.69	$0.72
2021	394.237m	$43.61	$8,75	$1.78	($0.52+$0.09)	($0.59)	$0.22	$0.80	$0.65
2022	392.983m	$47.93	$9.58	$1.94	($0.58+$0.09)	($0.60)	$0.22	$0.89	$0.72
2023	392.212m	$52.68	$10.49	$2.15	($0.64+$0.09)	($0.60)	$0.22	$1.04	$0.79
2024	391.881m	$57.33	$11.54	$2.34	($0.70+$0.09)	($0.60)	$0.22	$1.17	$0.86
2025	391.911m	$63.21	$12.71	$2.58	($0.76+$0.09)	($0.60)	$0.22	$1.35	$0.95
2026	392.320m	$69.83	$14.05	$2.85	($0.82+$0.09)	($0.60)	$0.22	$1.56	$1.05
2027	393.080m	$77.42	$15.58	$3.16	($0.88+$0.09)	($0.60)	$0.22	$1.81	$1.16
2028	394.169m	$86.24	$17.34	$3.52	($0.94+$0.09)	($0.59)	$0.22	$2.12	$1.29
2029	395,567m	$96.53	$19.39	$3.94	($1.00+$0.09)	($0.59)	$0.22	$2.48	$1.45
2030	397.254m	$107.31	$21.78	$4.38
Sum 2020 to 2029					($7.32)				$9.64

Notes

(1) 'Consolidated Statements of Equity' for FY2019 show a ($63m) 'Cumulative Effect of Accounting Change' charge amounting to ($63m)/392m = (16cps). This has not been itemised in FY2019 capital adjustments.

Question/ On 31st December 2020, the YUMC share price closed at $57.09. What is the expected 10 year compounding rate of return for a New Zealand investor if you bought that share on the day, assuming exchange rates remain constant? (note the dividend figure included in the calculation below is the proportion of the dividend due to ordinary shareholders, which now excludes the dividend paid to the controlling interests of YUMC minority owned businesses).

Answer/ 57.09 x (1+r)^10 = [ ($107.39+$7.32 - $9.64) ] => r = 0.063 = 6.3%

Question/ Warren Buffett likes to get a 15% compounding return on any share he invests in, What price would he need to pay for YUMC today to achieve that?

Answer/ P x (1.15)^10 = [ ($107.39+$7.32 - $9.64) ] => P = $25.97

Conclusion:

YumChina is a great company. But to purchase shares in it today would see you pay a high price. While a 6.2% after tax compounding return over ten years is OK, this is below the kind of return that Warren is seeking. I don't think Warren would be investing in YUMC, unless that acquisition price comes down.

Quote:

---

Originally Posted by Snoopy

The next step is to forecast the dollar value of YUMC share options to be redeemed in future years. There were no stock options on the books at the start of FY2016 (AR2016, Note 15 'Share Based Compensation' p115). That is because YUMC only became split off as a separate entity in October of that year. The picture of total options granted and options exercisable on record is as follows

	Total Options on Books	Options Exercisable	Options Exercised During Year
EOFY2016	24.728m	14.883m	0.590m
EOFY2017	21.595m	14.072m	4.168m

The 'options exercised' figure for FY2016 may have been affected by the 2016 'year' for YUMC being only two months long. Multiply the 0.590m figure by 6 to normalize it and I get: 6 x 0.590m = 3.540m. My hunch is that the since withdrawn 'takeover offer' at the end of FY2017 was - a trigger - to cause an abnormally high number of option holders to cash in. I am therefore taking 3.540m as a more normal number that might be redeemed in any one year. At a redemption price of $16.69 per share, that equates to $59m or 15cps for FY2019.

---

	Total Options on Books	Options Exercisable	Options Exercised During Year (Normalised)
EOFY2016	24.728m	14.883m	6 x 0.590m =3.540m
EOFY2017	21.595m	14.072m	4.168m
EOFY2018	17.670m	12.407m	4.493m
EOFY2019	14.373m	10.583m	4.234m
Total			16.435m
Average			4.109m

My previous 'hunch' that an abnormal number of options were converted as a result of the FY2017 takeover offer looks, with hindsight, to be wrong. To model the number of options converted in the future I am now going to use the average of all four years from which we have full reporting data.

At a redemption price of $20.92 (AR2019 p119) that equates to:

$20.92 x 4.109m = $85.960m ($86m), which is my forecast for FY2020. I will also use that figure for the whole ensuing ten years of my modelling.

SNOOPY

Quote:

---

Originally Posted by Snoopy

The functional currency of YUMC is the RMB, not the USD. So what happens if the revenue is converted to RMB?

	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018
Adjusted Normalised NPAT {A}	$284m	$254m	$372m	$474m	$591m	$634m
Revenue {B}	$6,905m	$6,934m	$6.909m	$6,752m	$7,144m	$7,774m
RMB/USD Exchange Rate	6.1932	6.1428	6.2284	6.6423	6.7518	6.6174
Revenue	RMB42.764	RMB42.594	RMB43.032	RMB44.849	RMB48.235	RMB51.444
Net Profit Margin {A}/{B}	4.11%	3.66%	5.38%	7.02%	8.27%	8.16%

The revenue growth rate in local currency per annum was:

RMB42.764 x (1+g)^5 = RMB51.444 => g=3.77% (compounding)

This is not great when you consider:

1/ local inflation is around 2%
2/ there has been a substantial number of new outlets created over the study period.

But it does show that the revenue is growing above inflation, albeit modestly. This was not apparent when the results were presented in USD.

---

The functional currency of YUMC is the RMB, not the USD. So what happens if the revenue is converted to RMB?

	FY2015	FY2016	FY2017	FY2018	FY2019
Adjusted Normalised NPAT (USD) {A}	$369m	$472m	$589m	$633m	$687m
Revenue (USD) {B}	$7,233m	$7,075m	$7,769m	$8,415m	$8,776m
RMB/USD Exchange Rate (Yearly Average) (1)	6.2850	6.6452	6.7572	6.6094	6.9050
Revenue (RMB)	RMB45.459	RMB47.015	RMB52.496	RMB55.618	RMB60.598
Chinese Inflation (3)	1.4%	2.0%	1.6%	2.1%	2.9%
Net Profit Margin {A}/{B}	5.10%	6.67%	7.58%	7.52%	7.83%

Notes

(1) Averaged annual exchange rates taken from https://www.netcials.com/forex-yearl...-rate/CNY-USD/
[2) I have revised my definitions of 'normalised profit' and 'revenues' from earlier years (see my posts 63 and 65).
(3) I grabbed the CPI inflation rate for China from here: https://www.focus-economics.com/coun...hina/inflation

Discussion

The revenue growth rate in local currency per annum was:

RMB45.459 x (1+g)^4 = RMB60.598 => g=7.45% (compounding)

The annual revenue growth rate in the reporting currency (USD) was:

$7,233m x (1+g)^4 = $8,776m => g=4.87% (compounding)

For the first time the majority of my study period is a time when YUMC was separately listed. The annual compounding growth rate is significantly higher than in the previously quoted comparative post, and a lot higher than you might think if you just looked at the USD revenue growth rate. The benefits of having YUMC as a separate listed entity (from late 2016) may be showing through here.

SNOOPY

Quote:

---

Originally Posted by Snoopy

I have mentioned before that YUMC came into being as a 'stock split' for the parent YUM corporation. This is a slight simplification of the truth. In fact at the time of the split, YUMC received an outside capital injection of $460m (AR2018 p115). This is as the result of two strategic investors being brought on board the share register:

1/ An affiliate of the 'Primavera Financial Group' called 'Pollis Investment L.P.' invested $410m.
2/ An affiliate of ''Zhejiang Ant Small and Micro Financial Services Co. Limited" called 'API Hong Kong Investment Limited" invested $50m.

The net effect of these transactions was to add 19.145m shares (along with the $460m) to the 363.758m shares that came into existence at the time of separation. These shares were added in the very last quarter of 2016 and so already appear on the FY2016 balance sheet information as presented in the table below.

	EOFY2016	Change	EOFY2018
Normalised Earnings {A}	$472m		$634m
No. of Shares {B}	383m		392m
eps {A}/{B}	$1.23c	+39c {D}	$1.62
Owner Equity {C}	$2,443m		$2,976m
Owner Equity per share {C}/{B}	$6.38	+$1.21 {E}	$7.59
Return on Incremental Equity / Share {D}/{E}		+32%

It is likely that the net effect of this earlier $460m investment was not felt immediately. So much of the profitability gain apparent from subsequent net capital injection into YUMC (mainly from senior employees cashing in their stock options) is 'piggy backing' on the earlier $460m cash injection not shown in the above table. Thus in my opinion a more meaningful comparison table is this second one:

	31/10/2016 (spin off date)	Change	EOFY2018
Normalised Earnings {A}	$472m (for all of FY2016)		$634m
No. of Shares {B}	364m		392m
eps {A}/{B}	$1.30c	+32c {D}	$1.62
Owner Equity {C}	($2,443m-$460m)		$2,976m
Owner Equity per share {C}/{B}	$5.45	+$2.14 {E}	$7.59
Return on Incremental Equity / Share {D}/{E}		+15%

Note that 15% is well below the overall ROE figure of 21.3% achieved over FY2018 and also below the ROE figure of 18.5% over the last five years. 15% return on 'incremental equity' is nevertheless a good figure, the kind of figure that a Warren Buffett would be happy with.

---

I have mentioned before that YUMC came into being as a 'stock split' for the parent YUM corporation. This is a slight simplification of the truth. In fact at the time of the split, YUMC received an outside capital injection of $460m (AR2018 p115). This is as the result of two strategic investors being brought on board the share register:

1/ An affiliate of the 'Primavera Financial Group' called 'Pollis Investment L.P.' invested $410m.
2/ An affiliate of ''Zhejiang Ant Small and Micro Financial Services Co. Limited" called 'API Hong Kong Investment Limited" invested $50m.

The net effect of these transactions was to add 19.145m shares (along with the $460m) to the 363.758m shares that came into existence at the time of separation. These shares were added in the very last quarter of 2016 and so already appear on the FY2016 balance sheet information as presented in the table below.

	EOFY2016	Change	EOFY2019
Normalised Earnings {A}	$472m		$687m
No. of Shares {B}	383m		395m
eps {A}/{B}	$1.23c	+51c {D}	$1.74
Owner Equity {C}	$2,443m		$3,175m
Owner Equity per share {C}/{B}	$6.38	+$1.66 {E}	$8,04
Return on Incremental Equity / Share {D}/{E}		+31%

Quote:

---

Originally Posted by Snoopy

The latest Chinese Covid-19 outbreak (24th January 2021 report) is in the Hebei province, just outside of Beijing. The provincial capital Shijiazhung and the city of Xingtai, which encompasses Nangong, have been largely sealed off from the rest of the country. Community isolation and large-scale testing have also been enforced.

Nearby Beijing, where around 2 million residents have been ordered to undergo new testing, and has reported two new confirmed cases. This is potentially serious for consumer confidence in 'Northern China'.

---

I am thinking this issue needs more than an 'annual update'. If you follow the general media, the impression I get is that China has been relatively successful in controlling Covid-19. But what is really happening 'on the ground'? The restaurant business is a good proxy for this Here is what has happened 'so far' in FY2021/CY2021.

Q1 FY2021

First quarter sales were impacted by regional resurgences of COVID-19 before the Chinese New Year and tightened public health measures across China. The tightened measures and associated consumer caution resulted in smaller gatherings and a noticeably reduced volume of travel. Our transportation inand tourist locations, representing high single digits of our store mix, were significantly affected by the decline in travel. According to government statistics, the number of travelers was down approximately 40% versus 2020, and down approximately 70% versus 2019, when compared to the corresponding 40-day Chinese New Year holiday periods. These impacts were more pronounced for KFC, which accounts for most of our stores in these locations.

The pandemic has also introduced volatility and uncertainty to our operations. The Company acted and reacted nimbly to changing conditions. By planning for a wide range of possible situations, our team worked tirelessly to meet shifting demand across city tiers, trade zones and sales channels. Leveraging our digital capabilities, direct connection with consumers and in-house supply chain, we were able to deftly adjust offers and promotions to changing market conditions. We deployed resources flexibly to help ensure the best possible levels of restaurant staffing and delivery riders, as demand patterns shifted.

Looking ahead, the Company expects a full recovery of same-store sales to pre-COVID-19 levels to take time, and the unevenness of recovery to linger for several reasons. Public health measures and social distancing behaviors persist as occasional outbreaks, such as those in the first quarter and more recent outbreaks in Yunnan province, remind people of the lingering risks. Dine-in traffic, as well as sales at our transportation locations, remains well below 2019 levels. Accordingly, the Company will continue to focus on driving the sales recovery while ensuring the safety of our employees and customers.

Q2 FY2021

The COVID-19 pandemic continued to impact the Company’s operations and results in the second quarter. Same-store sales recovery to pre-COVID levels was interrupted by the Delta variant outbreak in southern China, which started in late May. Local authorities tightened preventive health measures and social distancing requirements. Many communities were locked down. At the peak of this outbreak, approximately 400 of our restaurants were either temporarily closed or provided delivery and takeaway services only. This represents nearly 30% of our restaurants in Guangdong province, which has two of the four tier one cities in China, is the largest economy in China and one of Yum China’s largest markets. Across China, cautious consumer behavior persists as sporadic outbreaks remind consumers of the lingering risks. Same-store dine-in volume is still well below 2019 levels while off-premise occasions continue to grow rapidly. Overall, the pace of recovery varied by region with eastern and western China recovering relatively faster.

Traffic at our transportation and tourist locations improved from the first quarter but remained well below pre-COVID levels. According to government statistics, tourism spending for the three holidays in the second quarter was still down 20% to 40% compared to 2019. The impact was more pronounced for KFC, with its higher mix of stores in transportation and tourist locations.

As we entered July, traffic and sales continue to be pressured by lingering effects of COVID-19, such as reduced travel, a shortened school holiday and regional outbreaks in Yunnan. The latest outbreak in Nanjing, the capital city of Jiangsu province, is still evolving. The Company continues to expect that a full recovery of same-store sales will take time, with the recovery path impacted by regional resurgences and the corresponding public health measures. We will continue to focus on the elements of the business under our control, such as food innovation, compelling value propositions, a focus on customer experience, and operating efficiency, to drive sales and protect margins.

Special Report: 14 September 2021

Impact of the Delta Variant Outbreak

In our second quarter 2021 earnings release, we mentioned that the latest COVID-19 outbreak of the Delta variant, which started in late July in Nanjing, was evolving quickly. Since then, this outbreak has become the most widely spread regional outbreak since the national outbreak in 2020, impacting 16 provinces. A large number of areas were identified by the government as medium to high risk. As a preventative health measure, several major cities were locked down. For example, Nanjing and Yangzhou, key cities in eastern China, the most vibrant economic region and the most important market for us, were the most affected. Zhengzhou and Wuhan, the capital cities of Henan and Hubei provinces respectively, were also significantly affected. Strict public health measures were implemented across the country, including closures of many tourist locations. These actions led to substantially lower travel volume, cancelled summer holiday trips and fewer social activities, which significantly impacted the restaurant industry.

At the peak of the outbreak in August 2021, more than 500 of our stores in 17 provinces were closed or offered only takeaway and delivery services. Same-store sales in August 2021 declined by mid-teens percentage year over year, or close to an approximately 20% decline compared to August 2019. This was mainly due to a same-store dine-in sales decline in that month of approximately 20% to 30%, and a sharp drop in sales at our transportation and tourist locations of approximately 40% to 50% year over year, also on a same-store basis.

While the outbreak has subsided in recent days and restaurant traffic is gradually recovering, our operations continue to be heavily impacted. As we have previously noted, our business recovery remains to be uneven and nonlinear, as regional outbreaks occur and corresponding public health measures are implemented. The Company expects a recovery of same-store sales to take time.

As a result of the Delta variant outbreak, the Company has experienced significant operating deleveraging, and favorable based on the current trend, our adjusted operating profit, which excludes special items, may be reduced by approximately 50% to 60% for the third quarter of 2021, compared to the same period last year. This is primarily due to the significant sales deleverage impact from sharply reduced sales, which is especially pronounced in the third quarter, a seasonally strong quarter for sales and margins. Moreover, as we have previously discussed, our restaurant margins are further pressured by the diminishing favorable impact of commodity prices, by wage inflation of mid to high single digits, and as we step up value promotions to drive traffic.

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However, the 'special report' ended on an upbeat note:

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Confidence in Long-Term Growth

The COVID-19 pandemic may pose volatility in the near-term, but the fundamentals of our business remain strong. We are confident in the long-term growth potential of China. We will continue to act to ensure the Company remains well-positioned to capture future opportunities. The Company will accelerate its store network expansion, expecting to open 1,300 gross new stores in 2021, strengthen offerings for dine-in, delivery, takeaway and retail, and invest in digital and technology.

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The share price of YUMC has fallen close to 6% today to $US57.60 on this 'Special Update' news.

SNOOPY

Not sure if you're aware Snoopy but YUM Brands China is at risk of being delisted on the US stock exchange:

https://finance.yahoo.com/news/china...174941949.html

Quote:

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Matt Turner and Yiqin Shen
Fri, March 11, 2022, 8:21 AM·2 min read



https://s.yimg.com/ny/api/res/1.2/NB...60088c74dc843d
https://s.yimg.com/ny/api/res/1.2/FT...f7b4887145ca31




China Stocks Trading in U.S. Tumble 10% After Wild Ride in Asia


(Bloomberg) -- Chinese stocks are getting knocked down in U.S. hours after suffering intense swings in Asia, with the group heading toward its worst session since the global financial crisis.

Most Read from Bloomberg

The Nasdaq Golden Dragon China Index plunged 10% on Thursday, heading toward its biggest slide since October 2008. American depositary receipts of megacaps like Alibaba Group Holding Ltd. and Baidu Inc. tumbled at least 6%, with electric-vehicle companies including Nio Inc. and XPeng Inc. each down more than 9%.
Aside from the geopolitical concerns that have caught many global investors off guard, Chinese stocks have been under intense pressure after months of regulatory crackdowns. Thursday’s selloff is a swift change of fortunes for the nation’s shares traded in the U.S. Just a day before, the group jumped the most in more than a month amid a broad-based rally in risk assets and speculation that Chinese authorities had stepped in during the Asian day to support the domestic market.
Investors in Hong Kong were treated to an equally wild day of trading Thursday, with the Hang Seng Tech Index climbing as much as 4.4%, turning negative before closing higher by about 1%. That follows a similarly volatile session on Wednesday.
The U.S. Securities and Exchange Commission this week identified five Chinese firms under the Holding Foreign Companies Accountable Act, which it says the Public Company Accounting Oversight Board was unable to inspect. The newly identified firms -- BeiGene Ltd., Yum China Holdings Inc., Zai Lab Ltd., ACM Research Inc. and HUTCHMED (China) Ltd. -- could be subject to delisting from U.S. exchanges if they fail to comply with the HFCAA’s auditing requirements for three consecutive years.

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Quote:

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Originally Posted by SBQ

Not sure if you're aware Snoopy but YUM Brands China is at risk of being delisted on the US stock exchange:

https://finance.yahoo.com/news/china...174941949.html

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Yes this is risk associated with failure to giving suitable access to the accounts for US auditing purposes. This has been well flagged in the annual reports. I am not sure why this has suddenly hit the media today. But YUM China is also listed on the Hong Kong stock exchange.

https://finance.yahoo.com/quote/9987.HK/

So there is still a platform on which shareholders can trade their shares even if it is delisted in the USA.

SNOOPY

Hi Snoopy, did you buy on the Hongkong or US exchange? Thinking of dipping my toes in.

Quote:

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Originally Posted by Walter

Hi Snoopy, did you buy on the Hongkong or US exchange? Thinking of dipping my toes in.

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I have my YUM China shares on the US exchange. IIRC post Covid-19, some NZ banks were a bit shy about dealing with Hong Kong dollars. Not sure if this situation has resolved itself. Nevertheless it wasn't a particular intention of mine to buy on the US exchange. I got allocated the shares there because I am a foundation shareholder and I got my YUMC from the US parent company YUM sell down (I am a shareholder in YUM as well).

SNOOPY