BT1/ Top Three Position in Chosen Market (2017 perspective)
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
BT2/ Increasing 'eps' trend (2017 perspective) [one setback allowed]
|
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
BT3/ ROE > 15% for five years (2017 perspective) [one setback allowed]
|
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
BT4/ Ability to raise Net Profit margin above inflation rate (2017 perspective)
|
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
Buffett Test Summary (2017 Perspective)
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
Adjusting for 'Constant Currency' Aspect 1
Quote:
Originally Posted by
Valuegrowth
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.
Adjusting for 'Constant Currency' Aspect 2
Quote:
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.
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
BT2/ Increasing 'eps' trend (2018 estimate perspective) [one setback allowed]
|
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
BT3/ ROE > 15% for five years (2018e perspective) [one setback allowed]
|
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