YumChina (NYSE:YUMC)

[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]

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

[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

[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

[Snoopy]

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

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

[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

[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

[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.

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

[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

[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.