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  1. #31
    Join Date
    Jun 2004
    , , New Zealand.

    Default Developing a Business In China

    "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
    2015 7,176
    2017 7,983

    From 1987 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 over the last two years:

    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.

    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.

    "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.

    Last edited by Snoopy; 09-04-2019 at 09:41 AM.
    To be free or not to be free. That is the cash-flow question....

  2. #32
    Join Date
    Jun 2013


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

  3. #33
    Join Date
    Jun 2004
    , , New Zealand.


    Quote Originally Posted by Cricketfan View Post
    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.


    discl: hold RBD, YUMC, YUM
    Last edited by Snoopy; 22-04-2019 at 04:00 PM.
    To be free or not to be free. That is the cash-flow question....


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