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  1. #31
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    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
    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
    Last edited by Snoopy; 25-07-2019 at 08:20 PM.
    To be free or not to be free. That is the cash-flow question....

  2. #32
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    Default

    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
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    Default

    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.

    SNOOPY

    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....

  4. #34
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    Default BT2/ Increasing 'eps' trend (2018 perspective) [one setback allowed]

    Quote Originally Posted by Snoopy View Post
    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 AR2019), 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
    Last edited by Snoopy; 24-07-2019 at 02:13 PM.
    To be free or not to be free. That is the cash-flow question....

  5. #35
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    Default BT3/ ROE > 15% for five years (2018 perspective) [one setback allowed]

    Quote Originally Posted by Snoopy View Post

    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
    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
    Last edited by Snoopy; 23-07-2019 at 10:41 PM.
    To be free or not to be free. That is the cash-flow question....

  6. #36
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    Default BT4/ Ability to raise Net Profit margin above inflation rate (2018 perspective)

    Quote Originally Posted by Snoopy View Post
    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
    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
    Last edited by Snoopy; 24-07-2019 at 05:05 PM.
    To be free or not to be free. That is the cash-flow question....

  7. #37
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    Default Buffett Test Summary (2018 Perspective)

    Quote Originally Posted by Snoopy View Post
    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
    Last edited by Snoopy; 24-07-2019 at 05:12 PM.
    To be free or not to be free. That is the cash-flow question....

  8. #38
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    Default Buffett Growth Model (2018 Perspective): Data

    Quote Originally Posted by Snoopy View Post
    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.

    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.
    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 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.

    SNOOPY
    Last edited by Snoopy; 25-07-2019 at 11:39 AM.
    To be free or not to be free. That is the cash-flow question....

  9. #39
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    Default Buffett Growth Model (2018 Perspective): Spreadsheet

    Quote Originally Posted by Snoopy View Post
    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
    Last edited by Snoopy; 13-08-2019 at 09:30 AM.
    To be free or not to be free. That is the cash-flow question....

  10. #40
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    Default 'Dividend' disambiguation

    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
    Last edited by Snoopy; 10-08-2019 at 08:16 AM.
    To be free or not to be free. That is the cash-flow question....

  11. #41
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    Quote Originally Posted by Snoopy View Post
    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)
    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
    Last edited by Snoopy; 12-08-2019 at 08:16 AM.
    To be free or not to be free. That is the cash-flow question....

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    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.

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    Quote Originally Posted by SBQ View Post
    You're doing a lot of fancy analysis on YUM,
    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.

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

    For starters i'm not a fan of using EBITA
    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
    Last edited by Snoopy; 13-08-2019 at 09:55 AM.
    To be free or not to be free. That is the cash-flow question....

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    Quote Originally Posted by SBQ View Post
    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.
    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
    Last edited by Snoopy; 16-08-2019 at 10:52 AM.
    To be free or not to be free. That is the cash-flow question....

  15. #45
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    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.

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