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  1. #1
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    Default YumChina (NYSE:YUMC)

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

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

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

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

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

    Some analysis of YUMC will be forthcoming.

    SNOOPY

    discl: hold YUMC
    Last edited by Snoopy; 11-01-2019 at 09:29 PM.
    To be free or not to be free. That is the cash-flow question....

  2. #2
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    Default BT1/ Top Three Position in Chosen Market (2017 perspective)

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

    YumChina lists their competitive advantages as:

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

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

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

    Conclusion: Pass Test

    SNOOPY
    Last edited by Snoopy; 11-01-2019 at 09:26 PM.
    To be free or not to be free. That is the cash-flow question....

  3. #3
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    Default BT2/ Increasing 'eps' trend (2017 perspective) [one setback allowed]

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

    Notes

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

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

    Conclusion: Pass Test

    SNOOPY
    Last edited by Snoopy; 22-01-2019 at 09:36 PM. Reason: Added PE ratios
    To be free or not to be free. That is the cash-flow question....

  4. #4
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    Default BT3/ ROE > 15% for five years (2017 perspective) [one setback allowed]

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

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

    Conclusion: Fail Test

    SNOOPY
    Last edited by Snoopy; 09-01-2019 at 04:23 PM.
    To be free or not to be free. That is the cash-flow question....

  5. #5
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    Default BT4/ Ability to raise Net Profit margin above inflation rate (2017 perspective)

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

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

    Conclusion: Pass Test

    SNOOPY
    Last edited by Snoopy; 09-01-2019 at 04:43 PM.
    To be free or not to be free. That is the cash-flow question....

  6. #6
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    Default Buffett Test Summary (2017 Perspective)

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

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

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

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

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

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

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

    SNOOPY
    Last edited by Snoopy; 23-01-2019 at 10:11 AM.
    To be free or not to be free. That is the cash-flow question....

  7. #7
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    Default EBIT & EBITDA Multiples

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

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

    Notes

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

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

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

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

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

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

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

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

    SNOOPY
    Last edited by Snoopy; 11-01-2019 at 09:23 PM.
    To be free or not to be free. That is the cash-flow question....

  8. #8
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    Default The Revenue Dilemma

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

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

    But profit growth has been

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

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

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

    The revenue growth rate in local currency was

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

    This is not great when you consider:

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

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

    SNOOPY
    Last edited by Snoopy; 13-08-2019 at 10:36 PM.
    To be free or not to be free. That is the cash-flow question....

  9. #9

  10. #10
    Senior Member Valuegrowth's Avatar
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    Default

    Following two things suggest this is a business worth watching.


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

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

  11. #11
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    Default

    Quote Originally Posted by Valuegrowth View Post
    [*]Very respectable ROE (Yum China Holdings has a return on equity of 18% for the last year)
    If we take the headline NPAT of $429m and divide that with shareholder equity at last reported balance date (31-12-2017) I get a 'Return on Shareholders Equity' of:

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

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

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

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

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

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

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

    SNOOPY
    Last edited by Snoopy; 16-01-2019 at 02:13 PM.
    To be free or not to be free. That is the cash-flow question....

  12. #12
    Senior Member Valuegrowth's Avatar
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    Default

    Thank you for the analysis.

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

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

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

  13. #13
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    Default

    Quote Originally Posted by Valuegrowth View Post
    Thank you for the analysis.

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

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

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

    SNOOPY
    To be free or not to be free. That is the cash-flow question....

  14. #14
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    Default

    Quote Originally Posted by Valuegrowth View Post
    [*]Its debt to equity ratio is very low
    I see from AR2017 p76, the total borrowing facilities are listed to be "Approximately $US261m." I further note that "As of December 31, 2017, the full amount of borrowings were available under each facility."

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

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

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

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

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

    SNOOPY
    Last edited by Snoopy; 05-02-2019 at 03:43 PM.
    To be free or not to be free. That is the cash-flow question....

  15. #15
    Senior Member Valuegrowth's Avatar
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    Default

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

    How KFC Changed China and How China Changed KFC

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

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

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

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