YumChina (NYSE:YUMC)

[Valuegrowth]

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

[Snoopy]

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

[Valuegrowth]

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.

[Snoopy]

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.

I hadn't heard about the "K Pro" way of presenting KFC before. Here is the article published when "K Pro" opened in Shanghai.

http://www.timeoutshanghai.com/featu...-Shanghai.html

"The inside looks less KFC, more salad bar with a counter featuring fresh vegetables on display (mostly to show off the staff as they prepare your food)"

Looks like YUMC are treating healthy eating seriously! Mind you they aren't abandoning the traditional KFC way, with a 'hedging the bet' regular KFC right next door!

SNOOPY

[Agrarinvestor]

Hi Snoopy,

if you want to chat with china based investors:
https://xueqiu.com/S/YUMC

right click, and use translate to english

[SBQ]

SNOOPY: I see you're a big fan of fast food, particularly fast food in China.

Can I ask your thoughts on BABA and it's future outlook (after Jack Ma no longer the CEO) ?

[Snoopy]

SNOOPY: I see you're a big fan of fast food, particularly fast food in China.

Can I ask your thoughts on BABA and it's future outlook (after Jack Ma no longer the CEO) ?

SBQ, I don't follow Alibaba closely, but these guys obviously do:

http://knowledge.wharton.upenn.edu/a...thout-jack-ma/

Operationally, I don't see any problems in the medium term. Jack Ma will have stepped away from that part of Alibaba long ago. But as a charismatic figure head, Jack will be impossible to replace. So investors might not be prepared to pay such a high multiple for the company once the media fronting founder goes. Thus I see the 'investment risk' for shareholders as higher than the 'business operational risk'.

There are 'investors' (that I would call mathematically challenged gamblers) who are prepared to pay any market price to get on the share register of a globally big name company. At some point they will pay too much. But what point is that? This is a difficult question to answer. So difficult, that I prefer to leave those kinds of investments to others.

As far as doing business in China goes, there are special risks that the article I quote outlines. If we look at YumChina, which has a longer track record than Alibaba, their success seems due to their ability to be seen as a Chinese company (the senior executive team is Chinese, they sell franchises to local Chinese) that provide tangible benefits for Chinese workers. Raising the standard of living of the Chinese people is something the Chinese government have been very successful at. And I would say any China based business that produce for all stakeholders benefits in line with the Chinese government's vision will continue to do well.

SNOOPY

[Snoopy]

"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

[Snoopy]

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

The battle that YUMC has had in managing their Covid-19 response in China, provides an interesting insight into what happened with consumer food markets in general over FY2020 in China. The following are quotes from the three quarterly reports form FY2020 issued to date.

--------------------------

Q1 2020

First quarter operations were significantly affected by the outbreak. Working closely with local health authorities to safeguard the public, the Company began temporary store closures in late January where appropriate. Approximately 35% of stores were closed by mid-February at the peak of the outbreak, with significant regional differences. As of the date of this release (28-04-2020), approximately 99% of stores in China are either partially or fully open.

For restaurants that remained open, same-store sales declined due to shortened operating hours and reduced traffic, with a significant portion of stores providing only delivery and takeaway services. Our results were strong for the first three weeks of January, but then the outbreak led to subsequent same-store sales declines of 40-50% compared to the comparable Chinese New Year holiday period in 2019. As the first quarter progressed, sales performance recovered gradually, with same-store sales down approximately 20% in late March. The pace of recovery is uneven with recent sales and traffic still below pre-outbreak levels as people continue to avoid going out and practice social distancing. Same-stores sales were still down by more than 10% month-to-date.

Yum China pioneered contactless delivery and contactless takeaway in late January to enhance preventative health measures. Those services proved popular with customers and have supported the businesses during this period of reduced dine-in traffic.

Q2 2020

Sales improved sequentially in April and May but softened in June. Sales were primarily impacted by significantly reduced traffic at transportation and tourist locations, delayed and shortened school holidays and resurging regional infections. These factors and the lingering effect of COVID-19 continue to impact operations in July.

The unevenness in recovery was most pronounced in the differences between regions and trade zones. Eastern China recovered faster than other regions. Northern China's recovery was notably slower, primarily due to more stringent public health measures. Transportation and tourist locations, which accounted for high single digits of sales, continue to experience significant year over year traffic declines. The pace of recovery also varies across days of the week. Weekdays recovered the fastest as people returned to work and school, followed by weekends, with holidays lagging behind.

Q3 FY2020

Third quarter operations improved, although still impacted by reduced traffic at transportation and tourist locations, the delayed and shortened school holiday and the other lingering effects of the COVID-19 outbreak. Dine-in volume has been recovering, while delivery and takeaway remained popular options. The Company's primary focus continues to be safety, efficiency and driving traffic. We launched attractive digital and membership campaigns with strong value propositions to drive sales recovery.

Q4 FY2020

Fourth quarter operations improved sequentially from the third quarter. The Company's primary focus continues to be safety, efficiency and sales recovery. To counter the pandemic impact, we ran strong value and digital campaigns to drive traffic. Delivery and takeaway remained popular, while dine-in recovered sequentially. Proactive cost structure realignment, productivity improvements and one-off cost savings helped us achieve year-over-year expansion of restaurant margins and operating profit. However, the pace of recovery was uneven and non-linear, impacted by regional resurgences of COVID-19 in Qingdao, Xinjiang, Beijing, Dalian and elsewhere. October sales benefited from the National Day long holiday, but November and December sales were pressured by the regional outbreaks. Traffic at transportation hubs remained significantly below the prior year due to reduced travel.

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The latest Chinese Covid-19 outbreak (24th January 2021 report) is in the Hebei province, just outside of Beijing. The provincial capital Shijiazhung and the city of Xingtai, which encompasses Nangong, have been largely sealed off from the rest of the country. Community isolation and large-scale testing have also been enforced.

Nearby Beijing, where around 2 million residents have been ordered to undergo new testing, and has reported two new confirmed cases. This is potentially serious for consumer confidence in 'Northern China'.

SNOOPY

[Snoopy]

The latest Chinese Covid-19 outbreak (24th January 2021 report) is in the Hebei province, just outside of Beijing. The provincial capital Shijiazhung and the city of Xingtai, which encompasses Nangong, have been largely sealed off from the rest of the country. Community isolation and large-scale testing have also been enforced.

Nearby Beijing, where around 2 million residents have been ordered to undergo new testing, and has reported two new confirmed cases. This is potentially serious for consumer confidence in 'Northern China'.

I am thinking this issue needs more than an 'annual update'. If you follow the general media, the impression I get is that China has been relatively successful in controlling Covid-19. But what is really happening 'on the ground'? The restaurant business is a good proxy for this Here is what has happened 'so far' in FY2021/CY2021.

Q1 FY2021

First quarter sales were impacted by regional resurgences of COVID-19 before the Chinese New Year and tightened public health measures across China. The tightened measures and associated consumer caution resulted in smaller gatherings and a noticeably reduced volume of travel. Our transportation inand tourist locations, representing high single digits of our store mix, were significantly affected by the decline in travel. According to government statistics, the number of travelers was down approximately 40% versus 2020, and down approximately 70% versus 2019, when compared to the corresponding 40-day Chinese New Year holiday periods. These impacts were more pronounced for KFC, which accounts for most of our stores in these locations.

The pandemic has also introduced volatility and uncertainty to our operations. The Company acted and reacted nimbly to changing conditions. By planning for a wide range of possible situations, our team worked tirelessly to meet shifting demand across city tiers, trade zones and sales channels. Leveraging our digital capabilities, direct connection with consumers and in-house supply chain, we were able to deftly adjust offers and promotions to changing market conditions. We deployed resources flexibly to help ensure the best possible levels of restaurant staffing and delivery riders, as demand patterns shifted.

Looking ahead, the Company expects a full recovery of same-store sales to pre-COVID-19 levels to take time, and the unevenness of recovery to linger for several reasons. Public health measures and social distancing behaviors persist as occasional outbreaks, such as those in the first quarter and more recent outbreaks in Yunnan province, remind people of the lingering risks. Dine-in traffic, as well as sales at our transportation locations, remains well below 2019 levels. Accordingly, the Company will continue to focus on driving the sales recovery while ensuring the safety of our employees and customers.

Q2 FY2021

The COVID-19 pandemic continued to impact the Company’s operations and results in the second quarter. Same-store sales recovery to pre-COVID levels was interrupted by the Delta variant outbreak in southern China, which started in late May. Local authorities tightened preventive health measures and social distancing requirements. Many communities were locked down. At the peak of this outbreak, approximately 400 of our restaurants were either temporarily closed or provided delivery and takeaway services only. This represents nearly 30% of our restaurants in Guangdong province, which has two of the four tier one cities in China, is the largest economy in China and one of Yum China’s largest markets. Across China, cautious consumer behavior persists as sporadic outbreaks remind consumers of the lingering risks. Same-store dine-in volume is still well below 2019 levels while off-premise occasions continue to grow rapidly. Overall, the pace of recovery varied by region with eastern and western China recovering relatively faster.

Traffic at our transportation and tourist locations improved from the first quarter but remained well below pre-COVID levels. According to government statistics, tourism spending for the three holidays in the second quarter was still down 20% to 40% compared to 2019. The impact was more pronounced for KFC, with its higher mix of stores in transportation and tourist locations.

As we entered July, traffic and sales continue to be pressured by lingering effects of COVID-19, such as reduced travel, a shortened school holiday and regional outbreaks in Yunnan. The latest outbreak in Nanjing, the capital city of Jiangsu province, is still evolving. The Company continues to expect that a full recovery of same-store sales will take time, with the recovery path impacted by regional resurgences and the corresponding public health measures. We will continue to focus on the elements of the business under our control, such as food innovation, compelling value propositions, a focus on customer experience, and operating efficiency, to drive sales and protect margins.

Special Report: 14 September 2021

Impact of the Delta Variant Outbreak

In our second quarter 2021 earnings release, we mentioned that the latest COVID-19 outbreak of the Delta variant, which started in late July in Nanjing, was evolving quickly. Since then, this outbreak has become the most widely spread regional outbreak since the national outbreak in 2020, impacting 16 provinces. A large number of areas were identified by the government as medium to high risk. As a preventative health measure, several major cities were locked down. For example, Nanjing and Yangzhou, key cities in eastern China, the most vibrant economic region and the most important market for us, were the most affected. Zhengzhou and Wuhan, the capital cities of Henan and Hubei provinces respectively, were also significantly affected. Strict public health measures were implemented across the country, including closures of many tourist locations. These actions led to substantially lower travel volume, cancelled summer holiday trips and fewer social activities, which significantly impacted the restaurant industry.

At the peak of the outbreak in August 2021, more than 500 of our stores in 17 provinces were closed or offered only takeaway and delivery services. Same-store sales in August 2021 declined by mid-teens percentage year over year, or close to an approximately 20% decline compared to August 2019. This was mainly due to a same-store dine-in sales decline in that month of approximately 20% to 30%, and a sharp drop in sales at our transportation and tourist locations of approximately 40% to 50% year over year, also on a same-store basis.

While the outbreak has subsided in recent days and restaurant traffic is gradually recovering, our operations continue to be heavily impacted. As we have previously noted, our business recovery remains to be uneven and nonlinear, as regional outbreaks occur and corresponding public health measures are implemented. The Company expects a recovery of same-store sales to take time.

As a result of the Delta variant outbreak, the Company has experienced significant operating deleveraging, and favorable based on the current trend, our adjusted operating profit, which excludes special items, may be reduced by approximately 50% to 60% for the third quarter of 2021, compared to the same period last year. This is primarily due to the significant sales deleverage impact from sharply reduced sales, which is especially pronounced in the third quarter, a seasonally strong quarter for sales and margins. Moreover, as we have previously discussed, our restaurant margins are further pressured by the diminishing favorable impact of commodity prices, by wage inflation of mid to high single digits, and as we step up value promotions to drive traffic.

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However, the 'special report' ended on an upbeat note:

--------------------

Confidence in Long-Term Growth

The COVID-19 pandemic may pose volatility in the near-term, but the fundamentals of our business remain strong. We are confident in the long-term growth potential of China. We will continue to act to ensure the Company remains well-positioned to capture future opportunities. The Company will accelerate its store network expansion, expecting to open 1,300 gross new stores in 2021, strengthen offerings for dine-in, delivery, takeaway and retail, and invest in digital and technology.

------------------------

The share price of YUMC has fallen close to 6% today to $US57.60 on this 'Special Update' news.

SNOOPY