YumChina (NYSE:YUMC)

[Snoopy]

Return on Equity

In the 'Buffett Growth Model', it is 'Return on Equity' that is the most important factor in determining earnings for the year. I am happy with assuming a return on equity for Yum China of 18.8% (edit now updated to 18.5%) . In absolute terms, this will be a high number to roll over on itself for the next ten years. Yet the actual ROE over the last three years (the time since YUMC has been listed as a separate entity) have been noticeably higher than this. I am not expecting the high ROE figures from the last three years to continue. Profits have been growing a lot faster than sales. And I expect some re-balancing of costs upwards. Indeed, over FY2018, the 'Net Profit Margin' was, apparently, already shrinking.

I have mentioned before that YUMC came into being as a 'stock split' for the parent YUM corporation. This is a slight simplification of the truth. In fact at the time of the split, YUMC received an outside capital injection of $460m (AR2018 p115). This is as the result of two strategic investors being brought on board the share register:

1/ An affiliate of the 'Primavera Financial Group' called 'Pollis Investment L.P.' invested $410m.
2/ An affiliate of ''Zhejiang Ant Small and Micro Financial Services Co. Limited" called 'API Hong Kong Investment Limited" invested $50m.

The net effect of these transactions was to add 19.145m shares (along with the $460m) to the 363.758m shares that came into existence at the time of separation. These shares were added in the very last quarter of 2016 and so already appear on the FY2016 balance sheet information as presented in the table below.

	EOFY2016	Change	EOFY2018
Normalised Earnings {A}	$472m		$634m
No. of Shares {B}	383m		392m
eps {A}/{B}	$1.23c	+39c {D}	$1.62
Owner Equity {C}	$2,443m		$2,976m
Owner Equity per share {C}/{B}	$6.38	+$1.21 {E}	$7.59
Return on Incremental Equity / Share {D}/{E}		+32%

It is likely that the net effect of this earlier $460m investment was not felt immediately. So much of the profitability gain apparent from subsequent net capital injection into YUMC (mainly from senior employees cashing in their stock options) is 'piggy backing' on the earlier $460m cash injection not shown in the above table. Thus in my opinion a more meaningful comparison table is this second one:

	31/10/2016 (spin off date)	Change	EOFY2018
Normalised Earnings {A}	$472m (for all of FY2016)		$634m
No. of Shares {B}	364m		392m
eps {A}/{B}	$1.30c	+32c {D}	$1.62
Owner Equity {C}	($2,443m-$460m)		$2,976m
Owner Equity per share {C}/{B}	$5.45	+$2.14 {E}	$7.59
Return on Incremental Equity / Share {D}/{E}		+15%

Note that 15% is well below the overall ROE figure of 21.3% achieved over FY2018 and also below the ROE figure of 18.5% over the last five years. 15% return on 'incremental equity' is nevertheless a good figure, the kind of figure that a Warren Buffett would be happy with.

SNOOPY

[Snoopy]

I have mentioned before that YUMC came into being as a 'stock split' for the parent YUM corporation. This is a slight simplification of the truth. In fact at the time of the split, YUMC received an outside capital injection of $460m (AR2018 p115). This is as the result of two strategic investors being brought on board the share register:

1/ An affiliate of the 'Primavera Financial Group' called 'Pollis Investment L.P.' invested $410m.
2/ An affiliate of ''Zhejiang Ant Small and Micro Financial Services Co. Limited" called 'API Hong Kong Investment Limited" invested $50m.

The net effect of these transactions was to add 19.145m shares (along with the $460m) to the 363.758m shares that came into existence at the time of separation. These shares were added in the very last quarter of 2016 and so already appear on the FY2016 balance sheet information as presented in the table below.

	EOFY2016	Change	EOFY2018
Normalised Earnings {A}	$472m		$634m
No. of Shares {B}	383m		392m
eps {A}/{B}	$1.23c	+39c {D}	$1.62
Owner Equity {C}	$2,443m		$2,976m
Owner Equity per share {C}/{B}	$6.38	+$1.21 {E}	$7.59
Return on Incremental Equity / Share {D}/{E}		+32%

It is likely that the net effect of this earlier $460m investment was not felt immediately. So much of the profitability gain apparent from subsequent net capital injection into YUMC (mainly from senior employees cashing in their stock options) is 'piggy backing' on the earlier $460m cash injection not shown in the above table. Thus in my opinion a more meaningful comparison table is this second one:

	31/10/2016 (spin off date)	Change	EOFY2018
Normalised Earnings {A}	$472m (for all of FY2016)		$634m
No. of Shares {B}	364m		392m
eps {A}/{B}	$1.30c	+32c {D}	$1.62
Owner Equity {C}	($2,443m-$460m)		$2,976m
Owner Equity per share {C}/{B}	$5.45	+$2.14 {E}	$7.59
Return on Incremental Equity / Share {D}/{E}		+15%

Note that 15% is well below the overall ROE figure of 21.3% achieved over FY2018 and also below the ROE figure of 18.5% over the last five years. 15% return on 'incremental equity' is nevertheless a good figure, the kind of figure that a Warren Buffett would be happy with.

I have mentioned before that YUMC came into being as a 'stock split' for the parent YUM corporation. This is a slight simplification of the truth. In fact at the time of the split, YUMC received an outside capital injection of $460m (AR2018 p115). This is as the result of two strategic investors being brought on board the share register:

1/ An affiliate of the 'Primavera Financial Group' called 'Pollis Investment L.P.' invested $410m.
2/ An affiliate of ''Zhejiang Ant Small and Micro Financial Services Co. Limited" called 'API Hong Kong Investment Limited" invested $50m.

The net effect of these transactions was to add 19.145m shares (along with the $460m) to the 363.758m shares that came into existence at the time of separation. These shares were added in the very last quarter of 2016 and so already appear on the FY2016 balance sheet information as presented in the table below.

	EOFY2016	Change	EOFY2019
Normalised Earnings {A}	$472m		$687m
No. of Shares {B}	383m		395m
eps {A}/{B}	$1.23c	+51c {D}	$1.74
Owner Equity {C}	$2,443m		$3,175m
Owner Equity per share {C}/{B}	$6.38	+$1.66 {E}	$8,04
Return on Incremental Equity / Share {D}/{E}		+31%