Yum China Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 6, 2024

There are 10 speakers on the call.

Operator

Thank you for standing by, and welcome to the Yum! China 4th Quarter and Fiscal Year 2023 Earnings Conference Call. All participants are in a listen only mode. There will be a presentation followed by a question and answer I would now like to hand the conference over to Ms. Michelle Shen, IR Director.

Operator

Please go ahead.

Speaker 1

Thank you, operator. Hello, everyone. Thank you for joining Yum China's 4th quarter 2023 earnings conference call. On today's call are our CEO, Ms. Joey Hua and our CFO, Mr.

Speaker 1

Andy Young. I'd like to remind everyone that our earnings call and investor materials contain forward looking statements, which are subject to future events and uncertainties. Actual results may differ materially from these forward looking statements. All forward looking statements should be considered in conjunction with the cautionary statements in our earnings release and the risk factors included in our filings with the SEC. This call also includes certain non GAAP financial measures.

Speaker 1

You should carefully consider the comparable GAAP measures. Reconciliation of non GAAP and GAAP measures is included in our earnings release. You can find the webcast of this call in the PowerPoint presentation on our IR website. Please note that during today's call, all year over year growth results exclude the impact of foreign currency, unless otherwise noted. Now, I

Speaker 2

would like to turn the call over to Joey Hua, CEO of Yum China. Joey? Thank you. Hello, everyone, and thank you for joining us today. It's Chinese New Year this coming Saturday.

Speaker 2

I want to wish everyone a happy and healthy year of the Dragon. I would like to kick off today's call by expressing My sincere appreciation to all our employees. Their incredible efforts Help Yum China deliver exceptional growth in the Q4 and for the full year. 2023 was a pivotal time for our business. The transformation of our business fundamentals in the past few years have enabled us to seize opportunities emerging from China's reopening and evolving market conditions.

Speaker 2

In 2023, we hit record breaking revenue of $11,000,000,000 and grew system sales 21% year over year, outperforming the industry. Operating profit soared to RMB1.1 billion, an all time high excluding special items. Core operating profit grew 79%. We opened a record 1697 net new stores, expanding our total store count to 14,644 stores. KFC reached 10,296 stores, Pizza Hut reached 3,312 stores.

Speaker 2

On today's call, I would like to walk you through the tremendous growth opportunities we see and discuss our strategies to capture them in 2024 Thank you. For the past 36 years, we have been the market leader in China. During this time, Kona's restaurant operators have passed in and out of favor. Instead of being Guangdong, for the favor of the month, we want to be Changhome for the favor of the decade or even next several decades. In this developing market, While the restaurant industry is still growing double digits even during 2023, we see a long runway of growth for our brand.

Speaker 2

KFC still only serves 1 third of the China population. Our next ambitious target is to extend our reach to half of the population by 2026. How? By being closer to our customers, this means adding store density in existing cities and entering new cities. KFC currently operates across 2,000 cities in China and is tracking an additional 1,000 cities.

Speaker 2

For Pizza Hut and our emerging brands, The white space is even larger. China is vast with significant regional and city tier differences. In lower tier cities, urbanization and long term consumption upgrade are presenting attractive opportunities for us. With lower living costs, consumers in these cities has significant purchasing power for our products. So as an example, premium beef burgers sell well in lower tier cities just as in high tier cities.

Speaker 2

Over half of our new stores in recent years are in lower tier cities. These stores have performed well benefiting from lower labor costs And the ticket average is as good as in higher tier cities. For now, we are mainly serving middle class consumers in these markets. As we expand, we see further opportunity in widening price points to broaden our addressable customer base. Our vision is to reach 20,000 stores by 2026.

Speaker 2

We will continue to protect our New store payback at 2 years for KFC and 3 years for Pizza Hut. Over the past years, We have been improving our fundamental capabilities to reach this target. This is the key reason we can expand at an accelerated speed. Some of these improvements include: 1st, flexible store format with lower upfront investments open up more site potential across city tiers. 2nd, Core structure rephrasing lowered our rent ratio in 2023 to 8.7% of sales, the lowest level in the past 10 years.

Speaker 2

The majority of our leases are based on variable risk. 3rd, improved operating capabilities. AI enabled digital tools Empower our capable restaurant managers to oversee multiple stores without compromising quality. This also solves the bottleneck of having enough good RGM as we expand rapidly. Finally, strategic franchise partnerships allow us to gain access to locations that were beyond our reach before, such as highway service centers.

Speaker 2

In addition to new store growth, our same store sales grew 7% in 2023. It was fueled by a 12% increase in transactions indicating healthy growth. Our innovative menus, Excellent value for money and effective online channels captured over 1,700,000,000 transactions last year. Now let's talk about food innovation. In 2023, we rolled out more than 500 new or upgraded products.

Speaker 2

That means we offered something new every week. Some examples include KFC's beef wrap with spicy duck blood and chicken taco with bullfrog And Pizza Hut's Blackstone Yulean Pizza. These may sound a bit exotic, but I can assure you They are very popular in China. Over the years, many of our most popular products have entered our 100,000,000 club in U. S.

Speaker 2

Dollar sales and 2023 was no exception. Our Golden Spa Chicken Burger, Kuan Jin Spa, launched in Q4 of 2022 Join our 100,000,000 club in 2023 with very little spend on marketing. It offers amazing value for money using chicken breast meat and is very popular with younger customers. Chicken breast meat is very high quality protein, but the cost of breast meat is much cheaper in China than bad meat. Our Juicy Whole Chicken, is another remarkable success story.

Speaker 2

We launched it in 2021 and by 2023, we sold over 50,000,000 Whole Chicken. Whole Chicken and beef burgers combined now contribute close to 6% of our sales, more than the original recipe chicken that we have been selling in the last 36 years. K Coffee also grew rapidly in 2023, driven by product innovation and improving accessibility. 190,000,000 cups were sold last year, a 35% increase year over year. Our coffee offers great value for money at below RMB9.9 per cup.

Speaker 2

Great value for money remains a key factor to drive traffic in addition to the great food that I just mentioned. We have strategically enriched our menus with entry price point products to attract incremental customers. Our super in house supply chain empowers us to innovate and offer fantastic value while protecting margins. At KFC, apart from our long lasting value platform Crazy Thursday, We identified entry price combos as huge underserved market segments. Last year, KFC expanded the choices of its RMB 20 combo, including our recent Chinese burgers in Hanbao, which have been well received by customers.

Speaker 2

For Pizza, the under RMB50 segment represents a significant portion of the market, but is Under served at Pizza Hut, in November last year, we launched full entry price pizza, including the delicious Texas barbecue chicken pizza. We will continue to add more cautious choices to our menu this year to capture incremental sales. We also see amazing potential to further grow delivery sales. We are adjusting our delivery pricing structure to be more aligned with market norms. This will help us capture incremental traffic, especially in the smaller ticket segment and from more price sensitive customers.

Speaker 2

Our 3rd traffic driver is the Effective use of our own and third party online channels. In 2023, our digital sales surpassed $9,200,000,000 Of that, about 1 third came from our own super apps, 1 third from Mini Programs and 1 third from aggregators. Our all super app Sales grew rapidly last year, up 34%. We continue to actively recruit and engage members. Our loyalty programs exceed 470,000,000 members who contributed A record 65% of our sales.

Speaker 2

The purchase frequency of our K Friends, Our most loyal customers was more than 100 times a year. Our collaborations with major e commerce and and promote new orders in a cost effective manner. We consistently led the industry in terms of Sales generated on these platforms. Our brands are deeply ingrained in China, well loved and trust by consumers. We continued to deliver amazing growth despite operating in a challenging environment.

Speaker 2

KFC is rising and remains our key growth engine with a record operating profit of 1 $200,000,000 in 2023. Pizza Hut is kicking off adding 409 stores in 2023 alone compared to just 41 stores in 2019. Their 2023 core operating profit tripled year over year. LAVASA is on the right track With sales doubled and notable improvements in store economics, Taco Bell is making notable progress, Yes, there's more work in store model refinement and manual localization to Visa. Little Sheep returned to profitability in 2023.

Speaker 2

Its innovative store model, which caters to smaller party sizes has achieved initial success. We expect good momentum In opening stores both in China and overseas, Huang Jing Huang continues to be resilient, maintaining profitability every year since we acquired it in 2020. In 2023, Huang Zhihuan tripled profits and opened 14 net new stores. We will continue expanding our store footprint in China and overseas this year. Onward into 2024, we are serving up a combination of exciting menu items, Awesome toys and games for Chinese New Year.

Speaker 2

KFC's newest innovation, is absolutely delicious. It's comfort food for your soul. We are also offering our wildly popular Golden bucket again this year. It has a very lucky and sound to earth name, which means Get Rich Soup and the first letter also stands for KFC. So right now it's getting around, Pizza Hut is launching 18 new products, including Guagu beef pizza, Xiaohua henhyou pizza At just RMB69, the abundant choices and value are amazing.

Speaker 2

Although consumers are more rational and price sensitive in the current economy, there is a strong desire to indulge, Especially during holidays, our enticing offers are designed to generate excitement and attract traffic. I eagerly anticipate this vibrant trading period. With that, I will turn the call over to Andy. Andy?

Speaker 3

Thank you, Zoey, and happy Chinese New Year, everyone. Today, I will discuss our Q4 and full year 2023 financial results, followed by our outlook for 2024 as well as our capital allocation strategy. We delivered robust results in the 4th quarter and reached significant milestones for the full year. In response to current operating environment, we adopted our strategy and launched attractive campaigns. This allowed us to drive incremental traffic and sales.

Speaker 3

We maintained 21% system sales growth in the quarter, same as the full year. Core operating profit The Q4 quadrupled year over year and restaurant margin improved on a comparable basis. As you may have noted, we have introduced core operating profit to enhance comparability of our results and provide additional transparency on how we evaluate the performance of our core operations. This metric excludes foreign exchange impact, special items and other items affecting comparability. For further details, please refer to the reconciliation table in our earnings release and presentation.

Speaker 3

Let's now look at our 4th quarter performance in more detail. System sales increased 21% year over year, led by 12% net new unit contribution, 4% same store sales growth and lapping temporary closure from the pandemic in the prior year. By brand, KFC system sales increased 20% year over year. Same store sales growth of 3% mainly came from 16% same store traffic growth and 11% lower ticket average. To put it into perspective, Ticket average in the 4th quarter was RMB39, the same as last quarter and higher than 2019.

Speaker 3

Overall ticket average remains stable in the past 5 years and our focus has been to grow our traffic. A strong rebound of dine in sales, especially for breakfast daypart and successful expansion of our entry price offering contribute to lower ticket average. Pizza Hut system sales increased 24% year over year. Singular sales growth of 6% was driven by strong traffic growth of 15% and ticket average decrease of 8%. It is by design and consistent with our revitalization strategy since 2017.

Speaker 3

Our recent focus has been to expand pizza offerings below RMB50 and smaller party size options. The strategy has proven effective in expanding our addressable market and capturing incremental traffic. Our restaurant margin was 10.7%, 30 basis points higher than last year. On a comparable basis, our restaurant margin grew by 170 basis points. Improvement was mainly from self leveraging, lower rider costs, more favorable commodity prices and lower advertising expenses.

Speaker 3

This more than offset increased marketing campaigns and wage inflation. Now let's go through the key items. Cost of sales was 33.4%, 50 basis points higher year over year. During the quarter, commodity prices were favorable. We pass that to consumer by offering better value for money.

Speaker 3

Cost of labor was 29.0%, flattish year over year or improved 40 basis points on a comparable basis. Sales leveraging, loan rider costs and efficiency gains more than offset rate increases for frontline staff. Occupancy and other was 27.9%, improved 100 basis points year over year were 180 basis points on a comparable basis. This came from lower rent and depreciation expenses as well as more efficient management of marketing and advertising expenses. G and A expenses increased 6% year over year.

Speaker 3

We tightly manage costs and headcount to keep G and A Operating profit was $110,000,000 Core operating profit quadrupled. Our effective tax rate was 24.2% in Q4 and 26.9% for the full year. Lower effective tax rate on a year over year basis was mainly due to more preferential tax benefits and higher pretax income. Diluted EPS was $0.23 excluding special items, foreign exchange and Meituan Investments, the increase was 164%. Now let's turn to our outlook.

Speaker 3

We remain excited about the vast growth opportunities in China. In 2024, we anticipated Opening 1500 to 1700 net new stores. After 36 years in China, It's amazing that we are still growing our store at double digit. Our healthy new store payback give us confidence to continue expansion and reach 20,000 stores by 2026. As we shared at our Investor Day last year, we aim to grow system sales and operating profit by high single digit to double digit compound annual growth rate and EPS by double digit compound annual growth rate from 2024 to 2026.

Speaker 3

We will continue to capture our new opportunities by innovating new products, Our addressable customer base and drive incremental sales. We are confident in executing our 3 year plan. Cost structure rebasing continues to be a key focus. Our efficient cost management will enable us to pass the savings back to customers and drive traffic while protecting margins. Before I dive into the Q1 outlook, I would like to remind everyone that Q1 2023 was a phenomenal quarter, during which we achieved record setting profit.

Speaker 3

We captured robust demand from the reopening, delivering solid sales. On the cost side, we benefited from substantial temporary relief and VAT deduction benefits, which is not expected to recur this year. We also benefited from labor productivity gain from labor shortage in the Q1 last year. Looking ahead to the Q1 this year, as Joey mentioned, we are now operating under a new normal. Consumers are more rational in spending, yet have great expectation and appetite for new and exciting products and that can offer Great value for money.

Speaker 3

In response, we have successfully planned a very intensive number of new product launches and attractive promotion. We have also dedicated more resources to drive sales and capture the peak Chinese New Year traffic. In light of these challenges, we will work hard on productivity improvement and cost control, including G and A expenses. Our aim is to maintain our core operating profit, markedly stable on a comparable year over year basis in the Q1. This will exclude temporary relief, VAT deduction benefit and changes in foreign exchange rate.

Speaker 3

Now let's turn to capital allocation. There's no better investment than investing in our own organic growth, while delivering excellent returns to our shareholders. With a strong focus on efficient capital return, CapEx in 2023 totaled $710,000,000 at the low end of our original target. In 2024, CapEx is expected to be in the range of $700,000,000 $850,000,000 Since the spin off, we have returned $3,000,000,000 to shareholders and we plan to return another $3,000,000,000 in the next 3 years. We accelerated return to shareholders in 2023, returning a record $833,000,000 in cash dividends and share repurchases.

Speaker 3

In 2024, we plan to further Accelerate return to shareholders to around $1,500,000,000 We raised our dividend by 23% from $0.13 to $0.16 That would be roughly $250,000,000 for the full year. As for share repurchases, We already have a $750,000,000 program in place and plan to further increase repurchases by around $500,000,000 So a total of $1,250,000,000 share repurchase in 2024. This is equivalent to around 9% of our market cap at the current share price. The stepping up of returns demonstrate our confidence in our cash generating capability and commitment to return accepted cash to our shareholders. Let me pass it back to Joey for closing remarks.

Speaker 3

Joey?

Speaker 2

Thank you, Andy. Before we turn to Q and A, I would like to just summarize. In 2023, we reached record Top line and bottom line as well as net new store openings and we returned Record level of cash to our shareholders through dividends and buyback. These achievements were made possible by the transformation we implemented in our fundamental capabilities, Ranging from flexible store format and food innovation at scale to support supply chain management and industry leading AI applications. We have showcased our expertise and agility to navigate diverse market conditions.

Speaker 2

Acknowledging the high Our shareholders hold for us, we in turn set equally high standards for ourselves. We are fully committed to our 3 year growth target and generating long term sustainable value for our shareholders. I would like to thank our shareholders for your continued support. With that, I will pass it back to Michelle.

Speaker 1

Thank you, Joey. Now we will open the call for questions. In order to give more people the chance to ask questions, Please limit your questions to 1 at

Speaker 2

a time. Operator, please start the Q and A. Thank

Operator

Your first question comes from Michelle Cheng with Goldman Sachs. Please go ahead.

Speaker 2

Hi, Joy, Yandi. Congrats for still very resilient result and also the impressive shareholder Well, we understand the company's strong long term position, but my question is still want to focus a bit on the short term. So can you give us some colors regarding this And also I think Andy mentioned about in Q1 we are looking for more steady core operating profit. So can you clarify, does Lee refer to like profit level or margin? Yes, so that's my question.

Speaker 2

Thank you.

Speaker 3

Thank you, Michelle. So let me address your question about clarification on our Statement on core operating profit in the Q1, we are looking at the overall Level, not the margin side. I think it's important to keep in mind that in the Q1, Last year was exceptional, phenomenal quarter that we achieved record profit, which was posed by, obviously, the sales leverage from the initial reopening demand surge and then also some significant Temporarily VAT deductions and labor gains from labor shortage. So those factors, we don't Expect them to repeat again this year. And so I hope I answer that question and clarification.

Speaker 2

For the Chinese New Year trading, Andy has mentioned In his presentation earlier, it's a very, very tough lab because last Chinese New Year, we have a phenomenal Trading during the 2022 Chinese New Year. But we have prepared very full and exciting calendar For the Chinese New Year, not only the excitement of the marketing campaign, but products and this is first time we launched 5 new burgers, 5 weeks before going to the Chinese New Year, the excitement is there. So far has been trading has been the trading so far has been solid, but it's still a bit earlier because We really need to anticipate until the 1st day of the Chinese New Year. And then right now, The weather to a certain extent, the extreme weather is a bit of wildcard. So that's where we are and The focus going into the Chinese New Year after the 1st day of Chinese New Year is about our golden bucket.

Speaker 2

That was our total focus of all our Operation team. But it's very, very tough quarter. So we'll be happy if we We can stay flat with the same store sales. That's where we are right now.

Operator

Your next question comes from Brian Bittner with Oppenheimer. Please go ahead.

Speaker 4

Hi. Thank As it relates I understand the Q1 is a very difficult comparison versus last year, but Your goal is to keep the operating profits flat as I heard it. So what type of sales trends or same store sales do you need In order to keep those operating profits flat. And then Andy, once we get past this first quarter Difficult comparison. How do you think about the way the year will build?

Speaker 4

How do you think about the second half of the year and the opportunity to grow sales there versus maybe the first half of the year, which seems to be a more challenging setup.

Speaker 3

Thank you, Brian. Yes, so I guess there's a lot of question about the Q1 outlook, why do you so? But before again, like dive into more details On the Q1 outlook, let me just point out a couple of things, right? Overall, consistent with our 3 year plan, we are confident that we will maintain stable operating margins in the long run. As I mentioned, The emphasis here is a long run because in the near term, we're going to have certain factors that affect the near term And then over the long term, we also will look into potential opportunity as we have been doing so to restructure our cost base, Looking to improve our occupancy and other costs and then also leverage our digital capability to better manage Better use of more effective advertising and also G and A expenses.

Speaker 3

Now when we look at In 2023, restaurant margins and OP improved by meaningfully. That's driven by same store sales growth, Right. And as well as new possible construction. So KFC, you saw the offering at very High level in total margins. And then Pizza Hut has a little bit more room for improvement in the long term.

Speaker 3

Now if we look at the quality fluctuations, that's to be expected. As we mentioned, this is the 1st year So, normalizing operation post reopening. And in the Q1 And every quarter will be driven by some seasonality and then also will be driven by obviously the sales trends and other factor Sales is always a very important factor in terms of margin for us. And As you mentioned and mentioned, last year, it was the high days. We achieved, again, like a very phenomenal Quarter with record setting operating profit.

Speaker 3

And so and then there was also some one off, as you mentioned, you can look at the Looking to your table roughly $30,000,000 of one time that we received last year. So that's set of a high base for us this year. Obviously, we work hard to manage our costs and drive sales. And in the Q1, we ended walking under a new normal, Right. And as we have mentioned in our prepared remarks, consumers are more rational in terms of They're spending and eager for new and good value for money product.

Speaker 3

And so, as Sylvia just mentioned, we have set up a number of very intensive number of product launches in our Canada. And then we also make sure that we have significant resources and campaigns to drive that sales and traffic, especially around Chinese New Year, okay? So on again, like Chinese New Year right now is too early to give a very solid outlook Because this year Chinese New Year is a bit later compared to last year. So current right now, as We look at our plan, under the new normal is on track. However, as we mentioned, there's quite a few uncertainty with Chinese New Year because 100 of millions of people are traveling in very short period of time.

Speaker 3

And so the weather conditions, as we have observed recently, may or may not have an impact So we will continue to monitor the situation and adjust our plan as we always have been quickly to respond to any changes if necessary. And so on the cost side, as I mentioned, obviously, we will focus on productivity improvement, cost control, And then the goal is really to maintain a stable core operating profit after adjusting for the non recurring items and foreign exchanges. Thank you.

Operator

Your next question comes from Xiaopo Wei with Citi. Please go ahead.

Speaker 5

Good morning. Thank you for taking my question. I just look a little bit longer term in terms of business. And the first thing is, If you look at the financials, in 2023, actually a very good control G and A. If you look at G and A to sales ratio, actually going down.

Speaker 5

If we look at 24, as Julie and Andy mentioned, there are some factors which you cannot control in short term, like weather, like Macro, so shall we be certain that G and A to sales ratio will continue to go down in 24 because that we have more control Management of our admin cost at half quarter level? That is the first question. The second question is, Eddie and Joe, you mentioned that The consumers are more rational this year. So, could you comment on your competitors? Will competitor be more rational as well with more rational

Speaker 3

I will just quickly talk a little bit about our cost effort in conjunction with the G and A. You can see that over the past few years and last year, we have put a lot of effort to restructure our cost base. Our overall target for COS have been trying to keep stable and we have CapEx stable around 31% over the past few years. Obviously, COS Moved seasonally somewhat and we generally cap it around like, sorry, 31% plus or minus 1% For the full year. And then the other one is labor cost.

Speaker 3

Labor cost, obviously, over the past few years because of the pandemic, we did see some impact On cost inflation and also delivery mix shift that drive up the labor cost. But we're able to more than offset that through The reductions in occupancy and other costs, significant improvement compared to even pre pandemic level by almost like 3 50 basis points. Our brand is at record low right now as a percentage of sales. And so that's the longer term trend. And our depreciation costs also come down because we have improved CapEx efficiencies and then also optimize our portfolio.

Speaker 3

So those are the longer term trends. In terms of the other margin lever for us is marketing and advertising because we have invested a lot in digital And our member base right now is very large, 470,000,000 member, count for almost 65% of our sales already. So we think we'll be able to work on that in the future. In terms of G and A, G and A expense as a percentage of sales have improved this year Right, to 5.8%. We continue to aim to continue to sustain that trend by ensuring that G and A growth would remain Significantly lower than sales.

Speaker 3

To do that, obviously, we'll continue to improve labor, both like our efficiencies in in house, New technologies and other automation tools to help automate some of those administrative tasks. Thank you.

Speaker 2

Yes, Paul, I think I'm going to address your question by taking a step back by looking at the Trends, the industry trend, the competitors trend, the consumer trend and then our own Observation of our trading trend and that hopefully will give you a holistic sense of our long term view. 1st, industry. It's widely reported everywhere the China economy is growing at mid single digit, but it's rarely reported 2023, our industry actually grew at Double digit, actually 20%. So the recovery of the restaurant industry was very vibrant for 2020 And we are doing slightly better than industry average. However, for 2023, it was not Easy to disaggregate many factors, including the growth or the recovery.

Speaker 2

One reason is sometimes the headlines could be misunderstood. I'll give you an example. For quarter 3, Yum China performance, the headline was reported we grow sales of revenue by 9%, Missed the expectation by 5.7%. In reality, that is due to the foreign exchange difference. In our operating currency, which is in RMB in China, our sales growth was 15%.

Speaker 2

But the reporting currency is in U. S. Dollar, so it's reported at 9%. So if we disaggregate the foreign exchange from the Operating currency, we see the difference. But fundamentally, our industry is growing very nicely.

Speaker 2

And then of course, quarter 2, The actual recovery in terms of the system sales was as much as 32%. So net net, the industry Why other than Yum China, there's so many competitors have been so aggressive To open your store because opportunities are there. Is it competitive? Yes, absolutely. But fortunately, let's not forget, it has always been competitive in the last 36 years as well and we have always been able to stay as a market leader in the last 30 some years as well.

Speaker 2

That's point 1. Point 2, consumption trend. What I'm going to share is not the mainstream thinking, so we can agree to disagree. The mainstream thinking is China is going through consumption downgrade with many challenges. To a certain extent, it's true, but to a certain extent, customer are just getting more rational.

Speaker 2

However, what is not being mentioned at all is even with 5% GDP growth For mid single digit GDP growth, consumption upgrade is still also happening. Urbanization in China is still happening and we don't even need to look at the restaurant industry. We can look at China's top 6,000 shopping mall, which we Track because we opened a lot of stores in those shopping malls. Within the segment of top 6,000 shopping malls, 2023 alone, there were 400 new shopping mall open, not a small number and twothree of them opened during the second half of the year, quarter 3 and quarter 4. And we are happy to report to our shareholders that these shopping mall location stores are trading better than the rest.

Speaker 2

Well, Apart from the tourist and transportation location. So when a shopping mall Open near the high street or close the high street, you can imagine the traffic move to shopping mall and that itself is consumption upgrade. So come back to the rationalization of the customer, how do we respond to it? We are the market leader. We our focus in the last 30 some years and our ongoing focus is how to build a brand with a combination of good value, amazing products and opening up the price point.

Speaker 2

It's a combination of all of these. Good food is always number 1, and you can see why we Continue to roll out so many good food, but at the same time, we are very cautious about the price point. There's a reason why original recipe chicken after 36 years, the price is less than 5x of the price we launched 36 years ago. Only if the China housing price increased by the same ratio of original recipe, then I think many Chinese people are even happier. So we do a range of the product launch.

Speaker 2

We launched Wagyu beef The price as much as RMB50, but at the same time, we also introduced Marked as the entry price value combo at 20. This is the range we're going for and it's working. Point 3, come to the trading pattern, what have we seen during quarter 4 and that will give us Some idea about the 2024 going forward. We celebrate 10,000 stores of KFC during December This year, it was very meaningful for us and it also I hope gives some confidence to our investors that Western QSR is solid and has nice growth. Quarter 4 will start with a bit of softness.

Speaker 2

We don't have to reiterate again, but the trade improved in November and then improved a bit more in December. Good to know the trend is all right. And then the rebound of dining is very strong. However, delivery remains popular. It's still 36% of our business.

Speaker 2

Customers like the convenience. By trade zone all improved. As I mentioned earlier, tourist location and transportation are Recovering very well. Other than that, shopping mall are doing the best than the others. By region, recovery happened across all regions for Porta four Northern part of China recovered the best because last year COVID lapping, They were very difficult last year.

Speaker 2

And across the year, Eastern part of China, which is the most important part of our Business is still the most resilient region. In city tier, Tier 2 inland Central Power China One good example is Changsha, it's the destination for foodie in China. A lot of amazing food concept there. People go to Changsha just to enjoy different food, but little do people know Changsha's rent is only about 10% to 15% of Shanghai, And yet ticket average is not too different. And these are the example of the cities doing the best and going forward.

Speaker 2

And Pizza Hut are doing very well in lower tier cities and that proves that The Pizza Hut business model works for lower tier cities. Last but not least, our weekend trading right now is Better than we'd say. This is phenomenal for our team because if you remember in the previous earnings call, our Again, traffic was more challenged after the pandemic. People's behavior changed. The traffic during weekend dropped.

Speaker 2

What did we do? We launched the whole chicken and that product the whole chicken product target very, very has a very clear focus to drive the delivery business during the weekend. Customer can buy the whole chicken, put it on the table, have a veg and some rice and this is a very nice meal. So now Our weekend sales actually is better than we did, huge milestone for Thank you for indulging me. It's a long answer, but I hope that gives you some sort of long term view of the way that we share our business.

Speaker 2

Thank you, Jiapo.

Operator

Your next question comes from Lena Yan with HSBC. Please go ahead.

Speaker 6

Hi, management. Thanks for the very detailed walk through of your business. And your points are Well taken that you're very nimble in reacting to competition. But when I talk to my clients, what I heard most over Last quarter was the market affair as you brighten your price point, especially by launching more and enterprise offerings. It might drag down your ticket size.

Speaker 6

Obviously, Andy shared some numbers. Your TK size 39 was very like a stable quarter over quarter Y o Y in 4th quarter. But I'm wondering if you could give us more color in terms of how those entry price offering products affecting your sales mix and what's the impact on ASP and the number of transaction per ticket so that you can maintain a relatively stable like 39 ticket size. And on top of that, What will be the impact of enterprise offering on your GP margin? Thank you.

Speaker 2

Thank you. Let me To reiterate, we have been able to protect our ticket size and even grow a little bit over the years. So 2019 pre pandemic, the ticket average is 37. 2020 is 40 And then 39, 42 and then 41 for 2023. So this is the long term trend.

Speaker 2

And we even go back even another 5 years, it's not So this is always our trading strategy to keep the ticket average relatively stable. To go to specific, the introduction of the entry price product always comes with The new product it's a new product and also comes with the introduction of the high priced product. I mentioned that the beef burger, The beef burger grew by 18% last year, by the way, the category. So 50% RMB50 for group beef burger and RMB20 combo is a good balance. What also help is when we do promotion like even for Chinese New Year, We always try to help customer to trade up to a higher ticket average by Having a very attractive discount.

Speaker 2

So it's a combination of the marketing campaign that we have been doing to protect the ticket average. But specifically for the entry price product, it has three purpose, and we are happy to see all three purposes there. One is, it does attract incremental customer As we become more and more mass market, particularly for Pizza Hut, by the way, Pizza Hut's ticket average Move from 120 to right now 90 over the last 5 years as part of the turnaround strategy, obviously work, Because if we want to open more stores, become more mass market, we need to have product and price point that cater for the incremental Customer, so it work and to what percentage is above 5% right now is not like huge proportion that will offset the balance Of our margin, that's point 1. Point 2 is interestingly, when we have the entry price product, Does it mean the most of the customer will go there? Not necessarily.

Speaker 2

If you think about customer sidekick, many customers will still go for The product above the entry price product, you feel good. It feels good to choose something in the middle, not the cheapest one, right? You are the customer yourself, ask yourself how would you choose. 3rd, it really actually improved the price perception By having something very low cost there, I'll give you one example I did 10 years ago with KFC Business. I lower The small Pepsi coke price in our menu lowered it because it looks Good.

Speaker 2

It looks very affordable, but how many people actually went for it, not that many. But the perception It's important. It's almost as important as the reality to a certain extent. So I hope that gives a sense about How do we treat the entry price product? But certainly, it helps when we go down to Tier 5, Tier 6 city to introduce our product to certain customer.

Speaker 2

By the way, it's a fantastic way to Recruit young customers such as Udon as well, particularly with amazing product like Golden Spa Chicken burger is breast meat. Breast meat in the U. S, you can sell it at higher price than stock meat, but in China, it cost us less. So the margin of course, we protect the margin. The margin is just fine.

Speaker 2

Thank you.

Operator

The next question comes from C. G. Lin with CICC. Please go ahead.

Speaker 7

Thank you, Joy and Andy. So, we have talked a lot about the competition. I want to

Speaker 2

ask one question about Pizza Hut.

Speaker 7

So we see that Pizza Hut had quite good performance on margin in Q4, driven partially by the labor productivity gain and lower rider And we also mentioned before that Pizza Hut's margin is still lower than KFC and there's room for improvement. So what else we can do to further reduce cost and improve efficiency? Thank you.

Speaker 3

Thank you, Sijie. So again, when we look at our Cost and the focus, as we have said many times, including what Joey has just earlier mentioned, we Generally, we try to aim for comp sales to be markedly stable over the long term on a year over year basis. And that's because we have a very excellent supply chain team, very disciplined with our pricing. And this also comes from our commitment to continuously innovate And also introduce new products every year. And also, as we have mentioned many times, We make the best effort to using every part of the chicken or cow so that we can enhance The results usage minimized cost and all these qualitative have allowed us to provide great value for the money for our consumer, while keeping our cost of sales There will be some new quality seasonality and punctuation there.

Speaker 3

But if you look at our track record, We have been able to keep it around like 31% plus or minus 1% over the past few years. I think last year, we just went on the bat, 31%. Now when we look at the overall cost, labor costs, obviously right now we're So it would be probably more modest in terms of the rate increase. But more importantly, over the year, we have utilized Digital and Automation 2 and technology, like AI assisted scheduling or inventory that we have mentioned before to enhance Labor productivity to manage costs. We are also with the RGM initiative basically, We are trying to streamline administrative tasks and then like equipment or training, etcetera, to a more centralized process, As well as centralized food processing to further improve restaurant labor efficiency.

Speaker 3

And so obviously there is some fluctuation, but in the long term, we aim to keep labor cost Margly stable in the long run. Again, the emphasis here is on the long run, because in the short term, it's going to be always impacted by the sales leverage. Now, occupancy and others, this goes same for KFC and same for Pizza Hut. It's an area where we will have opportunity. Compared to the pandemic, as I mentioned earlier, we improved by almost 2 50 basis points.

Speaker 3

Now, right of sales ratio 1, we have good long term contracts and then we also have optimized our stock portfolio. As we expand into lower tier cities, they generally also come with lower rent. As we mentioned, the brand in Changsha is a lot lower And then we also have more flexible formats that are targeting delivery and takeaway That are small and also more cost efficient in terms of rent to sales ratio. Now, distribution cost is another one. We continue to work on this.

Speaker 3

You can see every year, Our CapEx per store has improved. Compared to a few years ago, it's around like RMB2.5 million, Today is around RMB1.5 million per new store. So our depreciation cost also improved And marketing, leverage and etcetera. So I think for Pizza Hut, obviously, labor Potentially, is there improvement opportunity there, O and O, definitely. As I mentioned before, KFC is already running at very high operating So the room volume footprint potentially will be in the

Speaker 8

O and O time.

Speaker 2

Let me give the overview and take a step back again. We've been very consistent with the Pizza Hut strategy since 2017 when we embarked on the Pizza turnaround. It sells first Profit later and then resiliency comes after that. Sales is obviously You remember, we work on a product, we work on marketing campaign, we work on the business model, we work on unit economics of each of the stores. Now once we turn around the same store sales within 18 months after we make the promise, then we really turn the focus To profit, because sometimes they have to do the trade off, particularly at the very beginning of the turnaround of building a brand.

Speaker 2

The trade off is always transferred properly later. So later on, we work on the cost side, all the details Andy just go went through with you a minute earlier. And We'll continue to do that and we want a bit more profit bit by bit on every element. What is after is resilience, It's more profit. We are going to open more stores, obviously, across all 3 tiers To improve to utilize the scale of our business to get better rent, to get better cost of sales, etcetera, etcetera.

Speaker 2

And then next is resiliency. We want to build a very resilient business, even more resilient They're now as resilient as KFC. Well, it's a very challenging goal, but Unfortunately, when you have 2 brothers and of course, 2 brothers compete with each other, it's just normal. So for example, one challenge we give to ourselves, which we got it already 2023 is We want each quarter to be profitable because Pizza Hut is quite a seasonal business, even more seasonal than Pepsi. So you can see that quarter 4, 2023, we remain profitable.

Speaker 2

It's very important because I just don't like business That make a lot, even though that's big and small quarter. And then we'll continue to improve the seasonality and we even continue to improve The resources allocation during the peak hour and slow hour of the day. And that's how we improve the resilience of the business, Not only for the shareholders, but for our employees as well. Thank you.

Operator

Your next question comes from Kevin Yen with JPMorgan. Please go ahead.

Speaker 9

Thank you. Thank you, Julie and Andy. My question is on the ASP. Okay. So good to see the ticket size was up from 39 to 42, which is very good.

Speaker 9

But we like to better understand if The Q4 'twenty three, a bit different versus before. So for example, on a like for like basis, KFC average ticket size down what percentage and traffic coming back by what percentage of points. So just try to quantify, In the Q4 ASP down and the traffic hit back, okay. And secondly, also like to note your source for 2024, Your conviction level to maintain flattish same store sales growth in 2024 and if we're considering The contribution from the G and A cost cutting, etcetera, what's the minimum same store sales growth level for you to maintain the restaurant margin in 2024. Thank you very much.

Speaker 3

Okay, Kevin. Thank you for the questions. So a little bit clarification on the TA and 4Q Yes, that's right. So for KFC, we have same store sales growth of about 3%. And transactions for TC count increased by 16%.

Speaker 3

And then the average ticket size was down 11%. For Pizza Hut, the same store sales growth was about 6% And then the traffic growth was 15% and then every ticket change was about 8%. So but as I mentioned before, the TA trend, the average ticket trend It's pretty consistent with our overall strategy and to broaden our market reach. And As Joey mentioned, the strategy and approach is to expand our software footprint, especially in the small city, expanding our pricing point And then offer consumer more product options to drive incremental traffic and sales. So the significant growth that we have observed both in transaction and overall system sales growth, I'd remind everyone for both KFC and Pizza Hut system sales grew More than 20% in both in the 4th quarter, but also for the full year.

Speaker 3

So obviously, if you look at the sales number, Now, our strategy is working effectively. Now, when we look at the ticket average changes on a year over year basis, It's worth noting that 2023 obviously was the 1st year of reopening. So this is an important context So keep in mind when we look at the TA movement and as we have mentioned before KFC, we're seeing favorable bus ticket average In the Q4, RMB39, which is consistent with the Q3 and is above what we have seen in the pre pandemic. In fact, the ticket average, as we have mentioned earlier, have been pretty consistent And over the past 5 years, obviously, with the recovery in the dine in sales grew strong this year, coupled with Strong performance in our breakfast and coffee sales has contributed to the year over year movement of the average ticket size for KFC. It's also consistent with our approach to expand the pricing range and our prior options that again effectively drove favorable traffic growth.

Speaker 2

Let me just add a little bit here about the quarter 4 ticket average and then Andy can Kevin, the ticket average of our quarter 4 is not that unusual. As Andy just point out, 2022 is the unusual year because it was still in lockdown, it's 42, that's very high. If we go back to 2021, quarter 4 is 38, like this the 2023 quarter 4 is 39, but 2021 quarter 4 is 38. 2020 quarter 4 is 38. 2019, which is one of our best year, the ticket average for Q4 is 37.

Speaker 2

So it's not that different. I mean, So over feeling is the market is getting more promotional, etcetera, etcetera. But as I went through in great detail that we are the market leader. And when we deal with challenges like that, which is not new to us by the way, we always have a combination of Good promotion, a good product, good mechanism to protect the TA, etcetera, etcetera. Therefore, we are able to maintain The TA, even during the quarter for across multiple years.

Speaker 2

Thank you.

Speaker 3

Right. Thank you, Joey. Again, it's very important Keep that context in mind because as you remember, it seems like long time ago, but it was only Q4 2022 that we have this reopening and big surge in infection At that time, we also experienced some labor shortage because of the infection rise. So and then the ticket, I think the delivery mix at that time was 45%, Which is very high. And so those are the context for that.

Speaker 3

And then turning to Pizza Hut, right, if you look at Pizza Hut, it's a very consistent strategy for Since 20 27 with the turnaround strategy, which is to, as Zoe mentioned earlier, Drive customer traffic first, then sales and then finally, enhancing profitability. So we have successfully mapped those 3 goals. If you look at our results, Moreover, this approach is very much in line with our latest strategy, which is aimed to reach underserved customer segment by expanding our price range, especially for pizza that is less than RMB50 subcategory. And we also want to offer more options for consumer that are suitable for smaller size or individual dining. Thank you.

Speaker 3

Thank you, Kevin.

Operator

Your next question comes from Chen Lu with Bank of America. Please go ahead.

Speaker 8

Thank you, Joey and Andy. And sorry, actually my line got disconnected just now, although I So, So basically, it's actually on margins. So I noticed that our restaurant margins for 2023 actually has already recovered to a level even slightly higher than 2019, so making it the 3rd highest margin since our spin off. But compared with 5 years ago, our margin structure has significantly changed. So our Labor cost as a percent of revenue has risen significantly, but our occupancy and others have reduced significantly.

Speaker 8

So going forward, do we think that there's room for us to maintain a largely stable Labor to sales ratio, especially given that recently our channel check suggests we have taken a lot of measures to control the rider costs, such as the introduction of Meituan and Eleleme as our future vendors as well as our Continue rollout of the RGM macro program. So do you think there's room for us to see a largely stable labor cost as opposed to the rising labor cost trend in the past few years. And meanwhile, I noticed that our food and paper cost as Tetsuya revenue has risen by 50 bps 80 bps For TFC and Fitbit for the whole group, given very promotional environment, do you think it's going to be a new normal for the entire year of And lastly, just now, I heard about guidance for Largely flattish OP for the full year excluding FX and one off items. But then if you look at the reported level, I remember last year we booked a one off gain of 27,000,000 Now OP, that may actually lead to around mid single digit impact. And then given the FX, there's another 5% impact.

Speaker 8

So is it fair to say that on the reported level, actually the OP may possibly decline By around 10 percentage ish. Of course, I think this is this should be the worst case, but hopefully if Everything is going in the right direction. The actual decline could be better than that. So these are all my questions. Thank you.

Speaker 2

Thank you, Lawton. Let me actually answer one question that Kevin and another And Brian, as early and then I'll come to your question. It's about the same store sales growth. Let me just point out that 60% of our store in our portfolio right now are built after 2019. So there's a reason why we really we'll continue to drive the same store sales, but the system sales growth is incredibly important for our business.

Speaker 2

And then we'll come to the cost side, mainly The labor costs, let's talk about O and O first. We have been operating with the guiding principle that we always are sincere about getting the best food To our customer, pass all the saving pass a lot of savings to our customer. So if you look at our cost of sales Over the last few years, it has been very stable, very, very stable through Better times or more challenging times. So if I start with 2019 pre pandemic or even well, 2019 pre pandemic 20 19, 31.3 percent 2020, 31.7 percent 2021, 31.4 percent 2022, 31.1 percent 2023, 31%. It's really Like less than 1% swing around 31%.

Speaker 2

It's always there, because whenever we have savings, we pass the savings To the customers through food, you can be assured that we'll continue to stay around 31% about the cost of sales because if my team Go significantly below that number, they will have a very hard time for myself, and they all know that. 2nd is cost of labor. Cost of labor, even in a year like this year, yes, it has increased because there are a lot of Sort of the insurance and etcetera, etcetera, all these costs are going up. And labor cost is always sort of Going up, I spent 10 years in the U. K.

Speaker 2

Even when the GDP was going south during the 5 year out of 10 years I was there, Labor cost was still going up. So we have to every year find ways to help our staff to become more Perfect. We have been doing it and going forward, you can see we even go as far as 1 store managing multiple stores. It has gone up few points. 2019 is 22.8% and then go up to 23%, 25%, 26% now it's Staying at 26% last 2 years.

Speaker 2

And the way that we run this business, we Generate savings from all in all, from rent, from depreciation, from everything that we could save and then pass the savings To our staff, we pay them at their pay and we hopefully pay them well. We give them really good health insurance, etcetera, etcetera, Because we want to have the best staff to provide the best service for our customers. So that will be the direction we'll continue to drive. In terms of OP, as a result of foreign exchange, etcetera, I'm sorry, cannot forecast that. It's beyond our company's capability.

Speaker 2

So we'll do everything we could to generate sales And to manage costs and then produce the results as a result of our good effort. Thank you, Walter. Thank you. That is all

Operator

the time we have for questions today. I'll now hand back to Ms. Shen for closing remarks.

Speaker 1

Thank you, Ashley, and thank you, everyone, for joining the call today. For further questions, please reach out through the contact information in our earnings release and on our website. Have a great day.

Speaker 3

Thank you. Thank you.

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Earnings Conference Call
Yum China Q4 2023
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