Eight analysts have increased their forecasts for this year and next for this Chinese quick-service company.
Yum China (YUMC)
From Cabot Emerging Markets Investor
Yum China (YUMC) is a new stock (though not a new company) that checks most of the boxes we look at when evaluating potential winners. Big company that’s a leader in its field? Check. History of solid growth? Check. Long runway of growth going forward? Check. And a stock that recently lifted into an uptrend? Yes!
Yum China is the Chinese arm of Yum! Brands, the global quick service restaurant giant. It was spun off from its parent company last October, but it’s been operating in China for a long time. The company recently celebrated the 30th anniversary of its first store in that country.
Today Yum China is far and away the leading western quick service restaurant operator in China. At the end of March, the company had 7,663 restaurants (nearly 5,300 were KFC locations, about 1,700 were Pizza Huts with the rest a mix of Taco Bell and a couple of newer, home-grown brands) that attract a combined two billion customer visits annually. For comparison, McDonalds has “only” 2,223 restaurants in China, while Starbucks operates 2,171 locations.
Despite its size, management sees plenty of growth potential ahead. In the first quarter, the firm opened 133 new stores (72 of which were KFC) and is aiming for 550 to 600 new openings for all of 2017 (including entering nine new cities), which would be a 7.6% boost in total restaurants. Long-term, given China’s booming urban population and the relative under-penetration of quick-service restaurants in cities, Yum China sees the potential to triple its restaurant count.
And those stores have generally paid back the company pretty quickly. On a pre-tax basis, new KFC openings have returned Yum’s initial investment within three years, while new Pizza Hut dining locations pay back in a bit less than four years. Those aren’t the best metrics we’ve ever seen, but they’re certainly good enough to generate solid returns and allow management to continue its steady store expansion.
As for the here and now, Yum’s stores are doing pretty well, though growth is sluggish. In the first quarter, same-store sales rose 1%, though system-wide sales rose 4% on a currency-neutral basis. Interestingly, the company has been very active in keeping customers returning by using both loyalty programs (70 million loyalty members to KFC in China and another 23 million for Pizza Hut, all of which get special offers) and technology (31% of payments are now mobile). Delivery sales now account for 12% of the total, a figure that’s been rising recently.
Thanks to cost controls and greater efficiencies from a larger network of stores, first-quarter operating profit was up 27% on a currency-neutral basis, while earnings rose 19%, easily topping expectations. Importantly, free cash flow of $283 million was much larger than net income, boosting Yum China’s cash position to a strong $1.2 billion.
From here, it’s just a matter of executing on the growth plan. With China’s overall economy continuing to crank ahead, Yum China needs to boost same-store sales growth, keep costs in check and steadily boost the store count. Analysts see sales rising about 3% this year (likely 5% to 6% on a currency-neutral basis) while earnings rise 17% from a year ago.
The stock certainly portends good things down the road. YUMC had a good first month after being spun off, but then began a very tight multi-month base. Notice how shares spent many weeks in the 25.5 to 27 range during December/January, and, after a brief blip higher, again in February/March. Such action is usually a sign of accumulation, as big investors pick up shares in a certain price zone. And now the stock is freewheeling, after having surged to new highs following its earnings report and following through to the upside in recent days.
The chart looks great, but given the market’s recent wobbles, YUMC’s recent run-up and our relatively small cash position, we’re going to play it a bit conservatively here. We’ll take a half-sized position tomorrow and look to average up if things go well in the weeks ahead. BUY A HALF.
Paul Goodwin, Cabot Emerging Markets Investor, www.cabotwealth.com, 978-745-5532, April 20, 2017