Restrictions Take Fourth-Quarter Bite Out of Rebounding Year for Yum China

Operator of KFC and Pizza Hut restaurants in China posted small revenue growth in fourth quarter as it continued to briskly open new stores despite Covid disruptions

Key Takeaways:

  • Yum China reported its revenue rose 1% in the fourth quarter, and managed to remain profitable despite tough Covid restrictions that led to weak consumption
  • China’s biggest restaurant operator opened a record 1,806 stores during the year, bringing its total to 11,788, as it marches towards a goal of 20,000 stores

By Doug Young

“Staying the course” is fast emerging as a major theme among big Chinese businesses in the fourth quarter earnings season, with KFC parent Yum China Holdings Inc. (YUMC.US; 9987.HK) as the newest conveyor of that message in its latest results released Tuesday. Those results showed the last three months of 2021 were challenging, while at the same time reflecting a relatively strong overall year that saw its revenue grow 19% in 2021.

Signals of the difficulties at the end of the year have been coming loudest from China’s retail sectors, which are trying to keep investors focused on their longer-term development plans even as they come under intense new pressure from a recent wave of disruptions tied to the Covid-19 omicron variant. Yum China, which operates the KFC, Pizza Hut and Taco Bell franchises in China, has joined the likes of global names like McDonald’s (MCD.US) and Starbucks (SBUX.US), as well as local brands like hotel operator Huazhu (HTHT.US; 1179.HK), in feeling what could well be described as a “fourth-quarter pinch.”

On a full-year basis Yum China reported a $766 million operating profit for 2021 in its latest report, excluding special items.

Among the limited number of Chinese peers to give fourth-quarter data so far, Huazhu has said its revenue per available room (revpar), a widely watched indicator that combines hotel room and occupancy rates, fell by 12.2% in the fourth quarter year-on-year. Starbucks reported last week its same-store sales were down by an even sharper 14% in the final three months of the year. By comparison, Yum’s same-store sales were down by 11%.

To understand why things went from bad in the third quarter to worse in the fourth, one needs to understand the kinds of measures China has taken to keep its Covid-19 caseload remarkably low by world standards. Entire housing compounds and retail centers can be locked down when a single case occurs, or if someone who lives or works there is a close contact of a confirmed Covid case. Things get even stricter when larger outbreaks occur, with entire cities being locked down.

What’s more, people are also strongly discouraged from travel through various means such as requiring frequent Covid testing, putting a major damp on tourism. In one exemplary case, Shanghai Disneyland was shut in late October and thousands of people were tested after a single case was reported at the park.

“So I think the way I look at the situation right now is that, sure, in the short term, we have Covid, we have some of the macro headwinds,” Yum China CFO Andy Yeung said on a call to discuss the company’s latest results. “So it’s in short term, a little bit more cautious. But we are very confident in our operations, our brand, our products and the consumer loyalties, I think, have been demonstrated amply.”

The fourth-quarter pain owed largely to the highly transmissible omicron variant, which made appearances in China starting around December, resulting in complete and partial shutdowns of the major cities of Xi’an, followed by Tianjin and Zhengzhou in January.

Yum China has suffered because it has large numbers of stores – especially KFCs – in transportation hubs like airports and train stations that have operated at a fraction of capacity with dwindling travel amid broader weak consumer sentiment. The sharp same-store sales drop also took a big bite out of Yum China’s restaurant margins, which fell by half to 7.5% in the traditionally slow fourth quarter from 15.1% a year earlier. The decline was less severe on an annual basis, with restaurant margins down to 13.7% for all of 2021 from 14.9% in 2020.

Things are seen improving modestly in the very near term, though Yum China says it still expects same-store sales to fall in the first quarter as the effects of Covid linger.

Post-pandemic focus

Following all that discussion on the present, we’ll return to our theme at the top of this story with more new numbers showing how Yum China is trying to focus on a future when pandemic disruptions will be mostly a memory.

Yum opened 563 stores in the fourth quarter and 1806 stores in all 2021, bringing its total store count to 11,788 at the end of last year, as it entered over 160 new cities and further consolidated its position as China’s biggest restaurant operator. It said it expects to open approximately 1,000-1,200 net new stores this year as it marches towards its previously stated goal of 20,000 stores by expanding in smaller cities and using a smaller store model that allows it to open new stores more cheaply in China.

The company was the first major Western restaurant operator to enter China back in 1987, and has used that advantage to build up its position as the clear market leader. By comparison, McDonald’s has about 4,000 China stores, while Starbucks has about 5,500.

The brisk rate of new store openings helped Yum China to post slight revenue growth during the fourth quarter, with the latest three-month figure up 1% to $2.29 billion. On an adjusted basis excluding a one-time gain, the company still managed to stay profitable for the quarter by posting an $11 million net income for the period.

Yum China’s New York-listed shares rose about 1.5% in Wednesday trade the day after the latest results were announced. The U.S. shares have largely tracked the pandemic over the past year, rallying in the first half of 2021 as China seemed to have its situation under control, only to lose about a third of their value from a peak last June as the situation grew cloudier in the second half.

The stock looks somewhat undervalued compared to the U.S.-based Yum Inc. (YUM.US), with a forward price-to-earnings (P/E) ratio of 21 compared with a 27 for the larger Yum Inc. It also trails domestic Chinese peers Jiumaojiu (9922.HK) and Haidilao (6862.HK), which operate popular hotpot restaurant chains and trade at forward P/E ratios of 23 and 30, respectively.

In terms of the future, Yum China is focusing on off-site services such as more digitization, delivery and creating more semi-finished food products that people can make at home. Delivery has become one of its big growth engines, rising 60% in 2021 from pre-pandemic levels in 2019 and now accounting for about a third of all sales. The company is also increasing automation for store operation to lower costs and improve efficiency.

The company is also focusing on its coffee business, seizing on a growing taste for the upscale product among China’s growing middle class. In addition to selling fresh ground coffee at KFCs, the company also formed a joint venture with Italy’s Lavazza last year, with a previously stated target of expanding its current network of 58 stores to 1,000 by 2025 selling both coffee and related retail products.

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