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Yum China (YUMC) Expansion Efforts Continue, Traffic Woes Stay

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Yum China Holdings, Inc. (YUMC - Free Report) continues to benefit from its continuous expansion efforts with respect to menu innovation and digitalization. Also, the company has adopted a high-grade delivery strategy that is expected to drive sales in the upcoming quarters.

However, high costs associated with restaurant operations as well as the pandemic-induced dismal traffic are causes of concerns.

Let us delve into the factors highlighting why investors should hold on to the stock for the time being.

Factors Driving Growth

Yum China is consistently focusing on unit growth of restaurants in order to drive additional sales. During the first quarter of 2021, the company opened 315 new stores, reaching the total store count to 10,725 as of Mar 31, 2021. This was mainly driven by development of the KFC brand. Also, it remodeled 108 stores during the reported quarter. The company also plans to open approximately 1,000 new stores in 2021. Meanwhile, more than 80% of the company's current portfolio has been remodeled or built over the past five years. On Mar 16, 2021, the company acquired a 5% equity interest in Fujian Sunner Development Co., Ltd. This strategic investment is intended to enhance the company’s supply chain security, product development and menu innovation.

The company depends heavily on the potential of KFC and Pizza Hut. During the first quarter of 2021, the company witnessed resilience and energy in its KFC and Pizza Hut brands. The company operates 7,373 units of KFC restaurants in China as of Mar 31, 2021. Meanwhile, Pizza Hut operates in more than 2,382 units and is keeping pace with rising consumer demand for casual dining and delivery services.

Another factor that encourages Yum China’s top-line growth is its continual menu innovation process. KFC’s extraordinary performance is attributable to greater sales of menu offerings like crayfish burger, stuffed chicken wing and spicy chicken burger. During March 2021, Pizza Hut refreshed its menu, replacing 40% of the menu with new or upgraded offerings such as Beef Wellington and Roast beef tapas. It also introduced Portuguese chicken curry on the delivery menu to dine-in. The company will increase investment to expand presence in the Coffee segment as it believes that the beverage has a strong demand in China. Growing from a small base, the company is expanding its takeaway and ready-to-cook business through menu innovation. This will make the takeaway and ready-to-cook business more convenient for consumers.

Also, Yum China is capitalizing on the benefits of technology. It holds a leadership position in the China restaurant space when it comes to delivery, mobile order and pay, and loyalty membership. The company is increasingly shifting toward digital and content marketing to expand its customer base. Notably, it has been strengthening its membership program in Super App to engage members and improve customer service. With expansion in the cards, the initiative is likely to help the company drive volume and leverage on the extensive network to control quality.

Yum China has also started robust loyalty program that has more than 315 million loyalty members, combining both KFC and Pizza Hut brands. During the first quarter, the company sold 11 million privilege memberships at KFC and Pizza Hut.

Concerns

Shares of Yum China have gained 8.3% so far this year compared with the Retail - Restaurants industry’s 10.3% growth. The dismal performance was primarily caused by the coronavirus pandemic. Although the situation in China is under control and the company has opened its restaurants, during the first quarter of 2021, traffic was still below the pre-COVID level. Dismal traffic is likely to hurt the company same-store sales.



The company is facing the structural high cost of labor and rentals. In addition to wage inflation, rising costs are stemming from promotion, menu innovation and technological novelty. In the first quarter, total costs and expenses rose 33.7% year over year to $2,215 million from $1,657 million in the year-ago quarter. The deterioration can be primarily attributed to a 42% increase in food and paper costs along with a 38% rise in payroll and employee benefits and a 31% increase in occupancy and other operating expenses.

Zacks Rank & Key Picks

Yum China currently carries a Zacks Rank #3 (Hold).

Some better-ranked stocks in the same industry include Bloomin' Brands, Inc. (BLMN - Free Report) , BJ's Restaurants, Inc. (BJRI - Free Report) and Chuy's Holdings, Inc. (CHUY - Free Report) . Bloomin' Brands and Chuy's Holdings have a Zacks Rank #1 (Strong Buy), while BJ's Restaurants carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Bloomin' Brands, Chuy's Holdings and BJ's Restaurants’ 2021 earnings are expected to rise 372.5%, 52.4%, and 110.6% year over year, respectively.

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