Shares of Yum China Holdings, Inc. (YUMC - Free Report) have witnessed a sharp gain of 39% in the past year, outperforming the industry’s growth of 20.4%. The increase can be primarily attributed to robust unit growth, solid performance of KFC, menu innovation and digitalization. However, high costs associated with restaurant operations and lesser focus on the franchise model are concerns. Can the company continue its bull run in 2020? Let’s delve deeper.
Yum China is focused on relentless unit growth of its restaurants to drive sales. In 2018, the company opened 819 restaurants and re-modeled 931 stores. This exceeds the company’s target of opening 600-650 stores in 2018. In the third quarter of 2019, Yum China opened 231 new restaurants and remodeled 126 stores, reflecting a significant rise from the first half of 2019. Notably, the company is aggressively remodeling in the fourth quarter to achieve the target of 500 store remodeling for the full year. More than 80% of the company's current portfolio has been remodeled or built over the past five years.
Yum China relies heavily on the potential of KFC and Pizza Hut. With chicken being the most preferred form of protein among Chinese people, KFC has become the largest restaurant brand in the country. The brand, which has been witnessing considerable average check growth owing to its affordability, currently operates in 6,324 units in China. Pizza Hut, on the contrary, operates in more than 2,255 units and is keeping pace with the rising consumer demand for casual dining and delivery services. Notably, the company reported its 12th consecutive quarter of system sales growth, with same-store sales improvement at both KFC and Pizza Hut during the third quarter.
Coming to loyalty memberships, Yum Brands created a robust loyalty program that has more than 265 million members, combining both brands. Backed by deliveries and digital sales, the company’s loyalty membership rose at a high-double-digit rate year over year for both brands in 2018. As of Sep 30, 2019, the KFC loyalty program constituted more than 200 million members and the Pizza Hut loyalty program had more than 65 million members, up from 55 million and 15 million, respectively, in the comparable year-ago period.
Yum China is facing structural high costs of labor and rentals. Apart from wage inflation, the company is bearing the costs stemming from promotion, menu innovation and technological novelty. In order to curb labor costs, it is increasingly focusing on delivery channels. This is again expected to curb margins in the near term. Also, costs related to transactions and franchises are expected to increase in the near future.
Notably, in 2018, total costs and expenses grew 6.9% year over year to $7,474 million. This upside can be attributed to a 10.5% increase in restaurant expenses, an 11.1% rise in Payroll and employee benefit expenses, and a 14.4% hike in food and paper expenses. In third-quarter 2019, total costs and expenses increased 3.9% year over year to $2,019 million. This upside resulted from a 4.2% increase in restaurant expenses, a 5.8% rise in Payroll and employee benefit costs and a 6.7% hike in food and paper expenses.
Zacks Rank & Stocks to Consider
Yum China has a Zacks Rank #3 (Hold). Better-ranked stocks worth considering in the same space include Chipotle Mexican Grill, Inc. (CMG - Free Report) , Domino's Pizza, Inc. (DPZ - Free Report) and Dunkin' Brands Group, Inc. (DNKN - Free Report) . All these stocks carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Chipotle Mexican Grill reported trailing four-quarter positive earnings surprise of 16.1%, on average.
Domino's Pizza and Dunkin' Brands Group have an impressive long-term earnings growth rate of 13.7% and 10.9%, respectively.
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