KFC and Pizza Hut show China’s restaurant industry recovering quickly from pandemic

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The COVID-19 pandemic continues to have a negative effect on businesses around the world, with the restaurant industry being one of the hardest hit industries. But for some channels, things could be much worse. The only licensee of KFC, Pizza Hut and Taco Bell in China since Yum! Brands (YUM -4.58%)yum china (YUMC -4.97%) — did pretty well in the second quarter of 2020, all things considered.

Almost all of Yum China’s more than 10,000 locations (a milestone reached in July) are open again; and while the recovery slowed in June and July as ongoing actions to combat the spread of the virus continued, revenues had rebounded to 93% of their level a year ago. Specifically, KFC’s same-store sales (an average of foot traffic and customer order value) were 90% of what they were in the second quarter of 2019. Pizza Hut was at 88%.

There’s work to be done before Yum China can get back to where it was at the start of 2020, but it’s an enviable improvement over where many other restaurants sit right now. The key to its success lies in its significant digital activity and its ability to invest even in lean times. And still in the black with plenty of cash and no debt on the books, it remains one of my favorite restaurant stocks.

Image source: Yum China

Some numbers for context

To be fair, Yum China’s headlines weren’t pretty. Revenue was down 11% from a year ago to $1.9 billion (or a 7% decline excluding currency). Adjusted operating profit fell 36% (33% excluding currency) to $132 million. And adjusted earnings per share (which includes a partial sale of Yum China’s stake in the food delivery service Meituan Dianping (MPNGF -5.54%), of which Yum China still owns 4.2 million shares) fell 24% to $0.35. As a result, the stock now trades at 39 times trailing 12-month adjusted earnings per share.

But here’s the good news: even in incredibly difficult times, Yum China remains a profitable business. Free cash flow in the first half of 2020 was $90 million (which includes $177 million of acquisition expenses related to Huang Ji Huang’s 607 hot pot locations). KFC and Pizza Hut had 265 million loyal members in the last quarter, with those members accounting for two-thirds of sales. And delivery, which was already a big piece of the puzzle at Yum China, hit 27% of sales at KFC (from 18% last year) and 35% at Pizza Hut (from 24% a year ago). Digital and delivery services have been invaluable assets this year and will continue to be in the years to come as the global consumer transitions into a new era of mobility.

Travel, new channels and plant-based food

Yum China management cited travel as one of the last remaining challenges to a full recovery, due to the fact that many KFC stores are located in areas like train stations and airports. Light traffic at travel hubs will likely remain much less busy than usual due to ongoing COVID-19 restrictions.

A promotional poster shows the Beyond Meat burger currently being marketed in KFC stores in China.

A promotional poster shows the Beyond Meat burger currently being marketed in KFC stores in China. Image source: Yum China.

But that hasn’t stopped Yum China from continuing its pace of expansion as it continues to move towards its goal of 20,000 restaurants across the country. Excluding the acquisition of Huang Ji Huang, 169 new stores were opened in the second quarter, most under the KFC banner. But emerging brands are also on the move. Taco Bell made its first appearance beyond Shanghai, with a new flagship store opening in Shenzhen and another nearing completion in Beijing. The COFFii & Joi chain also continues to grow as Yum China bets on the long-term growth of coffee in China.

And the final note was the potential for plant-based foods. CEO Joey Wat said plant-based protein testing campaigns were successful last quarter, with the roadblock now increasing domestic production of the food. KFC, Pizza Hut and Taco Bell campaigns all sold out within days last quarter, pointing to another possible growth driver for the company in the coming years if it can increase supply with its alternative product partners. to meat.

Things are far from perfect for the restaurant industry in China, and KFC and Pizza Hut still have some catching up to do. Still, the outlook could be much worse, and Yum China has a solid foundation to build on in the years to come with a globally profitable food empire and $1.71 billion in cash and cash equivalents on the books. Stocks aren’t cheap given the depressed earnings reported so far this year, but my positive long-term outlook for this multi-brand operator remains unchanged.

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