Morningstar

Yum China's Long-Term Story Remains Intact

Despite cautious projections for the rest of the year, there were plenty of long-term positives from the wide-moat company's update.

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Yum China Holdings Inc
(YUMC)

Admittedly, we were expecting loyalty program engagement, targeted marketing efforts, and digital and delivery adoption to drive consolidated comps in the mid-single-digit range--compared with the 3% reported comps (4% for KFC, flat for Pizza Hut)--and we share concerns over management comments about facing "factors outside of their control": a competitive environment, wage/commodity inflation, waning VAT retail tax margin benefits, and Pizza Hut's turnaround efforts in the coming quarters.

Nevertheless, we encourage investors to focus on the longer-term positives coming out of the update, including comps that continue to be driven by transaction growth stemming from new menu additions and not excessive discounting (lending additional support to our wide moat rating), plans for an improved delivery platform companywide (aided by learnings from the recent Daojia delivery platform acquisition), and a potential dividend announcement by the end of year.

While we'll temper our back-half comp assumptions to 4% (including mid-single-digit growth at KFC and flat to slight declines at Pizza Hut) from 6%, we plan to increase our $35 fair value estimate by a dollar or two based on increased optimism over long-term mobile ordering (currently representing 40% of sales) and delivery (13% of sales), sales/cost synergies (including store base optimization) from the consolidation of the Pizza Hut Casual Dining and Pizza Hut Delivery businesses, and five-year restaurant margins that will likely exceed 18% (assuming the company finishes just under 17% this year, which factors in roughly flat margins for the rest of the year). While we view shares as fairly valued, we would encourage investors to keep this name on their radar screens if near-term concerns pressure the stock.

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About the Author

R.J. Hottovy

Sector Strategist
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R.J. Hottovy, CFA, is a consumer strategist for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He is responsible for consumer discretionary and staples research. He has covered the consumer sector as an analyst and director of global consumer equity research for Morningstar since joining the company in 2008, and specializes in a broad range of consumer categories including restaurants, footwear and apparel retailers, consumer electronics retailers, fitness clubs, home improvement and furnishing retailers, and consumer product manufacturers.

Before joining Morningstar, Hottovy was a director and senior stock analyst for Next Generation Equity and an analyst for William Blair & Co., specializing in a wide range of retail and consumer product companies. He also spent two years at Deutsche Bank, covering waste management, water utilities, and equipment rental stocks.

Hottovy holds a bachelor’s degree in finance and a second degree in computer applications from the University of Notre Dame, where he graduated magna cum laude. He also holds the Chartered Financial Analyst® designation and is a member of the CFA Institute and the CFA Society of Chicago.

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