Meemi O.
May 30, 20226 min
Updated: Jun 7, 2022
In Part 1 of our Yum China series, we introduced the history and business portfolio of Yum! Brands' China-based spin-off, Yum China. In this article, we explore Yum China's financial metrics and examine the performance of the company's individual restaurant segments.
Yum China Series
Note: to be consistent with Yum China's financial reporting presentation, we use US dollars in this article rather than Renminbi.
Note: minor discrepancies may exist between diagrams in the article due to rounding
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Financial Overview
We first start with a company-level financial overview.
#1: Yum China's Total Revenue Grew At A CAGR of 4.9% Over The Past Five Years
Yum China's total revenue grew from US$7.77 billion in 2017 to US$9.85 billion in 2021, with a slight dip in 2020 due to the COVID-19 pandemic. During the same time period, the company's operating income increased by nearly 80% from US$778 million to US$1,386 million, with a noticeable jump in 2021 due to high other income primarily arising from a US$618 million equity interest re-measurement gain. Operating income for 2018 and 2020 were also inflated by similar gains of US$98 million and US$239 million respectively.
Note: specifically, in 2018, 2020, and 2021, Yum China re-valued its previously held equity interests in Wuxi KFC, Suzhou KFC, and Hangzhou KFC, three affiliates that operated KFC in Wuxi, Suzhou and Hangzhou cities, in order to financially consolidate these entities that were previously accounted for using the equity method.
#2: 90% of Yum China's Revenue Comes From Restaurant Sales
Breaking down Yum China's revenue drivers, we see that restaurant sales (referred to as "company sales") account for 90% of the company's total revenue each year, followed by transactions with franchisees and unconsolidated affiliates contributing 7% to 8%, and franchise fees and income generating 2% of total revenue.
Each revenue driver is defined as follows:
Company sales refer to in-store food sales and food sales via delivery channels. According to management, delivery sales contributed 32% of company sales in 2021.
Transactions with franchisees and unconsolidated affiliates consist of the sales of food and paper products to, and advertising and miscellaneous services provided for, Yum China's franchisees and unconsolidated affiliates. With regards to the former, Yum China centrally purchases the requisite food and paper products for almost all of its restaurants directly from suppliers, and sells and delivers the items to each individual store in its network. With regards to the latter, Yum China is typically responsible for contracting third-party advertising agencies and collects advertising contributions as a percentage of sales from its directly operated and franchised restaurants. Other services provided to franchisees and unconsolidated affiliates mostly comprise of customer and technology support services.
Franchise fees and income include upfront franchise fees (i.e. initial and renewal fees) and continuing fees.
Other revenues refer to services provided to KFC And Pizza Hut by Yum China's centralized delivery team, as well as logistics and warehousing services provided to third parties.
#3: Yum China Is A Low Margin Business With Declining Restaurant Margins
Yum China reports two margin metrics: restaurant margin, a gross profit margin metric that captures the profitability of the company's directly operated restaurants, and operating margin, defined in the traditional sense as accounting operating income divided by total revenue. Both margin metrics are in the low to mid teens, with Yum China's restaurant margin declining gradually over the years from 16.7% in 2017 to 13.7% in 2021. At the same time, operating profit margin was 10% in the two years without substantial other income gains (i.e. 2017 and 2019), but was higher in the other three years as a result of the equity interest re-measurement gains discussed above.
*Restaurant margin is defined as (company sales - restaurant expenses)/company sales, where restaurant expenses refer to all expenses incurred with regards to the operations of Yum China's directly owned restaurants
#4: Yum China's Restaurant Expense Structure Is Relatively Constant
Yum China's restaurant expenses can be broken into three categories: food and paper products, payroll and employee benefits, and occupancy and other operating expenses. The company's overall expense structure has remained close to constant over the past five years, with a minor rise in the share of food and paper products and payroll and employee benefits, along with a slight decrease in the share of occupancy and other operating expenses.
#5: Yum China's Growing Revenues Are Not Being Translated Into Higher Cash Flows
Yum China's operating cash flows have remained relatively constant since 2018, in spite of the company's growing revenue. Management attributes the higher operating cash flows in 2018 to higher operating income (compared with 2017) and the timing of payments for inventory, while there is a general drop in operating cash flow levels starting in 2019 due to changes in accounting regulations which henceforth require non-current operating lease liabilities to be deducted as an operating cash outflow. The year 2020 saw a particular drop in cash flows as multiple cities in China entered lockdown due to the COVID-19 pandemic, whilst normality resumed in 2021 which should have warranted a rebound or increase in operating cash flows. Nevertheless, removing the effects of non-cash items suggests otherwise, with very little change in net operating cash flows each year particularly after the substantial non-cash other income gains have been removed.
Note: the cash flows stated are net operating cash flows
Segment Analysis
We now turn to a segment analysis of Yum China.
Yum China has three business segments for financial reporting purposes: KFC, Pizza Hut, and All Other Segments. The last segment refers to all of Yum China's restaurant businesses excluding KFC and Pizza Hut, and includes its controlling stake in food delivery platform Daojia (Chinese: 到家美食会).
Note: Daojia is a minor player in China's food delivery market, which is dominated by Meituan and Alibaba Group's Ele.me (Chinese: 饿了么). As of the date of writing, Daojia's delivery application has already been removed from the Tencent app store (one of the largest Chinese app stores), and its official WeChat account has also been deleted. Management mentions declining sales for Daojia following Yum China's acquisition of the platform in 2017, which resulted in a total impairment charge of US$23 million as the goodwill and intangible assets associated with Daojia were written down to zero. In our opinion, Yum China will most likely terminate the Daojia business.
Note: the individual segment revenue data presented in this section may not necessarily sum up to company-level aggregate data since some of Yum China's revenue and profit are categorized as unallocated.
#1: Yum China's Revenue and Company Sales Are Dominated By KFC, While Pizza Hut's Contribution Is Declining
Yum China's total revenue is dominated and increasingly driven by KFC, with the segment accounting for more than 70% of the company's total revenue. In contrast, Pizza Hut's contribution to total revenue declined year-on-year from 28.8% in 2017 to 22% in 2021. The share of All Other Segments rose slightly over the past five years, attributable to Yum China's expansion into non-core (i.e. non KFC and non-Pizza Hut) businesses, including the acquisition of Huang Ji Huang and launch of new coffee businesses (see Part 1).
Looking specifically at revenue from company (i.e. restaurant) sales, we see similar trends with KFC contributing an increasing 70% to 75% of such revenue over the past five years, while Pizza Hut's revenue contribution shrank from 30% to 23%. Interestingly, company sales for All Other Segments show almost no change during this time period, in contrast to the growing revenue generated by these non-core businesses. Management explains that revenue for All Other Segments is driven by the delivery services Yum China provides to KFC and Pizza Hut restaurants (presumably to franchised stores), as well as online orders for Yum China products (e.g. pre-packaged food, seasoning, and coffee products).
#2: KFC Is Yum China's Main Profit Driver, While All Other Segments Are Generating Increasing Losses
In line with the revenue analysis above, KFC accounts for the majority of Yum China's restaurant and operating profits, while Pizza Hut contributes a substantially smaller share. Ignoring the loss impact of All Other Segments, KFC generates approximately 80% of Yum China's restaurant profit and 90% of Yum China's operating profit, while Pizza Hut contributes the remaining 20% and 10% of restaurant profit and operating profit respectively. In contrast, All Other Segments have been generating a small but increasing loss year over year.
Note: restaurant profit is defined as company sales minus restaurant expenses
#3: Profit Margins Are Declining Across All Segments
Restaurant and operating margins have been declining for KFC and Pizza Hut over the past five years including 2021, in spite of the latest year's relatively higher revenues and company sales. Decreasing margins for KFC and Pizza Hut have generally been driven by rising wage and compensation costs, commodity inflation during pre-COVID years, as well as higher rider costs to meet the surge in delivery demand during the COVID-19 pandemic.
Restaurant margin for All Other Segments has declined significantly especially in 2021, due to losses generated from Yum China's non-core and emerging brands with the exception of Huang Ji Huang (see Part 1). Interestingly, although the raw magnitude of operating profit for All Other Segments continued to decline year-on-year, operating profit margin for the segment is improving, likely due to the increase in revenue generated by Yum China's delivery services and online orders mentioned above.
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Yum China Series
Yum China (Part 1): Introducing Yum China
Yum China (Part 2): Brand Financials
Yum China (Part 3): The Future of Yum China
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