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.
Yum China's (YUMC) second-quarter sales and cautious statements regarding back-half trends sent shares tumbling, but we still believe the company's long-term free cash flow and capital allocation story remains intact.
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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R.J. Hottovy does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.