Yum China (NYSE: YUMC), the operator of KFC and Pizza Hut in China, recently announced a solid quarterly earnings report — especially solid, considering that its customers weren’t allowed to leave their homes for most of the quarter. Here’s how they did it.
Not your typical network effect
As Chinese lockdowns seeped into the second quarter, Yum China reported headline numbers that appear underwhelming on the surface. Revenue was down 13%, and same-store sales were down 16%. Same-store growth is revenue at stores that have been open for more than a year. Operating profit sank to $81 million from $233 million in the second quarter of 2021.
Considering that Shanghai endured citywide shutdowns during the quarter and Yum China had only 30% of its stores offering limited services, the numbers could have been far worse. Customers’ embrace of technology helped the company immensely. Digital orders at KFC stores were already the bulk of orders in last year’s Q2, representing 86% of orders. They improved to 88% in Q2 2022. Digital order increases at Pizza Hut stores were much more dramatic, growing from 84% of orders in Q2 2021 to 92% in the same quarter in 2022.
Yum China’s digital readiness manifested in higher deliveries during the lockdown-stricken quarter. At KFC, deliveries accounted for 37% of revenue in the quarter, compared to 29% last year. In its Pizza Hut stores, deliveries jumped to 43% of revenue from 35% last year.
The company’s innovation also extended to its menu. It offers prepackaged items like microwavable fried rice and dumplings, as well as ready-to-cook pasta and marinated steak. Sales of prepackaged menu items more than doubled in the first half of 2022 compared to 2021.
What makes Yum China special, though, is its distribution network. The Chinese restaurant industry is very fragmented, and therefore, so is its supply. Yum China spent the time and capital early in its life to build a distribution system that can source food and supplies from many small suppliers around the country to support its expansive operations.
The lockdowns limited store openings for the quarter, but management believes it can open 1,000 to 1,200 new stores in 2022, improving on the 12,170 it had at the end of the quarter. In a show of its commitment to further expansion, Yum China opened two new logistics centers and broke ground on a third.
Is Yum China a buy right now?
Investors likely have one big question: Will there be any more significant lockdowns in China? Of course, we can’t predict the future, but Yum China has proven it can overcome. The company managed $83 million in net income in the first quarter and managed a profit in each quarter in pandemic-laden 2020.
Given the uncertainty surrounding lockdowns, Yum China’s stock is down 24% over the last year. The company has wisely taken the share decline as an opportunity to allocate its profits to repurchase 400 million company shares.
The company has built a lasting moat around its business that will allow it to expand its store count and serve more customers over the years. Long-term investors could see value in fallen Yum China shares, which could lead the Chinese reopening recovery.