Sales growth was indeed a miss in 2Q24, but the net profit was a significant beat. For 2H24E, we are still very cautious about the demand and so as the level of competition. However, thanks to various efforts like Project Fresh Eye, Project Red Eye, rationalizing number of SKUs, more direct sourcing, and ramp up of more profitable store formats (e.g. K-coffee and Pizza Hut's WOW model) etc., we are confident on a turnaround in 4Q24E. Maintain BUY with TP of HK$294.91, based on 15x FY25E P/E. The stock is now trading at 13x FY25E P/E.
We are still conservative about the topline growth in 2H24E. We believe the growth will still be hindered by high base and weak macro environment, and therefore our SSSG assumptions for KFC/ Pizza Hut are -3%/ -6% in 3Q24E and +4%/ +2% in 4Q24E. In fact, these numbers have already considered many positive factors like 1) expanding price range in order to tap into a large group of customers (e.g. the sales of entry price pizzas in Pizza Hut has experienced double-digit growth in 2Q24), 2) launches of more innovation new products, as well as more one person meals, 3) ramp- up of new store formats such as K-coffee (targeting 500-600 stores by FY24E, from 300 in Jul 2024) and Pizza Hut's WOW model (targeting 200 stores by FY24E, from 100 in Jul 2024),etc..
But relatively more comfortable on bottom-line growth in 2H24E. Even with the potential operating deleverage, we still think the OP margin can be at least stable in FY24E (vs FY23), because of various costs saving initiatives: 1) Project Red Eye (started in late 1Q24), which targets to improve supply chain efficiency by spending better, from the customer point of view, such as simplifying the number of SKUs, or reducing unnecessary items provided to the customers in the past (e.g. ingredients like syrups for coffee, different packaging items, etc.), 2) sourcing more directly with the farmers, 3) Project Fresh Eye (started in 4Q23), which is aiming to improve the operational efficiency, by reducing the complexity of operational process, from the store manager's point of view, hence they are able to focus more on other tasks, 4) greater use of AI and automations, by rolling out systems like Pizza Hut's i-kitchen, which is able to enhance food quality, safety and operational efficiency, also, more than 80%/ 50% of Pizza Hut stores have equipped with automated fried rice machines and robotic servers, 5) minimal labour costs inflation (e.g. at around LSD in FY24E), 6) rigid control over G&A expenses, targeting 5% of sales (vs 5.8% in FY23), and 7) reduced A&P expenses, as % of total sales. All in all, we are now expecting sales/ OP/ NP growth to be at around 2%/ 8%/ 7% in 3Q24E and +1%/ 30%/ 13% in 4Q24E.
Maintain BUY but trim TP to HK$ 294.91. Our new TP is based on 15x FY25E P/E (rolled over from 23x FY24E to factor in the sector de-rating). We fine-tuned FY24E/ 25E/ 26E net profit by +3%/ -1%/ -1% to reflect the 2Q24 results beat. It is now trading at an undemanding valuation at 13x FY25E P/E.
2Q24 net profit was a significant beat. Yum China's sales rose by just 1% to US$ 2.68bn in 2Q24, and missed BBG/ CMBI est. by 3%/ 4%, mainly due to the weak SSSG (-3%/ -8% for KFC/ Pizza Hut) and increased mix of smaller sized stores. However, Yum China's net profit increased by 8% to US$ 212mn in 2Q24, 12%/ 21% higher than BBG/ CMBI est., thanks to: 1) resilient GP margin (esp. for Pizza Hut), at 70.3%, vs BBG/ CMBI est. of 68.9%/ 69.9%, 2) stable labour costs and rental expenses (both are flattish YoY), 3) increased focus on operational efficiency (hence G&A expenses fell by 13% YoY), etc. Moreover, the EPS growth was even more impressive at 17% in 2Q24, mostly driven by the massive amount of shares buyback. In terms of segment, the delivery sales growth was rather robust at 11% while the dine-in sales has dropped by 3%. KFC's SSS was resilient, dropped only by 3% in 2Q24 (vs -2% in 1Q24) while Pizza Hut's SSS decline was as high as 8% (vs -% in 1Q24). However, Pizza Hut's profitability has outperformed KFC, as the restaurant level OP margins for KFC/ Pizza Hut were at 16.2%/ 13.2%, -1.1ppt/ +0.8ppt vs last year.
Store opening plan in FY24E remained intact. Yum China is maintaining its net new stores target of 1,500 to 1,700 (so as the capex target of US$ 700mn to 850mn) in FY24E. But we do think this is totally adjustable if the macro environment becomes much less friendly. The mix of franchise stores has reached about 25% for KFC in 2Q24, which is a beat vs the mix of 15% to 20% mentioned in the 3 years target (FY24E-26E). We are not only confident that the franchisees can secure excellent locations for store expansions (by leveraging their local wisdom) but also deliver a decent operation quality, thanks to the highly digitalized system and modernized management method.
Change of CFO. Andy Yeung (CFO since 2019) will depart from Yum China from Oct 2024, but will be appointed as an advisor to the CEO from Oct 2024 to Feb 2025. He is leaving the Company to pursue another professional opportunity. Adrian Ding, the current CIO of Yum China and previously the GM of the Lavazza JV, will become the acting CFO.
2Q24 net profit was a significant beat. Yum China's sales rose by just 1% to US$ 2.68bn in 2Q24, and missed BBG/ CMBI est. by 3%/ 4%, mainly due to the weak SSSG (-3%/ -8% for KFC/ Pizza Hut) and increased mix of smaller sized stores. However, Yum China's net profit increased by 8% to US$ 212mn in 2Q24, 12%/ 21% higher than BBG/ CMBI est., thanks to: 1) resilient GP margin (esp. for Pizza Hut), at 70.3%, vs BBG/ CMBI est. of 68.9%/ 69.9%, 2) stable labour costs and rental expenses (both are flattish YoY), 3) increased focus on operational efficiency (hence G&A expenses fell by 13% YoY), etc. Moreover, the EPS growth was even more impressive at 17% in 2Q24, mostly driven by the massive amount of shares buyback. In terms of segment, the delivery sales growth was rather robust at 11% while the dine-in sales has dropped by 3%. KFC's SSS was resilient, dropped only by 3% in 2Q24 (vs -2% in 1Q24) while Pizza Hut's SSS decline was as high as 8% (vs -% in 1Q24). However, Pizza Hut's profitability has outperformed KFC, as the restaurant level OP margins for KFC/ Pizza Hut were at 16.2%/ 13.2%, -1.1ppt/ +0.8ppt vs last year.
Store opening plan in FY24E remained intact. Yum China is maintaining its net new stores target of 1,500 to 1,700 (so as the capex target of US$ 700mn to 850mn) in FY24E. But we do think this is totally adjustable if the macro environment becomes much less friendly. The mix of franchise stores has reached about 25% for KFC in 2Q24, which is a beat vs the mix of 15% to 20% mentioned in the 3 years target (FY24E-26E). We are not only confident that the franchisees can secure excellent locations for store expansions (by leveraging their local wisdom) but also deliver a decent operation quality, thanks to the highly digitalized system and modernized management method.
Change of CFO. Andy Yeung (CFO since 2019) will depart from Yum China from Oct 2024, but will be appointed as an advisor to the CEO from Oct 2024 to Feb 2025. He is leaving the Company to pursue another professional opportunity. Adrian Ding, the current CIO of Yum China and previously the GM of the Lavazza JV, will become the acting CFO.
