YUMC reported 5.4% YoY total revenue growth in 3Q24 with 1.0ppt YoY OPM expansion. Such robust quarterly results continued to outperform its rivals despite challenging market conditions, mainly attributable to its evolving business model with excellent execution. Besides further valuation upside potential for chain restaurant leaders in China, YUMC's shareholder returns now offer larger safety margin. Reiterate BUY.

Key Factors for Rating

3Q24 results review. YUMC's total revenue grew 5.4% YoY to US$3,071m in 3Q24, basically in line. System sales (ex FX) increased 4% YoY, on the back of accelerated openings and traffic, despite 3% YoY SSS decrease, as a whole. Its company restaurant margin remained roughly flat YoY at 17.1% in 3Q24; costs of food and paper, payroll, and occupancy were 31.7% (+0.6ppt YoY), 25.1% (-0.2ppt YoY), and 26.1% (-0.4ppt YoY). G&A expenses ratio dropped 1.3ppts YoY to 4.5%; accordingly, OPM rose 1.0ppt YoY to 12.1%, beating expectations. Coupled with net investment gain of US$34m (3Q23: a loss of US$4m) in relation to FV change of equity investment in Meituan (3690 HK/TP: HK$136.30, BUY), YUMC's net profit surged 21.7% YoY to US$297m.

KFC. In 3Q24, KFC reported 6% YoY system sales growth - SSS decreased 2% YoY (ex FX; stemming from 1% YoY same-store transactions increase, offset by 3% YoY average ticket decrease); KFC store count rose 14% YoY to 11,283 as of 30 Sept. 2024, with 352 net additions (2Q24: 328). Management expects KFC's ticket to be stable in the coming quarters, emphasising that the average ticket of RMB38 was resilient (3Q19: RMB36); however, we reiterate slightly lower ticket in 4Q24-2025, given 1) overall soft consumption sentiment, 2) strategy towards value-for-money proposition, and 3) solicitation of smaller orders, esp. on third- party aggregator's platforms with lower delivery fee. KFC member count was up to 475m, representing 65% of its system sales in 3Q24. Digital order contribution modestly rose to 90%. KFC company restaurant margin was down 0.3ppt YoY to 18.3% on pricing softness, despite cost tailwinds; operating profit grew 6.4% YoY to US$364m in 3Q24.

Pizza Hut. In 3Q24, PH reported 2% YoY system sales growth - SSS decreased 6% YoY (ex FX; stemming from 4% YoY same-store transactions increase, offset by 9% YoY average ticket drop); PH store count rose 13% YoY to 3,606 as of 30 Sept. 2024, with 102 net additions (2Q24: 79). Management expects PH to further consolidate market share at the cost of lowering average ticket, in coherence with its tilt towards the mass market. PH member count was up to 175m, representing 63% of its system sales, whilst digital order contribution was 91% in 3Q24. PH company restaurant margin was unchanged YoY at 12.7%; operating profit grew from US$47m in 3Q23 to US$52m in 3Q24.

New business initiatives. Each of the two initiatives is in a unique position to underpin market acceptance, in our view. 1) Side-by-side K Coffee store count reached 500 by Sept., ahead of the previous guidance. We like K Coffee's distinct menu with the "coffee & hot dog combo" at RMB9.9 and other value-for-money innovative SKUs. K Coffee also launched the "privilege subscription" (RMB8.8 for 30 days, coffee from RMB5 per cup) in 3Q24, in order to drive repeat purchase. Another factor is that K Coffee can work in synergy with existing KFC locations, driving customer traffic and minimising cost for investment and operation. 2) PH WOW. Management views the WOW model as a major breakthrough, which will become more mature and profitable in the long run. Currently, management will focus more on market penetration, sequentially in dine-in and delivery channels. WOW store count reached 150 in November from the first store in May, with a coverage of 10 provinces from tier-1 to lower-tier cities and towns. Initial results seem promising and we believe that the WOW model can meet the rising demand for good variety, value-for-money foods in fast casual format with lighter service.

Guidance. Store expansion target remains intact - 1,500-1,700 new stores (with agile business model and healthy payback), implying a YoY or QoQ deceleration in 4Q24. Going forward, in terms of new openings, the proportion of its franchise restaurants would substantially increase to more than one-third in 2025-26, as management is poised to exploit opportunities, strategically in 1) lower-tier cities and towns and 2) specialty channels (e.g. hospitals, schools, transportation hubs and highways). Capex could stabilise within a reasonable range in 2025-26 (note: US$700-850m for 2024). Management reiterates that cost saving is essential and sustainable, on efficiency (e.g. menu revision, process digitalisation, automation, etc.) & procurement control. We forecast the company (system) restaurant profit margin to lift to nearly 17% in 2025-26. G&A expenses ratio could be c.5.0% in 2024 (2023: 5.8%) and further go down in 2025-26, according to management. Operating profit is likely to grow at a HSD%-to-LDD% CAGR from 2023 to 2026. Remarkably, YUMC plans to raise its targeted capital return to shareholders from US$3bn to US$4.5bn between 2024 and 2026, as a whole. Currently, the implied 2024E total shareholder return equals to c.8%.

Key Risks for Rating

Risks: 1) SSSG softness; 2) intensified competition; 3) commodity cost inflation;

4) slower-than-expected pace of store expansion; 5) unsuccessful execution of new initiatives; and 6) forex rate fluctuations.

Valuation

We have fine-tuned our top-line forecasts for 2024-26E. We have revised up our OPM forecasts as a result of lower G&A expenses ratio assumptions in 2025-26E. Also, we have factored the equity investment gain into our calculation for 2024E bottom-line. As a result, we have elevated our shareholders' profit forecasts for 2024-26E by 3-5%. EPS is likely to increase at a 3-year CAGR of nearly 15% from 2023 to 2026, considering the impact of repurchases on the number of shares outstanding. We continue to list YUMC as our top pick for the Consumer Services (Restaurant & Catering) sector. Based upon 21.0x 25E P/E (previous: 20.0x 25E P/E), we derive our TP for YUMC-H and YUMC-US at HK$433.00 and US$55.50, respectively, both with BUY rating.