EUR 850.00 For Business Accounts Only

Morningstar | Near-Term Pressures Abound but Yum China Offers Long-Term China Consumption/Capital-Allocation Play

Yum China was spun off into an independent, publicly traded company in October 2016, although it remains a trademark licensee of Yum Brands. Although sales trends have been uneven at times amid macroeconomic uncertainty, a changing competitive set and increased promotional activity from rivals, evolving consumer views regarding health and wellness, and executional missteps, we still view Yum China as a wide-moat business thanks to a powerful brand intangible asset as well as its advanced distribution infrastructure and local site development teams. We find longer-term goals of high-single-digit system sales, 17% restaurant margins (after the 3% of systemwide sales licensing fee paid to Yum Brands), and low- to midteens earnings per share growth realistic given favorable China consumer demographic trends and the operating leverage inherent in its business model.We view Yum China as one of the most direct ways for investors to participate in the increased spending power of Chinese consumers and identify significant opportunities for market share and unit expansion in the highly fragmented Chinese restaurant market. In this market, chains account for just 9% of China's restaurant locations compared with 53% in the U.S. and 27% across the globe, based on data from Euromonitor. We're also optimistic about Yum China's various top-line drivers, including value platforms, menu simplifications, alternative restaurant formats such as kiosks, enhanced digital marketing efforts (underscored by 145 million and 50 million loyalty program members at KFC and Pizza Hut, respectively, giving the company one of the largest consumer loyalty programs in the world), unrivaled delivery capabilities (representing 18% of sales at company-owned locations), and nascent brand expansion potential in Taco Bell and Little Sheep. In our view, future China comp stabilization--which we expect to be the key driver behind stock performance--and meaningful cash returned to shareholders through share repurchases and a quarterly dividend of $0.12 per share (backed by $1.5 billion in cash and equivalents on the balance sheet as of June) offer dual catalysts for long-term shareholders.