Morningstar | Yum China's Strong Start to 2019 Reinforces Competitive Positioning, New Growth Opportunities
In our view, wide-moat Yum China's first quarter was highlighted by KFC's successful Chinese New Year product innovation, regionalized product strategies, and focus on value (driving strong comps of 5%, on top of 5% a year ago), Pizza Hut showing further signs of its turnaround (with 1% comps largely driven by 8% increase in transactions and restaurant margins improving 380 basis points to 14.3%), and plans to accelerate its 2019 unit growth plans above its previous target of 600-650 locations. With first-quarter comps putting the company ahead of our full-year targets (0%-1%) we plan to increase our $50 fair value estimate by a few dollars, even after factoring in higher poultry prices and 500 Pizza Hut remodel investments. While we'd prefer a wider margin of safety, we continue to view Yum China as one of the most direct ways to play the growth of the Chinese middle-class consumer.From a longer-term perspective, we reiterate four themes coming out of last month's investor day. First, we don't believe the market is giving the company full credit for the unit growth potential of new restaurant formats (including remodeled Pizza Hut locations and gas station partnership with Sinopec/CNPC). Second, there is increasing visibility behind Pizza Hut's revitalization, with menu simplification, value pricing, and expanded delivery control positioning it for margin expansion. Third, Yum China remains uniquely positioned to capitalize on specialty coffee in China, with K-Coffee offering a mass platform already at scale and COFFii & Joy building awareness in the premium space (including a partnership with WeWork). Lastly, with improving fundamentals, we have greater conviction in Yum China's ability to return $1.5 billion to shareholders the next three years. These trends also reinforce our five-year targets calling for 8% system sales growth, 6% unit growth, 2% average comps, and 17% restaurant margins, and 12% operating margins (implying low double-digit growth).
Yum China Holdings is a holding company. Through its subsidiaries, the company is a restaurant company in the People's Republic of China (China). The company's restaurant base consists of restaurant concepts, including KFC, Pizza Hut brands, as well as brands such as East Dawning, Little Sheep, Taco Bell and COFFii & JOY. The company has the right to operate and sublicense the KFC, Pizza Hut and Taco Bell brands in China (excluding Hong Kong, Taiwan and Macau), and own the intellectual property of the East Dawning, Little Sheep and COFFii & JOY concepts outright. Most restaurants in the KFC, Pizza Hut, East Dawning, Taco Bell and COFFii & JOY concepts provide delivery service.
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