EUR 850.00 For Business Accounts Only

Morningstar | YUMC Updated Star Rating from 01 Feb 2019

Wide-moat Yum China carried its recent momentum into the fourth quarter, with positive traffic trends at both core brands reinforcing the effectiveness of recent promotional strategies and digital ordering/delivery enhancements. Though top-line trends could be uneven over the next few quarters against more difficult comparisons and a more competitive and value-focused Chinese restaurant industry, we believe the key takeaway for investors is that Yum China is making changes to weather this uncertainty. We're planning a modest increase in our $44 fair value estimate for time-value-of-money adjustments, but we remain comfortable with our five-year outlook calling for 8% currency-neutral average annual top-line growth (6% system unit growth and 2% average comps) and restaurant margins growing from 15.7% in 2018 to 16.5% in 2023 (which we don't believe is reflected in the current market valuation, even after the rally after earnings).

KFC comps were the highlight of the quarter, coming in at 3% versus 1% last quarter, driven entirely by transaction gains. Two-year comps of 9% were a slight deceleration from last quarter's 11%, but still encouraging. While China's consumer environment will likely be choppy in the near term, we believe new value platforms, daypart/category expansion (coffee and dessert), and loyalty/delivery engagement should keep comps in the low single digits in 2019. Pizza Hut comps fell 4%, but with traffic improving 1% and the 5% decrease in average ticket due to long-overdue pricing adjustments to make the brand more competitive, there is evidence that the brand refresh, menu simplification, and value efforts are gaining traction. We expect Pizza Hut comps to remain slightly negative in 2019 but resume positive growth in 2020. Although we expect additional Pizza Hut transformation investments in 2019, we believe modest sales leverage and cost-containment efforts still make our five-year consolidated restaurant margin target achievable.

The other components of our positive longer-term investment bias remain in place. First, Yum China's digital assets continue to drive customer retention and average check, with membership enrollment continuing to grow at a healthy clip (up 46% at KFC and 43% at Pizza Hut) and sales per member remaining healthy despite aggressive industry discounting. Second, new unit returns remain healthy--payback periods are roughly two years for KFC and three to four years for Pizza Hut--which we partly attribute to the Yum China's delivery platform and supportive of management's guidance calling for 600-650 gross store openings and our longer-term outlook calling for 20,000 system locations. Third, Yum China remains a solid capital allocation play even as new initiatives are put into place, with an annualized dividend of $0.48 representing a yield just north of 1% and $960 million remaining on its current buyback authorization.