The Colonel’s chicken has demonstrated its universal appeal, and Yum China Holdings Inc’s (NYSE:YUMC) second-quarter earnings, today, will shed light on progress in the Chinese market.
Heavy capital expenditures with lower-than-expected return on capital in the years leading up to the IPO and multiple food safety scandals during that period, cast an uncertain cloud over the future of Yum! Brands, Inc. (NYSE:YUM) in China.
But after a positive first quarter that assuaged those concerned with historically lumpy performance (restaurant margin expansion and same store sales growth), YUMC stock has been rewarded handsomely.
Overall, Yum China has had an enviable post-spinoff run. Since last October when it spun-off from its parent company, YUM, shares have made major gains, up 54%. CEO Micky Pant’s purchase of 100,000 YUMC common shares at a price of $31.16 per share on April 7, 2017 gave further confidence to investors.
So after this run, how much higher can YUMC stock go?
YUMC’s Digital and Delivery Strategy
The Daojia deal announced in May is proof of YUMC’s commitment to executing on its digital and delivery strategy. Daojia is “an established online food delivery service provider focusing on higher-end orders in large cities in China including Beijing, Shanghai, Guangzhou and Shenzhen.”
This is a great opportunity for YUMC to leverage Daojia’s technology to further enhance the digital customer experience for KFC and Pizza Hut customers. As of the first quarter, over 4,400 of Yum China’s 7,663 restaurants offered delivery services. Delivery represented 12% of company sales.
This is such a crucial component of the growth strategy, so the company must continue to show that the investment of time and money into the strategy is paying off for shareholders.
More specifically, I want to know how Yum China is going use the 93 million loyalty members between its KFC and Pizza Hut apps. In theory, it’s an unrivaled source of consumer data and direct feedback mechanism in the ultimate play for customer satisfaction. How to take that theory and make it a reality that helps YUMC sustain a competitive advantage is trickier.
YUMC’s Runway Still Long
The Chinese QSR market remains fragmented, continuing to offer fertile ground to conquer with strong international brands. Western QSR penetration lots of room to grow still, and YUMC has won back customers post-food safety scandal. The company has cracked down on its supply chain to ensure to those scandals in 2013-2014 are firmly in the past.
The opportunities in lower tier cities are expansive as are those surrounding the growth in traffic transportation hubs. Those hubs guarantee YUMC a captive audience and provide what should be highly profitable stores.
In a strategy targeting Chinese millennials who are interested in new culinary experiences, Yum China launched Taco Bell at the beginning of this year. The opening was impressive and YUMC smartly showed off its digital capabilities; there is free Wi-Fi, digital ordering kiosks, digital menu boards and a range of payment options.
Pant reiterated YUMC’s advantages and was optimistic about its ability to introduce Mexican fare:
“Leveraging our deep insights into Chinese consumer preferences, developed from close to 30 years operating in this market, we thoroughly researched and fine-tuned the Taco Bell menu for China and the initial response from customers is very encouraging.”
Naturally, Yum China localized its menu with a mix of signature and new items like the Shrimp and Avocado Burrito. It will be important to follow performance in the coming quarters to see if the concept has legs.
If it does well, this would provide a differentiated growth driver that the market should continue to reward. Valuations aren’t as compelling as earlier this year, but as YUMC captures more of the vast Chinese QSR market via a new store rollout accompanied by a deep understanding of their customers’ habits, it will be difficult for competitors to catch up.
As of this writing, Luce Emerson did not hold a position in any of the aforementioned securities.