Yum China Expands Presence in Lower-Tier Cities to Drive Growth Amid Increasing Consumer Caution – Restaurant Brands Intl (NYSE:QSR), McDonald’s (NYSE:MCD)

Key points:

  • Yum China’s revenue grew 21% in both the fourth quarter and full-year 2023, as it opened a record nearly 1,700 new stores last year
  • The main franchisee of KFC and Pizza Hut restaurants in China had 14,644 stores at the end of last year and reiterated its plan to increase that to 20,000 by 2026

By Doug Young

Yum China Holdings Inc. YUMC has seen the future of fast food in China, and that future lies in the nation’s thousands of smaller cities that currently have few or none of the posh fast food outlets that have become common in major centers like Shanghai and Beijing.

These smaller cities account for more than half of the nearly 1,700 new stores opened last year by major restaurant franchisee KFC and Pizza Hut in China, according to a fourth-quarter report released Tuesday. The new openings marked a record for Yum China, surpassing the previous target of 1,400-1,600 stores for the year. The company ended 2023 with 14,644 stores and said it is aiming for double-digit growth this year as it approaches its goal of 20,000 total stores by 2026.

While KFC is often considered a high-end dining option in smaller cities, the company is rolling out a growing stable of made-for-China products to attract customers. While the list is topped with best-sellers like whole chickens, it also includes a growing number of locally flavored products you won’t see anywhere else, like spicy duck blood beef rolls and chicken and frog tacos bull.

The broader theme is that Yum China is taking advantage of its first-mover status in China, with more than three decades in the market since its arrival in 1987. In addition to localizing its menu, the company is getting used to outsourcing many of its functions that was once maintained in-house to control quality in an earlier era when Western-style restaurants were still an exotic dining option in China.

This has led the company to move more aggressively into franchising which is a staple for major fast food operators in the West. Yum China’s partnerships with major e-commerce and social media platforms have also helped extend its reach beyond physical stores. It is also working closely with popular third-party Chinese delivery services such as Meituan and Ele.me that can help it meet consumers’ growing passion for convenience.

“In this developing market, we see a long growth path for our brands. KFC still serves only a third of China’s population. Our next ambitious goal is to extend our reach to half of the population by 2026,” said Joey Wat, CEO of Yum China.

Yum China and many of its competitor countries are moving toward growth through expansion as China’s economy slows after years of breakneck growth. The country’s GDP grew just 5.2% last year, the slowest rate in more than 30 years, excluding the pandemic. According to data from the National Bureau of Statistics of China, the annual sales of food and beverages in 2023 reached 5.2 trillion yuan ($723 billion), up 20.4% year-on-year, outpacing the recovery in other sectors.

The company’s shares rose 4.2% in New York on Tuesday after the results were released, and rose as much as 28% on Wednesday’s trading day in Hong Kong. Concerns about the Chinese economy have had a negative impact on the stock, which has fallen about 12% this year. At its latest price, the stock now trades at a lower price-to-earnings (P/E) multiple than major global fast food operators like its former parent company. Yum brands YUMas well as McDonald’s MCD AND International restaurant brands QSR.

Growth through expansion

Yum China’s latest results have been largely positive, although much of its strong gains are due to its rapid expansion. Its revenue rose 19% to $2.49 billion in the final three months of the year, and the figure would have been 21% excluding the impact of weakness in China’s local currency, the yuan. This brought the company’s full-year revenue to approximately $11 billion, also up 21% excluding foreign currency translation.

But same-store sales rose a much more modest 4% in the fourth quarter from a year earlier, with a 7% increase through 2023, fueled by a 12% increase in transactions for the full year.

To drive incremental traffic and acquire new consumers, Yum China has expanded the overall price range of its products by focusing on attracting more value-oriented customers at the low end of its range. Its branded apps will contribute a third of online sales in 2023, growing 35% to more than $9.2 billion last year.

The company also continued to enhance its loyalty program. Its KFC and Pizza Hut loyalty clubs had as many as 470 million members at the end of last year, up 14% from the previous year, and those members accounted for about two-thirds of all sales.

In another attempt to broaden its appeal at the lower end of the market, the company has also begun testing a program to reduce delivery expenses by working more with the previously mentioned third-party delivery services rather than relying solely on its own drivers dedicated.

At the same time, the company has also sought to operate more efficiently through greater digitalization and automation, more flexible store formats and expanding its model in which individual management teams oversee groups of stores rather than needing a dedicated team for each store.

By keeping costs low and gaining greater efficiency from its operations, the company increased its restaurant margin to 10.7% in the fourth quarter, up 1.7 percentage points from a year earlier, excluding temporary government aid during the pandemic. Restaurants’ annual margin also increased 2.7 percentage points on the same basis to 16.3%, even higher than pre-pandemic 2019 levels.

The bottom line is that Yum China’s profits increased 81% in the fourth quarter and 87% in the previous full year, to $97 million and $827 million, respectively. Operating profit even increased by 170%, while core operating profit quadrupled. The company has returned $3 billion to shareholders through share buybacks and dividends since its New York listing in 2016, and said it plans to accelerate that effort by returning another $3 billion over the next three years.

We’ll conclude with a look at some of the company’s smaller brands, led by its two local Chinese chains that achieved significant milestones last year. Its Huang Ji Huang chain has been one of the strongest since it acquired the brand in 2020, and last year it opened 40 new stores and tripled its profits. Meanwhile, its Little Sheep chain that uses a popular hotpot format returned to profitability last year. Both Chinese restaurant brands plan to expand locally in China and overseas markets this year.

This article comes from an unpaid freelancer. It does not represent Benzinga’s reporting and has not been edited for content or accuracy.

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