Yum China: Stock of the Week

Kate Lin: Yum China is a popular stock - both for foodies, and for the readers of Morningstar's Asia websites!

The Chinese restaurant market is fragmented. Chains account for only18% of restaurant spending, well below the 60% level in the U.S.

But, this gap will narrow.

With a boom in urban population, fast-food is set to be far more appreciated in China, especially by time-strapped workers and smaller-size families, who typically opt for the convenience of take-out food.

Enter Yum China. The company, which operates KFC and Pizza Hut in China, added over 3,700 new outlets in the past 3 years. This makes Yum China a true contrarian, as store openings braved the pandemic challenges. This paid off in the form of more favorable lease terms. According to our analyst Ivan Su, this move will soon prove earnings positive.

Now that the zero-COVID policy is officially over, Yum China has no plans of slowing down, instead, it will accelerate its expansion into lower-tier cities.

According to Morningstar estimates, there are 1,200 Chinese cities currently with no KFC or Pizza Hut - and that's probably where Yum China will head.

For Morningstar, I am Kate Lin.

 Bulls Say

1. Average unit volume (US$ 1.3 million pre-COVID-19), pretax cash payback periods (between 2-3 years), and cashon-cash returns (roughly 20%) for new KFC China units exceed the economics of most chains in the region.
2. Despite COVID-19 disruptions, we see several top-line growth drivers, including value platforms, smaller/ alternative restaurant formats, digital ordering/marketing, delivery, and nascent brands like Lavazza, Taco Bell, and Huang Ji Huang.
3. Wage hikes, urbanization trends, and relatively young populations should continue to drive restaurant spending across China.

 Bears Say

1. Although the zero-COVID-19 policy is officially over, restaurants still contend with cautious consumer spending.
2. While having a proven track record in capturing Chinese’s appetite for Western food, the group has had limited success in Chinese concepts.
3. As Yum China's Western rivals look to expand their presence in the market and local players build scale, price competition will likely intensify.