Kate Lin: For many years now, the belief has been that the key driver of China's growth is consumption, and the basis of this theory is that an uptick in per-capita income, coupled with shifting demographic trends would drive consumer spending. However, as the economy slows. What happened to this theory?
We're talking to Ivan Su, our senior equity analyst at Morningstar, about what is going on in restaurants.
Hi Ivan, our bull call for Chinese restaurant stocks hinges on their ability to capture the rising dining-in demand. First, as the economy slows, is consumption slowing as well?
Ivan Su: Yes. Overall consumption is definitely slowing in China across the board.While restaurants obviously are no exception to the slowdown, it remains an outperformer with double-digit growth in the third quarter this year.And that's really just driven by the fact that a lot of these COVID area restrictions have been lifted.
Lin: How are in-restaurant dining companies faring in this current environment?
Su: So we talked about how overall dining demand has shown improvement compared to last year, but same-store sales for the industry are still trending below the pre-pandemic levels in 2019.This is because Chinese consumers are still feeling uncertain about the future, so they choose to spend less on dining out. The negative impact of their cautious spending patterns has negatively impacted restaurants in the industry.
Yum China's Expansion Plan
Lin: Let’s move on to talk about some individual names. Ivan, you just came back from Yum China (09987, YUMC)'s investor day in Xi'an. Tell us what is new.
Su: Yeah, so we came out of the investor day feeling pretty optimistic about the company's long-term outlook. During the investor day, Yum China committed to delivering double-digit revenue growth over the next three years. They said that they will be able to do that by taking a larger share of the restaurant market. We think that they will be able to achieve this goal and will be done mainly in two ways.
One, it's done by opening up more KFC and Pizza Hut [stores] across the more than 1000 lower-tier cities in China that currently do not have any of its restaurants present. Number two, they will be working more closely with franchisees to establish more strongholds in strategic locations, basically places such as highway rest areas, hospitals, college campuses, and tourist attractions.
With these two drivers in mind, we continue to like Yum China's stock and view its shares as undervalued.
Our Best Idea Vs. Hotpot Stocks
Lin: You recently initiated coverage of three other Chinese restaurant stocks, where Haidilao (06862) trades an overvaluation and Jiumaojiu (09922) is closest to getting its narrow moat rating. How do these compare with our best idea, Yum China?
Su: Yeah, you're right. We don't like Haidilao as much because the company's fundamentals have deteriorated over the recent years and there's really no visibility around whether this company can return to meaningful growth amid increased competition in the Chinese hotpot category.
As for Jiumaojiu, we think it's a much higher quality business because its Tai Er brand has established itself as the go-to restaurant within the sauerkraut fish category. It's a category that has gained immense popularity within China over the past five to six years. We also like Jiumaojiu’s continued investment in brand development, product innovation, and also supply chain capabilities. With all these investments, we think the company is shoring up its competitive position for the long run.
As it pertains to how they compare to Yum China, these are very different concepts. Yum China is the largest quick-service dining concept in China and has been in China for about 30 years, while the other Chinese concepts haven't been in the business for nearly as long.
From a track record perspective, we think Yum China is a much better-positioned company. Yum China also has its own supply chain capabilities, which help its restaurants to secure lower food costs and also a faster menu refresh. So, we think these factors will drive Yum China’s continued outperformance in the industry over the long run.
Lin: Thank you so much, Ivan. For Morningstar, I'm Kate Lin.
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