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Yum China (YUMC) Rides on Unit Expansion Amid High Costs

Yum China Holdings, Inc. YUMC is focused on unit expansion, menu innovation and digitalization to drive growth. These efforts helped the company to report better-than-expected earnings for eighth straight quarters. Consequently, its shares have gained 27.7% year to date, outperforming the industry's rally of 16.4%. However, increased expenses remain a concern.

Let’s delve deeper into the factors that substantiate its Zacks Rank #3 (Hold).

Growth Drivers

Yum China is focused on relentless unit growth of restaurants in order to drive incremental sales. In 2018, the company had opened 819 restaurants and re-modeled 931 stores. This had exceeded its target of opening 600-650 stores in 2018. In the third quarter, Yum China opened 231 new restaurants and remodeled 126 stores, reflecting a significant rise from the first half of 2019. Notably, the company is aggressively remodeling on an accelerated pace in the fourth quarter, in a bid to achieve the target of completing 500 store remodeling for the full year. Moreover, it is on the track to open 800-850 new stores in 2019.

Yum China’s continual menu innovation to drive top-line growth is another key catalyst. KFC’s extraordinary performance is attributable to greater sales of menu offerings like crayfish burger, stuffed chicken wings and spicy chicken burger. Moreover, it introduced several exciting burger LTOs during the last reported quarter. It also launched Spicy Skewers and stew pots in 10 cities, and is gradually expanding its coverage.

Yum China holds a leadership position in the Chinese restaurant space when it comes to delivery, mobile order and pay, and loyalty membership. The company is increasingly shifting toward digital and content marketing to expand the customer base.

Coming to loyalty membership, Yum Brands created a robust loyalty program that has more than 265 million loyalty members combining both the brands. Backed by delivery and digital sales, the company’s loyalty membership increased at a high-double digit pace on a year-over-year basis for both the brands in third-quarter 2019. As of Sep 30, 2019, the KFC and Pizza Hut loyalty programs had more than 200 million and 65 million members, up from 55 million and 15 million members in the corresponding period of 2018, respectively.

Hurdles

Yum China is facing structural high costs associated with labor and rentals. In addition to wage inflation, the company is also bearing the brunt of additional costs stemming from promotion, menu innovation and technological novelty. In order to curb labor cost, it is increasingly focusing on delivery channels, which are anticipated to hamper margins in the near term. Further, costs related to transactions and franchises are expected to rise in the near future.

Notably, total costs and expenses increased 3.9% year over year to $2,019 million in the third quarter. This upside was due to a 4.2% increase in restaurant expenses, 5.8% rise in Payroll and employee benefit costs, and 6.7% hike in food and paper expenses.

Key Picks

Some better-ranked stocks in the same space include Chipotle Mexican Grill, Inc. CMG Cracker Barrel Old Country Store, Inc. CBRL and Dunkin' Brands Group, Inc. DNKN, each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Chipotle, Cracker Barrel and Dunkin’ have an impressive long-term earnings growth rate of 19.6%, 10% and 9.8%, respectively.

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