Yum China Holdings, Inc. (YUMC) CEO Joey Wat on Q3 2021 Results – Earnings Call Transcript

Yum China Holdings, Inc. Q3 2021 Earnings Conference Call October 27, 2021 8:00 PM ET

Company Participants

  • Michelle Shen – Director, Finance
  • Joey Wat – CEO
  • Andy Yeung – CFO

Conference Call Participants

  • Michelle Cheng – Goldman Sachs
  • Lillian Lou – Morgan Stanley
  • Xiao Po Wei – Citi
  • Chen Luo – Bank of America
  • Anne Ling – Jefferies


Good day, and thank you for standing by. Welcome to the Yum China’s Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions]

I would now like to hand the conference over to your is speaker today Michelle Shen. Thank you. Please go ahead.

Michelle Shen

Thank you, Lyndon. Hello, everyone, and thank you for joining Yum China’s third quarter 2021 earnings conference call. Joining us on today’s call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung. Before we get started, I’d like to remind you that our earnings call and investor presentations contain forward-looking statements which are subject to future events and uncertainties. Our actual results may differ materially from these forward-looking statements. All forward-looking statements should be considered in conjunction with the cautionary statements in our earnings release and the risk factors included in our filings with the SEC.

This call also includes certain non-GAAP financial measures you should carefully consider the comparable GAAP measures, reconciliation of non-GAAP and the GAAP measures is included in our earnings release.

Today’s call includes three sections. Joey will provide an update regarding recent development and our third quarter 2021 results. Andy will then cover the financial performance in greater detail. Finally, we will open the call to questions. You can find the webcast of this call in the PowerPoint presentation, which contains operational and financial information for the quarter on our IR website.

Now I would like to turn the call over to Ms. Joey Wat, CEO of Yum China. Joey?

Joey Wat

Thank you, Michelle. Hello, everyone, and thank you for joining us today.

As we shared in mid-September, we navigate a very challenging situation in the third quarter. The Delta variant outbreak that started in late July spread to 16 provinces became the most widely spread regional outbreak since the first quarter of 2020.

Strict public health measures were implemented across the country. Trading was significantly impacted during the peak summer season which is traditionally a very strong quarter for our business. Same store sales declined by 7% in the quarter as demand fell for dining although this was partially offset by growth in delivery.

I want to take a minute to commend our 440,000 employees for working diligently and rapidly finding solutions in this fluid situation. In response to the sharp decline in dining traffic, we quickly adjust marketing campaigns, operations and supply chain to drive demand for off-premise. Delivery sales grew 23% year-over-year or 62% on a two-year basis and contribute approximately 34% of sales in the third quarter.

New retail business grew rapidly with sales in the third quarter almost equal to the first two quarters combined. Our ability to engage customers digitally with essentials during this difficult time.

In the third quarter, over 60% of system sales came from members. We added about another 20 million members, ending the period with a total member count over 350 million. We sold 19 million privilege subscriptions, including the popular KFC Chicken lovers Wang Zha Ka which is a summer exclusive.

Having to get important initiatives to drive sales, we saw a sequential recovery in September. For the quarter, system sales growth was positive compared to last year and to pre-COVID. New unit growth more than offset the same-store sales decline. We broke record by opening 524 new stores, ending the quarter with 11,415 stores.

However, we do not compromise quality for quantity. We have prudent new store approval process and carefully track the performance of each new store. New store payback remains healthy at around 2 years at KFC and 3 years at Pizza Hut.

Our smallest store format enable us to increase store density in higher tier cities and further penetrate into lower-tier cities with lower CapEx and rent.

Let me provide some color on our key brands. First KFC. We stepped up value and promotional campaigns to drive traffic and we introduced great food items. The whole chicken was sold out within a week. Our mid-sized wagyu or beef burger also proved popular Our premium beef burgers have been very successful since becoming permanent menu item.

We are building a beef burger platform covering different price points. We’re taking menu innovation and localization to the next level following the success of Hot Dry Noodles, Re Gan Mian in Wuhan. We rolled that out nationwide in September. In a week of launching, we sold over 1 million bowls. It’s the best performing limited time offer breakfast item in the past three years.

We also introduced steamed dumplings, Xiao Long Bao to more stores in Eastern China. More recently, we launched Hot Pepper Soup, the very famous Wuhan Hot in Henan. All of these are very well received by our customers.

KFC has nearly 1,000 stores and entered 150 new cities over the past 12 months. As we mentioned during the Investor Day, we are now tracking 1200 potential cities that we could enter in the future with multiple store formats. Next, let’s talk about Pizza Hut. Years of transformation has proved — has improved Pizza Hut’s fundamentals and resilience.

In the third quarter, Pizza Hut opened 103 stores, the highest number of store openings in the quarter since 2016, satellite stores and other smaller format accounted for over 70% of the new stores and enable us to capture the strong demand for delivery with higher store density.

We upgrade our buy one get one pizza promotion. For the free second pizza, customers we’re given more flexibility to choose when, where and what pizza they would like to have. This mechanism was a breakthrough for us, enabled by our upgrade digital platform. The promotion was exciting for customers and create sales uplift.

During this 10-day campaign, we sold approximately 1 million buy one get one pizza set. For a limited time, we also offered new pizza flavors modelled on popular Chinese dishes such as Seabass Pizza with Pickled Vegetables, [Foreign Language] and spicy stir-fried Pizza [Foreign Language]. These innovative products were Pizza Hut’s take on localization and position as to attract young consumers who love to try new things.

Moving onto coffee. Our third growth engine. We are very excited about our deepened partnership with Lavazza. This 126 years old Italian brand offers a truly authentic Italian experience. Our Italian coffee exclusively uses high quality Lavazza beans roast in Perino, Italy.

In addition to coffee, customers love the delicious food. Popular item like Emiliano which is toast sandwich and mini croissant with ham and cheese are made fresh in our fully equipped kitchen. The high proportion of food which is 25% contribute to a higher ticket average.

At the end of September, we had 26 Lavazza stores in four top-tier cities. We expand beyond Shanghai to Hangzhou, Beijing and Guangzhou where our stores received great customer feedback. Our first Beijing store is already ranked the most popular cafe in Chaoyang district. Encouraged by the positive results, we expect to enter into more top-tier cities and more than double our current store base in the fourth quarter.

Despite recent challenges, our commitment to China’s long-term goal remains on chicken. We are always planning for the future and have been executing on the strategies outlined during our September Investor Day. Despite the difficulties posed by the outbreak, we work diligently to build our store pipeline. We now expect to open over 1,700 row of new stores in 2021 up from 1300.

I’m also excited about our investment in Hangzhou catering service group. This will allow us to accelerate growth across our brands in Xicheng province. Lastly, we continue to enhance capabilities in surprising in digital. These are stores — these are our core enablers for sustainable growth in the long term. Thus, we opened our digital R&D center with three sites in Shanghai, Nanjing and Xian. The center is a key part of our strategy to build a dynamic digital ecosystem.

The R&D center will consolidate and expand dedicated resources to develop solutions and services to optimize customer experience and operating efficiency. We plan to invest $100 million to $200 million and to employ up to 500 staff over the next five years for this particular initiatives.

As for supply chain, in addition to the logistics center in Chengdu, we have another one under construction in [indiscernible] which is in Guangzhou Province. There are also several sites in the pipeline.

As we mentioned during the Investor Day, we plan to operate about 45 to 50 logistics centers and consolidation centers over the next several years to support our expansion and to further increase efficiency.

With that, I will turn the call over to Andy.

Andy Yeung

Thank you, Joey, and hello everyone.

Let me first review our third quarter financial performance and then discuss this year’s outlook. Unless noted otherwise, all percentage changes are before the effect of foreign exchange. Let me first cover the third quarter performance. Actual results are in line with the business update we released in mid-September.

Third quarter performance was disrupted by the delta variant outbreak. We are selling in same-store sales decline of 7% year-over-year. However, we still delivered positive revenue growth and system sales growth, which is led by new unit contribution. Total revenues grew 2% year-over-year and reached $2.55 billion. System sales increased 1%.

Similar to prior quarters, we are providing pro forma measures here while convenience comparisons with 2019. Same-store sales were approximately 87% of the third quarter 2019 level. KFC’s same-store sales were approximately 92% of the last year level, and 87% of the 2019 level with same-store traffic at approximately 82% of 2019 level. Average price ticket grew roughly 6% versus 2019, mainly due to the increase in delivery made.

These same-store sales were approximately 95% of last year and 89% of 2019 level. Same-store traffic is on par with the 2019 level while average ticket decreased by about 10% driven by the increased mix in off-premise occasions, which have a lower ticket than dine-in. KFC was slightly more effective than Pizza Hut again this quarter as KFC has a higher store mix in transportations and tourist location.

These locations experienced a sharp decline in sales and approximately 40% on a two year basis in the quarter. Restaurant margin was 12.2%. They are 640 basis points compared to last year. This was mainly caused by sales leveraging, more value promotion, higher wages and increased delivery costs with more delivery orders, as well as lower COVID related relief this year.

Cost of sales was 32.2%, 100 basis on higher than last year. Modestly prices in commodity prices year-over-year, partially offset the step up value promotions to drive customer traffic. And phasing out of plastic packaging and other affecting upgrade. Cost of labor was 25.6%, 400 basis points higher than last year. This is due to a few factors. First, wage inflation was 6% in the quarter, notably higher than previous quarters.

Second, increased delivery volume contributed to higher labor cost percentage. Third, additional labor hours was scheduled going into the third quarter which is typically a seasonally strong trading period bought. We also scheduled more labor hours for increased safety protocols during the outbreak.

We were quick to adjust labor scheduling to mitigate the sales leverage and impact. Occupancy and other was 30%, 140 basis points higher than last year, mainly attributable to the sales deleveraging impact. In addition, we received 10 million cubic related one-time relief in the third quarter last year, while the amount was only $2 million this year. G&A expenses increased 6% year-over-year, mainly due to higher compensation costs and increased headcount.

We have possible in the quarter with operating profit of $178 million excluding a non-cash measurement gain of our existing equity insurance in Lavazza joint venture of $10 million, adjusted operating profit was $168 million, a 52% decrease year-over-year or a 48% increase compared to 2019. Our effective tax rate is 28.3%. We maintained the full-year effective tax rate outlook at 27% to 29%.

Net income was $104 million and adjusted net income was $96 million. excluding $32 million net investment loss of Meituan, it was $128 million down 50% year-over-year. Diluted EPS was $0.24 mark-to-market loss in Meituan negatively impacted our EPS by $0.07. In the quarter, we returned $85 million to shareholders in the form of cash dividends and share repurchases.

As we look ahead to the fourth quarter, we remain cautious. Strict public health measures are still in effect. Consumers are cautious about spending and are traveling less. According to government statistics, for the seven day National Day holiday starting October 1, the number of travelers was down 2% compared to the same period last year and down 30% versus 2019.

Related travel spending was down 40% compared to 2019. While we are seeing a slight differential recovery, our same-store sales still remain below prior year and pre-COVID 2019 level. As overall in volume and traffic and transportation hubs, our sales are less than with impact. We expect the recovery of same-store sales with decline with a non-linear and uneven app.

Recently, we have seen a resurgence of cases across 12 provinces and municipalities including inner Mongolia, Guangzhou and Beijing. We will continue to monitor the development and stay agile. In addition, the fourth quarter is seasonally the smallest quarter for sales and profit margin/ Based on what we’ve seen so far, we expect the margin and operating profit in the fourth quarter to be significantly impacted by one, deleveraging as same-store sales remain below prior year and pre-COVID level. Rising commodity prices.

Since the fourth quarter of 2020, we have benefited from a deflationary environment which will very likely end in the fourth quarter. Cost of sales will also pressure by aggressive campaign as we continue to drive traffic through attractive promotion. Three, wage inflation which is expected to be in the mid-single-digit rate. Wider costs are likely to continue to increase as delivery trend further upward.

Please note that the fourth quarter last year included several one-time items including one COVID and other one-time relief from government level, almost $30 million. Two, lower staffing levels due to shortage of working. These are unlikely what we keep this year. Now, despite the near-term challenges, we remain committed to driving long-term growth.

In the short term, we will focus on keeping our operation agile and resilient in the face of considerable disruption and uncertainty caused by the pandemic. For the long run, we will focus on fortifying our competitive mode in our growing our business and making continuous improvement in our business model and store operations.

We have a strong track record of managing our cost structure and growing our business profitably over the years. We’ll continue to focus on product innovation and leveraging the strength in our supply chain to mitigate the impact of commodity price swing. On the CLL fund, we will continue to invest in technology automation and digital infrastructure with improved labor productivity.

On the other hand, the near-term tonnages while tough for the restaurant industry as a whole also create favorable condition for us to expand our store network and capture growth opportunity. As Joey mentioned, we now expect to open 1700 new units in 2021, almost five stores per day.

We are maintaining our peers capital expenditure target of $700 million to $800 million which benefited from our ongoing efforts to reduce CapEx spending for our new store. Looking ahead, we will continue to invest in accelerating growth and fortifying our resiliency as outlined at the Investor Day in September.

We will provide you details on 2020 target during out fourth quarter earnings release in early 2020s.

With that, I will pass you back to Michelle to start the Q&A. Michelle.

Michelle Shen

Thanks, Andy. We will now open the call for questions. In order to give as many people as possible the chance to ask questions, please limit your questions to one at a time. Lyndon please start the Q&A.

Question-and-Answer Session


[Operator Instructions] Your first question comes from Michelle Cheng from Goldman Sachs. Your line is open.

Michelle Cheng

Hi, Joey and Andy, thank you for taking my questions. My question is about the commodity cost inflation. So we hear many companies are starting to talk about price hike recently. So understanding the confidence that is the most very challenging. So can you share with us your pricing strategy and also compared with the previous chicken cost inflation cycle back in ’18-’19 when we managed the margin pretty well, so what could be the difference now versus the past experience? Thank you.

Andy Yeung

Good morning, Michelle. Thank you for your questions. We’re getting pricing as we have a long-term pricing strategy here at Yum China, we want to provide a good value for consumer and so over the years, we always have been very cautious about price increase. We do partial inflation to be invested for consumer, but mostly, we will try to find efficiencies in our operation to offset those inflationary pressure.

Now, if you look back in the last few years, obviously there is commodity price fluctuation. Sometimes, it goes up, sometimes it comes down. And then over the years in China, we always have seen labor inflation right, so labor inflation generally is in the mid-single digit to high-single digit range.

And I think sometimes, when there is a sudden surge or disruptions in the market, then you do see the impact on our margin. For our quarter, this quarter for example, the biggest impact obviously is our sales right, because of COVID outbreak and so you have a deleveraging impact which is ultimately impacting the margin and then, so if you think about commodity prices, we generally have a very, over time, we will have new product innovation, how to make use in our board to feel better. We would also have diversifying the different voting. So we have chicken now, we have beef, we have a variety of fish and other seafood.

So that has helped us to balance the commodity price increase over time. And then obviously, we have a strong supply chain. We always work with our supplier closely to try to mitigate some of this pricing fluctuation.

We generally have a sort of like place our order also in the contract, a quarter or two ahead of the quarter so that we sort of know how to manage that cost increase over time. And then, we also work out our buyer obviously to when good time, the price go up, they just have to earn a little bit less, and when time is bad, we also have to try to support them.

So over time, we have a stable pricing situation and for us as well. So that’s generally how we deal with it and in terms of labor inflation, over the year, you have seen that. We have to invest quite a bit in digital automations and technology in our infrastructure.

Overall, we are trying to improve labor productivity. As we have outlined in the Investor Day, you have seen how we presented how technology helped us. It sounds like improved labor productivity. So a few years ago, we have 400,000 plus employees. Today, we have similar number of employees that we have with a high number of [indiscernible] to be happy.

So if you look at our UC margin or look at our restaurant margin, we have remained markedly stable. Right. So I think 16% or roughly 15% range. And then in 2019, it was about 16%. And then last year, it was about [technical difficulty]. So all in all, we — over time, we were able to manage all these different cost components, the cost structure very well meeting them. Thank you.

Michelle Cheng

Thank you Andy, that’s clear.


Your next question comes from Lillian Lou from Morgan Stanley. Your line is open.

Lillian Lou

Thanks management. My question is more on the CapEx plan because we definitely increased the gross new opening quite a lot versus the previous guidance but maintained CapEx overall. So maybe a little more. I know the company talked a bit for some times in terms of the unique cap has put store with this small format model, but can you share with us a little bit more about the details of what, how they have been doing in the recent quarters in terms of the unique CapEx and the unique higher mix versus before that caused us maintaining the similar cap which was much more comfort for our stores. Thank you.

Andy Yeung

Thank you, Lillian. So obviously this quarter we did set up our CapEx for the whole year, hopefully higher than last year. I think our CapEx year-to-date is about $480 million and I think — let me check that number here. Yes, so obviously, as we have outlined in our capital expenditure plan in our Investor Day, investment for CapEx will drive organic growth and also give you the competitive mode.

So that’s the multiple component to it. One is obviously the store that we’re opening and we are accelerating that and as we have mentioned before, we have over the past few years, we have reduced the CapEx per store investment.

So if you think about a few years back, our CapEx per store was about RMB2.5 million and then now is under RMB3 million, mostly RMB2.5 million. And as we continue to this driver for that, obviously the size of the store change. The other one is — so overall, per store cost reduction and so our team worked very hard as one team, our brand team worked very hard to do that and make it more efficient.

So I think with our new smaller store format for example, Pizza Hut, KFC, new model and more small store format catering to delivery and take away, I think we still have some opportunity to further do with use that CapEx per store going forward. Also, the other component obviously is remodeling. I think that over time, we’ll continue to trend up just because we have a bigger portfolio of stock.

And then the third part is, investment in supply chain and infrastructure that we have outlined before and in Investor Day is to drive efficiencies and resiliency in the supply chain, is to drive labor for the improvement through investment in technology, digitalization and et cetera. And so, I don’t think there’s fuel change to our plan. So hopefully, we can give you more update next quarter in terms of our full year CapEx spend. Thank you Lillian.

Joey Wat

I think as you comment on this one, Lillian, for today we update the new store guidance for the year from last quarter, 1300 stores to 1700 stores for the year. But we did not increase the CapEx spend for the year, it’s still they add $700 to $800 million range. But what happened here obviously, as you guys know us quite well, we don’t chase after a blind store number. We opened good quality stores.

If we can find a good quality store with additional profit and sales, then we will open it. So in terms of store economics here, I would like to give you a comment. One is, the store, the smaller store are driven by increased off-premise, means that delivery and take away.

So that’s more that helped that business and the smallest store helped us increase the store fantasy in the top tier city in particular. So these are the Pizza Hut store, the KFC smaller store and also, these stores with the lower investment and incremental sales and profit.

They help penetrate into the smaller cities because we have variety of different business models for different locations. So number 2 comments, it is normal that these smaller stores have smaller cells per unit. But as I mentioned earlier, to drive incremental sales and profit, it demands less CapEx so as Andy mentioned earlier.

Third, is the payback healthy. So that KFC payback is always about two years and Pizza Hut right now, if you notice what I said earlier is the Pizza Hut store payback is at three years now in total. That is an improvement because in the past, we always conclude that the payback for Pizza is about three to four years. So now, it has improved to three years because the small store, the Pizza Hut separate store right now, the payback is at two to three years. So in total, the improvement is at three years.

So I hope that gives you a sense about why we are increasing the new store guidance for the year. Because if we look at our system sales growth number, it also tells the story for the entire Yum China versus 2020. We are driving 15% year-to-date same-store sales growth and that includes 12% year-to-date system sales growth for KFC and 20% system sales growth year-to-date for Pizza Hut.

And then for KFC even compared to 2019 for year today, we are also achieving 4% system sales growth. Despite all the challenges of the outbreak and also same-store sales. So let me conclude the question here. Thank you. Lillian.

Lillian Lou

Thanks a lot. Joey and Andy. It is very detailed and helpful.


Your next question comes from Xiao Po Wei from Citi. Your line is open.

Xiao Po Wei

Hi, good morning, Joey and Andy. A very brief question. So your acquisition in the press release this morning, you mentioned value acquired 28% stake in Huangzhou catering services which operating a few grade logo Chinese brand. My question is, were you opening some store on standalone basis under those brands pursuing to any arrangement with the Huangzhou catering company or you are more looking at bringing those to greater [indiscernible] to your existing KFC stores or Pizza Hut to diversify your portfolio to bring more local food into the Chinese consumers. So any color would be highly appreciated. Thank you.

Joey Wat

Thank you, Xiao Po. So we have been working with Huangzhou catering, this company for a few decades now. This is our joint venture partners of Huangzhou KFC stores and Huangzhou market is one of our best market in terms of sales and profit. And we are very grateful that we have the opportunity to invest at 28% into the Huangzhou catering and that enables us to achieve consolidation of Huangzhou KFC business which is about 700 stores with future very nice expansion opportunity ahead, so that’s point one.

Point two is while Huangzhou catering has other business such as the new one and old one et cetera, our focus is still on our KFC business. In terms of future cooperation, we do see cooperation in two areas. One is working with them on their central kitchen or factory whatever you call it. They have very high quality facilities and actually with this already with our Xiao Long Bao launch in Huangzhou market, they were produced by the Central Kitchen at the factory of Huangzhou catering.

The second area we see, we are going to further expand our cooperation is store opening because another key shareholder of Huangzhou catering is a very successful and important player in the commercial properties in Zhejiang province. And already what we’ve done to open our first and the most important flagship store for Lavazza in Huangzhou, so these are the two areas that we certainly we’ll see us accelerate our cooperation on top of KFC, so expansion in Zhejiang province and particularly, Huangzhou. Thank you.

Xiao Po Wei

Thank you very much.


Your next question comes from Chen Luo from Bank of America. Your line is open.

Chen Luo

Thank you Joey and Andy. My question is on the marketing side. Our Q3 record margin saw over 6% year-on-year decline, I understand that it has been negatively impacted by the COVID outbreak in the quarter. However, if we look at Q2 and Q3 last year, we had a similar or even higher same-store sales decline, but our margin trends were better back then.

I’m just curious to get more color on the different dynamics behind, in particular our labor cost was up 4% year-on-year, which was higher than the magnet fuel off labor cost increase in Q1 last year, which was the worst time of the COVID outbreak. Apart from the weak inflation and sales deleverage, will you actually deleverage a bit more on other regions for us to better understand the lead, the dynamic we see behind labor cost increase.

In addition, our occupancy and other cost ratio have also increased normally in normal times. It is always trending down and served as a big driver to our need and margins. So do we still see further room of line item in the future barring [indiscernible] decreases last year for your clients. Thank you.

Andy Yeung

Thank you, Chen Luo your question. I think let me try to address the question here. First of all, I think before, we go into line item, I want to really emphasize that leverage increase. We went in restaurant business so when sales come down, and it would have an impact on our labor cost and on our O&O.

So I don’t want any those understanding. I know we have been very well over it last couple of years. And last year was also some special situation obviously. So let me address that year on example, on the cost of labor, on the sales dynamic if you look back in, for example, in 2020, right.

As we have mentioned at that time, we have a very strong, strong sales trading going into the Chinese New Year period in 2020. And the period before Chinese New Year and during Chinese New Year normally is a very important, very, very good trading season for us for both sales and profitability.

So we have a benefit at that time for that first month okay. Because if you recall, the outbreak was way around trying to. But there is timing difference in terms of this quarter for example in the third quarter. The outbreak happened and impacted the full quarter at the beginning to the end.

So we have this full quarter impact in the sales trading situation. So that’s why when you have a very profitable quarter for example, especially for us which is July and August time period before they could go back to school, that’s how trading would have an impact on the sales level.

The other one is commodity prices obviously. This year, we have a couple of things that is going to impact us. One is, as we have mentioned before, we are facing our plastic packaging. We have mentioned that last year, that’s really going to have an impact on us and then when we look at the, get up our sales revenue obviously, we have always been superior to deliver product to our restaurant.

So when sales lending happens, we are going to impact the package for example that they would deliver to the restaurant. And then if you look at labor, for example, labor this year as we have mentioned in last quarter, we raised our best range in June and July. That’s out there, it felt like holding it back and control the cost for their first half of the year.

So at that time, our labor inflation was above 2% to 3%. In the third quarter, it is about 6% to 7% increase, so it is higher. And then another thing that is very important to notice is that we, as I mentioned on the prepared remarks, is a peak trading season. So we have planned some of this labor scheduler ahead of time. In fact during the outbreak, we also have to step up staffing and make sure that we have even tightened up our follow up that tightening up health protocol.

Right. So we measure temperature, check if you are well, to do more sweeping, table cleaning, et cetera, et cetera. So that’s still our impact there. And then all in all, obviously we have some labor costs. But whenever you open a restaurant, you will have your cost, you only have some of the land, some of it is fixed, and some of it is [indiscernible].

So again, you’re going back to that less impact on the margin. I think in the long run, I think we have been able to manage the cost structure quite well. We have seen obviously as mentioned before, commodity price fluctuations for labor cost increase. again, going back to what we do best, we’re working with our team, our innovation team to introduce good products at great value for consumer.

One example that we have recently done is we have a fired chicken bone at the stack, the pizza, so that’s a good way to utilize obviously part of the chicken that we have not used previously. We also used that for example, soup right. So to a point, innovation is very important for us and we will continue to do that.

Working with supply chain is very important. I think a couple of years ago, when price again was searching all coming down, we have mentioned consistently that we work with our supplier for the long term. So we have each other in good time and bad time, and so in that case, we have to mitigate, not completely eliminate the impact that would try to mitigate.

So we’ll continue to do that working with our supply chain. And still obviously, it is very important to notice that delivery cost, volume go up in pandemic, it is going to have an impact on still ads, [indiscernible] but we are able to manage that long term. But sometimes in this short term change in the delivery would also have an impact.

So again, we’re going to invest in technology, infrastructure, automation, including investment in our pizza delivery and make it more efficient. Right. So the productions, queuing for food production, the route, optimization for our rider, [indiscernible] in all that, but we’re trying to continue to make the operation more efficient.

Chen Luo

Thank you for the helpful color and I also look forward to having a try on the pizza next time. [indiscernible].

Joey Wat

And many other products will [indiscernible].

Andy Yeung

Right. Thank you Chen Luo.

Chen Luo

Thank you, Andy.

Joey Wat

Thank you.


Your next question comes from Anne Ling from Jefferies. Your line is open.

Anne Ling

Thank you. Hi management team. Also questions regarding your acquisition, the Huangzhou Catering Group. Does that mean that you’re now owning 73% of the company? So meaning that moving forward, you will consolidate that 700 stores in terms of sales and operating profit and then you take out you at the minority line?

And so if this is the case, number one, is that would there be any exceptional gain on the revaluation of your KFC investment loss of the subsidiaries in the 4Q. Second question as I like to know how should we be expecting in terms of the sales and-or the operating profit impact is it, I mean, be in Huangzhou sales will still possibly will be higher and what would be the profitability impact like?

And the minor question is regarding if it is solely an associate, then I’m not sure my populations. So it seems that third quarter, it was a loss of 6 million. So I’m not sure whether it is related to the Huangzhou business or it is something else. Thank you.

Andy Yeung

Sorry, Anne. Like the last part, I didn’t get it like what was a $6 million.

Anne Ling

Oh, the 6 million a loss is the associated equity contribution the — load operating profit line. So it’s the equity contribution from your investment and in the cash flow in your…

Andy Yeung

So I didn’t quite understand the question, so we may have to take that question offline, but I will try to address the first questions. I think first of all, like we did not acquire Huangzhou catering. We invest 25%, 28% in Hangzhou catering. So we have a 28% stake in that company, not acquisition of that company.

The other part is that because of that and also because of some of other top of arrangement, so now we actually have no basically control of Huangzhou JV and so. So now, we will consolidate that and you’re correct, similar to prior validation of our JV [indiscernible], generally, we would have a commercial and gain because obviously, it was a very successful JV.

Right. So, but it is just kind of complicated accounting if we have two business combination. Right. So on the US GAAP, even though you’re only acquire a portion of the stake, you’re generally treated as a combination of business and then they’ll treat you as a whole, what the gain of your entire or your portion of that.

So it’s not just the proportion to the interest that you have higher but the overall company. And so that’s why normally, you would see this this proportionate measurement gain. And then eventually, it will flow into balance sheet because obviously, it is based on the allocation and so generally with the increase in goodwill as well as intangible. So and that office is similar to our treatment of that in Suzhou.

And so, if you want more detail, I will refer you to our filing, that you and the 10-Q and 8-K payment, they will have more detailed explanation and technical information, kind of treatment of such a combination.

Joey Wat

And just to be very clear, we have originally minority control of our handle joint venture of KFC with the additional 28% investment into Huangzhou catering, we will, Yum China will control and consolidate our Huangzhou KFC with approximately 60% equity interest directly and indirectly.

Andy Yeung

That’s right. And yes, so, and then in terms of the impact, obviously, it will not impact themselves. It would probably increase that result, but in terms of the possibility or increase that we still assessing it, because as we mentioned, there will be some, amortization coming from this and then also the measurement of the franchise right is a lot complicated.

So, we still assessing it, but we similar to as we mentioned to the impact of consolidation, like accounting impact with similar to that of Suzhou, but the offer is not as straightforward as immediately, the activity.

Anne Ling

Okay, okay, got it. Got it. Thank you very much.


Presenters there are no further questions at this time.

Joey Wat

Thank you for joining the call today and we look forward to speaking with you on the next earnings call. Have a great day.

Michelle Shen

Thank you, all.

Andy Yeung

Thank you, everyone.

Source: Seeking Alpha

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