Yum China Holdings, Inc. — Q3 2022 Form 10-Q
Reporting period: Quarter ended September 30, 2022; financial amounts are in U.S. dollars. Yum China operates KFC, Pizza Hut and other restaurant concepts primarily in China. It reported more than 12,000 restaurants across over 1,700 cities.
Financial performance
| Metric | Q3 2022 | Q3 2021 | Year to date 2022 | Year to date 2021 |
|---|---|---|---|---|
| Total revenue | $2,685 million | $2,554 million | $7,481 million | $7,562 million |
| Operating profit | $316 million | $178 million | $588 million | $753 million |
| Net income attributable to Yum China | $206 million | $104 million | $389 million | $515 million |
| Diluted EPS | $0.49 | $0.24 | $0.92 | $1.19 |
| Restaurant margin | 18.8% | 12.2% | 15.1% | 15.6% |
| Operating cash flow | Not separately presented for the quarter | $1,329 million | $1,074 million |
- Q3 revenue rose 5% reported and 11% excluding foreign-exchange effects; operating profit increased 77% reported and 86% excluding FX. Net income attributable to Yum China nearly doubled.
- For the first nine months, revenue declined 1% reported but increased 1% excluding FX. Operating profit fell 22% reported and 20% excluding FX; attributable net income declined 25%.
- Q3 system sales increased 5% excluding FX and same-store sales were flat year over year. Year-to-date system sales declined 5% excluding FX and same-store sales declined 8%.
- Cash and cash equivalents were $1,211 million and short-term investments were $2,826 million at September 30. Current assets were $4,710 million versus current liabilities of $2,104 million.
- Total lease liabilities were $2,343 million. The company reported no bank borrowings outstanding; credit facilities totaled approximately $529 million before reductions for outstanding guarantees.
Drivers, changes and unusual items
- Management attributed Q3 recovery to relatively calmer COVID conditions in July and August, comparison with the prior-year Delta outbreak, unit growth, productivity and temporary relief. These benefits were partly offset by restaurant closures or service restrictions, food and wage inflation, utility costs and higher delivery-rider costs.
- In September, an average of approximately 900 stores were temporarily closed or offered takeaway and delivery only, up from approximately 400 on average in July and August. In October, approximately 1,400 stores were in those categories as outbreaks resurged.
- Q3 restaurant margins improved substantially year over year, while year-to-date margins edged lower. The year-to-date operating-profit decline reflected COVID-related disruption, weaker same-store sales, inflation and higher delivery costs, partly offset by productivity, temporary relief and the Hangzhou KFC acquisition.
- Operating cash flow increased year over year, primarily due to VAT-asset refunds. The company spent $509 million on capital projects, repurchased $413 million of shares and paid $152 million in common-stock dividends year to date.
- Foreign-currency translation reduced Q3 comprehensive income attributable to Yum China to a loss of $56 million, despite positive net income; year-to-date attributable comprehensive loss was $101 million.
- Q3 included a $15 million investment loss, primarily related to the fair-value decline in the Meituan investment. The company also recorded $24 million of amortization of reacquired franchise rights in Q3, mainly associated with Hangzhou KFC.
Outlook, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management said cash on hand, operating cash flow and access to credit facilities should be adequate for operations and anticipated capital expenditures over the next 12 months.
- Management warned that COVID-related outbreaks and restrictions remained uncertain and could continue to materially and adversely affect results, cash flows and financial condition. The filing cites lower travel and spending during China’s October National Day holiday.
- A Chinese tax-authority transfer-pricing audit concerning related-party transactions from 2006–2015 remains ongoing, focused on the YUM franchise arrangement. The potential assessment cannot be reasonably estimated; additional tax, interest and penalties could be material.
- Yum China and YUM are in a dispute over royalties on delivery fees and third-party aggregator commissions, as well as allegations concerning use of YUM intellectual property. Yum China paid disputed royalties under reservation of rights; the dispute-resolution process was continuing. An unresolved dispute could proceed to arbitration and could put license rights at risk.
- The company identifies RMB/USD movements, commodity and labor costs, restaurant leases, consumer demand and China-related regulatory and operating conditions as risks. A 10% weakening of the RMB was estimated to reduce quarterly operating profit by approximately $30 million, assuming no other changes.
- The company is winding down COFFii & JOY by year-end 2022 and completed the closure of East Dawning units by March 2022. Taco Bell development milestones call for at least 100 stores by year-end 2022 and 225 by year-end 2025, subject to the license terms.
- After the quarter, Yum China’s Hong Kong listing became a primary listing on October 24, 2022, and the board declared a $0.12-per-share dividend payable in December.
Important facts for investors to verify
- Whether COVID-related closures and restrictions persist, and whether same-store sales recover beyond the Q3 level.
- Progress and potential financial exposure from the YUM royalty and intellectual-property dispute and the Chinese transfer-pricing audit.
- Whether VAT refunds continue to support cash flow, and the timing and recoverability of remaining VAT assets.
- How food, wage, utility and delivery costs affect restaurant margins, particularly against the year-to-date margin decline.
- Capital allocation, including remaining share-repurchase authorization of approximately $1.2 billion, dividend payments and investment in store expansion.