Yum China Holdings, Inc. — Q1 2019 Form 10-Q
Reporting period: Quarter ended March 31, 2019. Unless stated otherwise, financial amounts are US$ millions. Yum China operated 8,653 restaurants, primarily KFC and Pizza Hut, across more than 1,300 cities in China.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total revenue | $2,304 | $2,221 | +4% reported; +10% excluding foreign-exchange impact |
| Operating profit | $303 | $395 | -23% reported; -18% excluding foreign-exchange impact |
| Net income attributable to Yum China | $222 | $288 | -23% |
| Diluted EPS | $0.57 | $0.72 | -21% |
| Adjusted net income | $230 | $214 | Up year over year |
| Adjusted diluted EPS | $0.59 | $0.53 | Up year over year |
| Operating cash flow | $344 | $551 | Down, primarily due to timing of inventory payments |
- Company sales were $2,089, up 4% reported and 10% excluding foreign exchange. System sales rose 9% excluding foreign exchange; same-store sales rose 4%; restaurant count increased 7% year over year.
- Restaurant profit was $386, up 7%; restaurant margin increased to 18.5% from 17.9%. KFC’s margin declined to 20.0% from 20.9%, while Pizza Hut’s rose to 14.3% from 10.5%.
- Adjusted operating profit was $303 versus $297, and adjusted EBITDA was $428 versus $417. These are non-GAAP measures.
- Cash and cash equivalents were $1,247 at quarter-end, with $284 of short-term investments. Current assets were $2,067 and current liabilities $1,587.
- The company reported no borrowings outstanding and approximately $423 of credit facilities, reduced by about $10 of bank guarantees. Operating lease liabilities were $2,233; total lease liabilities, including finance leases, were $2,258.
- Capital spending was $110. Investing cash outflow was $267; financing cash outflow was $113, including $65 of share repurchases and $46 of dividends paid.
Changes, unusual items, and management commentary
- Reported operating profit and earnings were lower partly because Q1 2018 included a $98 gain on remeasurement of the previously held Wuxi KFC interest upon acquisition. Excluding special items, adjusted net income and adjusted EPS increased.
- Q1 2019 included a $10 unrealized gain on the company’s Meituan investment and an $8 additional transition-tax expense. The effective tax rate increased to 28.9% from 26.6%, primarily due to the transition-tax adjustment.
- Adoption of the new lease accounting standard on January 1, 2019 added approximately $2.0 billion of operating lease right-of-use assets and $2.2 billion of lease liabilities. A $60 net impairment adjustment was recorded against opening retained earnings; additional Q1 restaurant impairment expense was $12.
- Management attributed restaurant growth to unit expansion and same-store sales. It cited wage and commodity inflation and higher promotion/product-upgrade costs as offsets; Pizza Hut benefited from labor efficiency, lower depreciation, and commodity deflation.
- The company stated that existing cash and expected operating cash flow should fund operations and anticipated capital expenditures for the next 12 months. No specific earnings or revenue guidance was provided.
- Risks highlighted include the China-focused business and RMB exposure, food and labor costs, competition, leased-property obligations, and regulatory and tax uncertainty. A Chinese transfer-pricing audit covering 2006–2015 may have significant developments within 12 months; the potential impact cannot currently be reasonably estimated. A separate potential Chinese indirect-transfer tax related to the 2016 separation could be significant.
- Management estimated that a 10% weakening of the RMB against the US dollar would reduce quarterly operating profit by approximately $28, assuming no changes in volume or local-currency prices.
Important facts for investors to verify
- Whether operating and same-store sales momentum persists, particularly the differing KFC and Pizza Hut margin trends.
- How much of the earnings comparison reflects the prior-year Wuxi acquisition gain, and whether adjusted performance translates into sustained GAAP earnings growth.
- Cash conversion and working-capital trends, given the year-over-year decline in operating cash flow.
- The scale and duration of lease commitments, including $87 of signed leases not yet commenced, and future impairment exposure.
- Developments in the transfer-pricing audit and indirect-transfer tax contingency, as well as the company’s ability to realize its $249 input VAT credit asset.
- Meituan investment valuation, currency exposure, and planned capital returns; the board declared a subsequent $0.12-per-share dividend payable in June 2019.