Yum China Holdings, Inc. — Q1 2020 Form 10-Q
Reporting period: Quarter ended March 31, 2020. Dollar amounts are U.S. dollars in millions unless stated otherwise. Comparisons are with Q1 2019 unless noted.
Business context and period
Yum China operates and franchises KFC, Pizza Hut and other restaurant brands in China. It reported 9,295 system restaurants at quarter-end, up 7% year over year. COVID-19 materially disrupted operations from late January; about 35% of stores were closed at the outbreak peak. By the end of April, approximately 99% were partially or fully open.
Financial results and liquidity
| Metric | Q1 2020 | Q1 2019 | Change / context |
|---|---|---|---|
| Total revenue | $1,754 | $2,304 | Down 24% reported; down 21% excluding foreign exchange |
| Company sales | $1,548 | $2,089 | Down 26% reported; down 24% excluding foreign exchange |
| System sales | — | — | Down 20% excluding foreign exchange; same-store sales down 15% |
| Restaurant profit and margin | $165; 10.7% | $386; 18.5% | Profit down 57%; margin fell 7.8 percentage points |
| Operating profit | $97 | $303 | Down 68% reported; down 67% excluding foreign exchange |
| Net income attributable to Yum China | $62 | $222 | Down 72% |
| Diluted EPS | $0.16 | $0.57 | Down 72% |
| Adjusted EBITDA | $219 | $428 | Company-defined non-GAAP measure |
| Operating cash flow | $60 | $344 | Lower mainly from reduced earnings and working-capital timing |
Cash and cash equivalents were $1,048 at March 31, with $490 in short-term investments; current liabilities were $1,483. The company reported no borrowings outstanding under credit facilities of approximately $454, though $12 of bank guarantees reduced facility availability. Lease liabilities totaled $2,134, including $1,704 of non-current operating lease liabilities. Net cash used in financing was $52, including $45 of dividends and $8 of share repurchases.
Material changes and management commentary
- KFC system sales fell 15% excluding foreign exchange and same-store sales fell 11%; operating profit declined 45% excluding foreign exchange to $153.
- Pizza Hut system sales fell 38% excluding foreign exchange and same-store sales fell 31%; the segment recorded a $28 operating loss versus $50 operating profit a year earlier.
- Management attributed the downturn primarily to COVID-related sales declines and temporary closures. Higher delivery-related rider costs and commodity inflation also weighed on restaurant results. Partial offsets included labor efficiency, utility savings, $20 of government social-security contribution reductions, and $14 of landlord rent concessions.
- April same-store sales remained down more than 10%, despite the reopening of most stores. Management said recovery was uneven and expected COVID-19 to materially adversely affect full-year 2020 results, cash flows and financial condition; it provided no quantified full-year forecast.
Outlook, risks and unusual items
- To preserve liquidity during the pandemic, the company temporarily suspended share repurchases and dividends for the next two quarters, and increased credit facilities. Management stated that cash, operating cash flows and facilities were expected to cover operations and anticipated capital expenditures for the next 12 months.
- In April, the company completed the acquisition of a 93.3% interest in Huang Ji Huang for approximately $185 cash. It also agreed to buy an additional 25% of a KFC unconsolidated affiliate for approximately $149, subject to closing conditions; completion was expected in the second half of 2020.
- A Chinese national transfer-pricing audit concerning related-party transactions from 2006–2015 remains ongoing. The company said the potential impact cannot be reasonably estimated; an adverse assessment, including interest and penalties, could be material.
- The company disclosed potential exposure under a tax agreement relating to possible Chinese indirect-transfer tax on its 2016 separation from YUM; any settlement could be significant. Routine legal matters were not expected to have a material adverse effect.
- Meituan investment fair-value movements produced an $8 loss in Q1 2020 versus a $10 gain in Q1 2019. The quarter also included a $9 restaurant-level impairment charge and a $1 special share-based compensation expense for Partner PSU Awards.
- Foreign-exchange exposure is significant because most operations and assets are in China; management estimated a 10% RMB weakening would reduce quarterly operating profit by approximately $10, assuming no other changes. Food commodity costs, consumer behavior, supply chain, labor and China/U.S. regulatory and economic conditions are additional risks.
Important facts for investors to verify
- Whether sales and traffic recovery continued after April, and the resulting full-year impact on earnings and cash generation.
- Liquidity, credit-facility availability and capital spending needs, including the effects of suspended dividends and repurchases and the April acquisitions.
- Developments in the Chinese transfer-pricing audit and any potential indirect-transfer tax indemnity exposure.
- Restaurant-level margins and impairment trends, particularly at Pizza Hut, and the sustainability of government subsidies and landlord concessions.
- RMB movements and the market value of the Meituan investment.