Yum China Holdings, Inc. quarterly report, Q2 FY2019

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Yum China Holdings, Inc. — Q2 2019 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2019. Amounts are US$ millions except per-share data, percentages and store counts. Yum China operated 8,751 restaurants, primarily KFC and Pizza Hut, across more than 1,300 Chinese cities.

Financial performance

MetricQ2 2019Q2 2018Six months 2019Six months 2018
Total revenue$2,124$2,068$4,428$4,289
Operating profit$204$193$507$588
Net income attributable to Yum China$178$143$400$431
Diluted EPS$0.46$0.36$1.03$1.08
Operating cash flow—$657$819
  • Q2 revenue rose 3% as reported and 10% excluding foreign-exchange effects; company sales increased 2% reported and 9% excluding FX. System sales grew 10% excluding FX and same-store sales rose 4%.
  • Q2 operating profit increased 6% reported and 14% excluding FX. Net income rose 24%; the effective tax rate declined to 20.0% from 26.0%. A $17 million unrealized gain on the Meituan investment contributed to pretax income.
  • Q2 restaurant margin was 14.7%, down 0.4 percentage points. For the six months, margin was 16.7%, up 0.1 points. Management cited sales and unit growth, lower depreciation, utilities savings and labor efficiency, partly offset by wage and commodity inflation, promotions and product upgrades.
  • Six-month revenue grew 3% reported and 10% excluding FX. Operating profit fell 14% reported, while adjusted operating profit was $507 million versus $490 million. Adjusted net income was $408 million versus $357 million and adjusted diluted EPS was $1.05 versus $0.89; these are non-GAAP measures.

Cash, liquidity and capital

  • Cash and cash equivalents were $1,296 million and short-term investments $284 million at June 30, 2019. Current assets were $2,137 million versus current liabilities of $1,626 million.
  • Six-month operating cash flow was $657 million, down from $819 million, which management attributed primarily to timing of inventory payments. Investing cash outflow was $368 million, including $212 million of capital spending; financing outflow was $259 million.
  • The company reported no borrowings outstanding. Credit facilities totaled approximately $418 million, with remaining terms of one year or less; $10 million of bank guarantees for restaurant lease payments reduced available capacity.
  • Yum China repurchased $140 million of shares and paid $91 million in dividends during the first half. It had $820 million remaining under its $1.4 billion repurchase authorization. A further $0.12-per-share dividend, estimated at $46 million, was declared after quarter-end.
  • Adoption of lease accounting in January 2019 recognized $1,954 million of operating-lease right-of-use assets and $2,164 million of operating-lease liabilities at June 30. These accounting balances do not represent newly incurred borrowings. Adoption also reduced opening retained earnings by $60 million for impairment, net of related tax and noncontrolling-interest effects.

Changes, outlook and risks

  • KFC Q2 system sales grew 12% excluding FX and same-store sales rose 5%; Pizza Hut system sales grew 4% excluding FX and same-store sales rose 1%. KFC operating profit was $205 million; Pizza Hut operating profit increased to $29 million from $19 million.
  • The prior-year six-month comparison included a $98 million nonrecurring gain from remeasuring the previously held Wuxi KFC interest upon acquisition. In 2019, the company recorded an additional $8 million transition-tax adjustment. Meituan fair-value gains were $27 million for the first half.
  • No numerical earnings or sales guidance was provided. Management said existing cash and expected operating cash flow should fund operations and anticipated capital expenditures for the next 12 months, while noting this depends on continued cash generation and access to financing.
  • Material risks include a Chinese national transfer-pricing audit covering related-party transactions from 2006–2015; the company said the outcome cannot currently be estimated and a tax, interest or penalty assessment could be material. A separate potential Chinese indirect-transfer tax connected with the 2016 separation also remains uncertain and could result in a significant settlement under the tax matters agreement.
  • Other noted exposures include RMB/USD movements, commodity and labor cost inflation, changing VAT benefits, and the recoverability of a $243 million input VAT credit asset. Management estimated that a 10% RMB weakening would reduce quarterly operating profit by approximately $20 million, assuming no other changes. The filing reported no material change to previously disclosed risk factors; disclosure controls were deemed effective.

Important facts for investors to verify

  • Whether same-store sales and unit growth can offset wage, commodity, promotional and currency pressures, particularly for KFC and Pizza Hut margins.
  • Developments in the transfer-pricing audit and any potential indirect-transfer tax exposure, including amounts, timing and indemnity allocation.
  • Operating cash flow conversion and planned capital spending, repurchases and dividends; the filing gives no specific forward earnings guidance.
  • Performance of newer COFFii & JOY and e-commerce operations, which remain within the aggregated “All Other Segments” and reported an operating loss.
  • Effects of lease obligations, RMB movements and the realization of the VAT credit asset on future liquidity and reported results.