Yum China Holdings, Inc. — Form 10-Q Summary
Reporting period: Second fiscal quarter ended May 31, 2017 (three months), and year to date through May 31, 2017 (five months). Unless noted, amounts are US$ millions. Yum China became an independent public company on October 31, 2016; prior-year comparative results include combined China operations while they were part of Yum! Brands and may not reflect standalone costs.
Business context
Yum China operates, franchises or holds interests in restaurant businesses in mainland China, principally KFC and Pizza Hut, alongside smaller concepts. It reported more than 7,600 restaurants across over 1,100 cities at May 31, 2017. KFC and Pizza Hut were the two reportable segments; East Dawning, Little Sheep, Taco Bell and newly acquired delivery platform Daojia were included in All Other Segments. Pizza Hut Casual Dining and Home Service were combined for segment reporting.
Financial performance and liquidity
| Metric | Quarter ended May 31, 2017 | Prior-year quarter | Year to date 2017 | Prior-year YTD |
|---|---|---|---|---|
| Total revenue | $1,594 | $1,588 | $2,878 | $2,891 |
| Operating profit | $143 | $87 | $397 | $296 |
| Net income attributable to Yum China | $107 | $77 | $282 | $222 |
| Diluted EPS | $0.27 | $0.21 | $0.71 | $0.61 |
| Restaurant margin | 15.3% | 12.6% | 18.7% | 15.6% |
| Adjusted EBITDA | $259 | $226 | $579 | $505 |
- Quarterly revenue was essentially flat as reported; system sales grew 7% and company sales grew 6% excluding foreign-exchange effects. Same-store sales increased 3% overall. Quarterly operating profit rose 64% and net income attributable to Yum China rose 39%.
- For the five-month period, reported revenue declined less than 1%; operating profit increased 34%, net income attributable to Yum China increased 27%, and diluted EPS increased 16%.
- Quarterly segment operating profit: KFC $154 versus $109; Pizza Hut $30 versus $12; All Other Segments loss of $2 versus a loss of $2. Year-to-date segment operating profit: KFC $361 versus $300; Pizza Hut $97 versus $50; All Other Segments approximately breakeven versus a $1 loss.
- Management attributed profit improvement principally to same-store and new-unit growth, lower restaurant operating costs and the favorable effect of China’s retail tax/VAT reform, partly offset by higher labor costs, commodity inflation and G&A. The prior-year leap day contributed an estimated $4 to year-to-date operating profit.
- Operating cash flow was $473 year to date, compared with $423. Investing cash outflow was $432, including $229 of short-term investment purchases, $177 of capital spending and $25 for the Daojia business acquisition. Financing cash outflow was $43, including $30 of share repurchases. Cash increased $7 to $892.
- At May 31, cash and cash equivalents were $892 and short-term investments were $310. Current assets were $1,692 and current liabilities $1,002. Total liabilities were $1,289; capital lease obligations were $27. The company reported no outstanding borrowings and had approximately $330 of credit facilities available.
- YTD capital spending was $177. The company repurchased 1.07 million shares for $39 under its $300 million authorization, leaving $261 available. It declared $22 of dividends during the period.
Outlook, commentary and risks
- No specific earnings or revenue guidance was provided. Management said cash on hand and expected operating cash flow should fund operations and anticipated capital expenditures for the next 12 months. It cited ongoing restaurant development; the company had added units and reported 6% net unit growth year over year.
- Management cautioned that benefits from VAT reform may fluctuate as implementation and interpretation evolve. At May 31, the company recorded a $111 input VAT credit asset and had not recorded an allowance, expecting future use against VAT payables.
- Most revenue, costs and assets are RMB-denominated, and the company did not hedge foreign-currency earnings. Management estimated a 10% RMB weakening would reduce quarterly operating profit by approximately $15, assuming no changes in sales volumes or local-currency prices.
- A potential Chinese indirect-transfer tax relating to the separation remains uncertain. The company concurred with Yum! Brands’ view that the tax was more likely than not not applicable, but any assessment could be significant; the related obligation was not considered probable or estimable at filing. Allocation of any liability is governed by the tax matters agreement.
- Daojia acquisition consideration was $36.7, with a concurrent $25 capital contribution. Yum China held 90% of common shares (80% on a fully diluted basis). Daojia’s VIE structure, integration demands and realization of expected synergies are identified risks.
- The company cited approximately $3 billion of future minimum operating lease payments. It expects the lease accounting standard, effective for it in fiscal 2019, to materially affect the balance sheet through recognition of lease assets and liabilities.
- Other key risks include food safety, labor and commodity cost inflation, competition, dependence on China and the YUM master license agreement, regulation and currency controls in China, access to capital markets as a company without a credit rating, and limits on cash transfers and dividends. The filing reported disclosure controls were effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- How much of improved restaurant margins and operating profit reflects sustainable sales and operating performance versus VAT reform, currency movements and other period-specific effects.
- The recoverability and timing of use of the $111 VAT credit asset, and any changes in Chinese VAT implementation or rates.
- Developments in the potential separation-related indirect-transfer tax and the company’s share of any resulting liability under the tax matters agreement.
- Daojia’s operating contribution, VIE regulatory status, integration costs and progress toward expected benefits.
- Future capital spending, restaurant growth, share repurchases and dividends, including Chinese statutory limits on dividend distributions and the company’s ability to access financing if needed.