Yum China Holdings, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Amounts are in U.S. dollars; financial statement figures are in millions unless stated otherwise. Yum China operates KFC, Pizza Hut and other restaurant and food businesses, primarily in China, and reported 10,150 restaurants at quarter-end.
Financial performance and liquidity
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenue | $2,348 | $2,319 | $6,004 | $6,747 |
| Operating profit | $556 | $300 | $781 | $807 |
| Net income attributable to Yum China | $439 | $223 | $633 | $623 |
| Diluted EPS | $1.10 | $0.58 | $1.62 | $1.60 |
| Adjusted operating profit | $320 | $300 | $550 | $807 |
| Adjusted net income attributable to Yum China | $263 | $223 | $462 | $631 |
| Adjusted EBITDA | $436 | $407 | $916 | $1,156 |
Q3 company sales grew 1% year over year (flat excluding foreign exchange); same-store sales fell 6%. The company restaurant margin was 18.6%, up 0.9 percentage points. For the first nine months, total revenue declined 11% (9% excluding foreign exchange), system sales fell 8% excluding foreign exchange, same-store sales declined 11%, and restaurant margin fell 2.3 percentage points to 14.7%.
Cash flow: Nine-month operating cash flow was $899, versus $1,045 in 2019; capital spending was $284. Investing activities used $2,333, substantially reflecting investment purchases and acquisitions. Financing activities provided $2,144, including $2.2 billion net proceeds from the September Hong Kong listing. Cash and cash equivalents were $1,782 at September 30, and short-term investments were $2,424.
Balance sheet and funding: Current assets were $4,800 and current liabilities $2,007. Total liabilities were $4,179. The filing reports no bank borrowings outstanding and approximately $509 million of credit facilities, reduced by $15 million of bank guarantees. Lease liabilities totaled $2,259, including $2,232 operating and $27 finance lease liabilities. These lease obligations are distinct from bank borrowings.
Material changes and unusual items
- Reported Q3 operating profit included a non-cash $239 million gain from remeasuring Yum China’s previously held interest in Suzhou KFC when it acquired an additional 25% interest and began consolidating the business. The gain materially lifted reported operating profit and net income; adjusted operating profit excludes it.
- Reported Q3 net income also reflected $38 million of investment gains, primarily fair-value gains on Meituan shares. Nine-month investment gains were $75 million.
- Q3 operating results improved sequentially, but the nine-month operating-profit decline reflected COVID-19-related sales weakness and closures, partly offset by rent concessions, government social-security contribution reductions and the Suzhou KFC gain. The filing identifies $31 million of year-to-date rent concessions and a $49 million one-time social-security contribution reduction.
- In April, the company acquired 93.3% of Huang Ji Huang for $185 million. In August, it paid $149 million for an additional 25% of Suzhou KFC, increasing its ownership to 72%. Acquisitions also increased goodwill and intangible assets.
- The Hong Kong secondary listing issued 41.9 million shares at $53.16 per share and generated $2.2 billion net proceeds. The company suspended share repurchases and dividends through Q3; the board subsequently declared a $0.12-per-share dividend, estimated at approximately $50 million, payable in December 2020.
Outlook, commentary and risks
Management said results improved sequentially in Q2 and Q3, but traffic and sales remained below pre-outbreak levels. It expected COVID-19 effects, including reduced traffic at transport and tourist locations and altered school holidays, to continue affecting Q4 2020. The filing provides no specific forward revenue or earnings guidance; management said the duration and scale of the pandemic’s effects remain uncertain and could materially adversely affect results, cash flows and financial condition.
Other significant risks include a Chinese tax-authority transfer-pricing audit concerning related-party transactions from 2006–2015, focused on the YUM franchise arrangement. Potential tax, interest and penalties cannot be reasonably estimated and could be material. The company also disclosed RMB exposure, competitive and operating risks, uncertainty around acquisition benefits, and U.S. regulatory risk related to PCAOB access to audit work papers for China-based operations. A 10% weakening of the RMB was estimated to reduce quarterly operating profit by approximately $52 million, assuming no other changes.
Important facts for investors to verify
- Separate recurring operating performance from the $239 million Suzhou KFC remeasurement gain and Meituan investment gains; reconcile reported and adjusted measures.
- Track recovery in same-store sales, traffic and restaurant margins, especially against management’s stated continuing Q4 pandemic impacts.
- Review cash generation and deployment, including the use and liquidity of short-term investments, acquisition spending, lease commitments and the resumption of dividends or repurchases.
- Monitor developments in the Chinese transfer-pricing audit and any potential assessment, and assess the uncertainty around PCAOB inspection access and U.S. listing requirements.
- Evaluate whether acquisitions and expansion support sustainable growth, and account for the changing mix of company-owned, franchised and unconsolidated-affiliate restaurants.