The macro headwinds have been tough, but in our view, Yum China has already tackled them very well. Based on our estimates, SSS recovery for KFC and Pizza Hut in 10M25 (vs 2019) was as high as 88%, which is way better than industry average of 70%. And we believe the main reason for such outperformance lies in its commitment to deliver good food with great value. In terms of company guidance (the FY26E-28E target), we believe the major beat is from Pizza Hut (esp. on store expansion and restaurant level OP margin), but the figures for KFC are slightly below expectation (esp. for the restaurant level OP margin). Moreover, we are pleased with Yum China’s plan to increase its level of dividend and commitment to distribute 100% of its free cash flow since FY27E and onwards.
Going forward, Yum China will not only continue to strengthen its value-formoney, but also focus more on core (e.g. hero products), unlocking the white space and enrolling more new group of customers and capturing more needs on different new occasions. On top of that, Yum China’s efficiency will be further improved by executing its RGM 3.0 strategy (improving efficiency from the front-end to back-end, from supply chain to store level and virtual space, etc.). Therefore, while we are still highly cautious about China’s catering sector outlook in FY26E and FY27E, Yum China should be able to perform better than its peers and at least can deliver reasonably high shareholder returns in the next 2-3 years. Hence, we maintain BUY and raise our TP.
Yum China group has laid down its mid-term (FY26E-28E) goals on top of the current FY25E forecasts. In terms of system sales growth during FY26E-28E, Yum China is aiming for a mid- to high-single-digit CAGR (mid- to high-single-digit for KFC and high single-digit for Pizza Hut). For SSSG, the Company is targeting around 0%-2% (same for both KFC and Pizza Hut). For restaurant operating margin, Yum China is expecting it to improve slightly from 15.7% in FY24 to 16.2%-16.3% in FY25E, and to 16.7% or above in FY28E. That for KFC is expected to remain stable, rising from 16.9% in FY24 to 17.3% in FY25E, and to 17.3% in FY28E. And that for Pizza Hut is expected to climb meaningfully, from 12.0% in FY24 to 12.7% in FY25E, and to 14.5% or above in FY28E. For group level’s OP margin, Yum China is looking for an improvement from 10.3% in FY24 to 10.8%-10.9% in FY25E, and to 11.5% or above in FY28E. In terms of capex, despite the acceleration in store expansion, the amount planned for each year during FY26E-28E will be at around US$ 600mn- 700mn, which is fairly stable, even comparable to the current target in FY25E.
Shareholders’ return could still be decent in FY27E- 28E, under CMBI est.. In terms of shareholders’ return, which is one of the investors’ key focuses, it will still be rather healthy. The Company will continue to fulfill its commitment (deduced from the US$ 4.5bn for FY24-26E) of delivering not less than US$ 1.5bn cash return (a combination of dividend, share buybacks etc.) in FY26E. And for FY27E and beyond, the Company will increase the dividend per share over time (CMBI est. about US$ 322mn in FY25E), and distribute 100% of its free cash flow (where the average annual return will be at around US$ 900mn-1.0bn or above). All in all, we are expecting the effective cash return in FY27E-28E to be at about US$ 1.65bn- 1.89bn, which is not less than the guaranteed US$ 1.5bn in FY26E.
Maintain BUY and raise TP to HK$ 457.48/ US$ 58.56 (based on 21x FY26E P/E, rolled over from 21x FY25E P/E). We fine-tune FY25E/ 26E/ 27E net profit forecasts by -0%/ -2%/ 0%, in order to factor in: 1) faster-than-expected store expansion and 2) better-than-expected OP for Pizza Hut but lower-than-expected OP for KFC, etc.. The stock is trading at 17x FY26E P/E, not particularly attractive given its sales growth. However, we still maintain BUY because of its limited downside, as its FY26E-28E guidance is solid and conservative enough (which made it very difficult to miss), together with its capital return programme (about 9% of its current market cap).
KFC’s FY26E-28E plan is roughly inline with expectation (sales growth is slightly faster but rest. OP margin is slightly lower vs CMBI est.). KFC is targeting a mid- to high-single-digit system sales CAGR during FY26E-28E, which contains the target of 0%-2% SSS CAGR during the same period and the 10% store CAGR during FY26E-30E (implied by the Yum China group’s store count target of 20,000 and 30,000 by FY26E and FY30E). The growth drivers outlined by the management include: 1) hero product strategy (the Company will continue to upgrade and innovate the chicken products) and new product launches (e.g. a carbohydrate type hero product will be rolled out in FY26E), 2) enhancing the valuefor- money (improve product’s taste and texture, strengthen the marketing around the value campaigns, as well as value meals like the 3-item combo), 3) product category expansion (e.g. will double down on K-coffee, targeting for 5,000 stores in 2 years’ time from about 1,800 stores at the moment) will also further ramp up K-pro, aiming for 1,000 in the long run (from about 100 stores at the moment) 4) capturing more new occasions (such as more solo meals, which will invest more starting from FY26E on the drive through demand, launching more indulgent snacks, more products for customers like the riders, uni-students and office workers, etc..) and 5) revamping and rolling out of more new store formats (e.g. small town mini stores, Gemini model (two stores of different brands, placed side by side to enhance cross selling and save more space and staffs by sharing many area and equipment) and the franchising model).
In terms of margin, the Company is aiming for a restaurant level OP of US$ 10bn in FY28E, as well as a stable restaurant level OP margin at around 17.3% or above during FY26E-28E, for the KFC brand. While this target is kind of conservative vs CMBI est., we do think it is highly achievable, because of different drivers like: 1) further improvements in supply chain efficient as well as food costs 2) further reductions on rental expenses, aided by more efficient and smaller store formats, better use of store areas and more simplified food preparation and cooking process, and 3) further boost on productivity per labour with the help of AI, or the adoption of mega store managers etc.. We believe the positive impacts should be more than offset the margin drags by: 1) increasing sales mix from franchising business and 2) higher sales mix from delivery business.
Pizza Hut’s FY26E-28E plan is an all-round beat (store expansion and sales growth are both faster while rest. OP margin is much higher vs CMBI est.). Pizza Hut is targeting a high-single-digit system sales CAGR during FY26E- 28E, which also contains the target of 0%- 2% SSS CAGR in the same period and the 13% store CAGR during FY26E-30E (implied by Yum China’s long-term goal of 30,000 stores by FY30E). Highlighted by the management, the growth drivers are: 1) greater investments on production innovation (on both dough innovation or flavour innovation) and hero product strategy (Pizza Hut has already cut its number of SKUs from 105 to just 80, and will further strengthen on top of this result), 2) improving the value-for-money (may decrease the average ticket size from RMB 70 or above to just RMB 60 or above and will launch more entry level priced (RMB 39 to RMB 49) pizzas or products), 3) product category expansions (e.g. will expand the burger product series and launch more offerings, or any other products with potential), 4) capturing more new occasions (such as solo meals, which will make the purchasing and dining process for takeaway and delivery more seamless and friendly for customers); and 5) accelerating the store opening process, as Pizza Hut is aiming to have about 6,000 stores by FY28E (vs CMBI est. of 5,300), from around 4,000 in FY25E.
In terms of margin, it is another beat for Pizza Hut, where the Company is targeting to double its restaurant level OP to US$ 300mn in FY29E, as well as improving its restaurant level OP margin to around 14.5% or above in FY28E, from just 12.7% in FY25E. We believe there are many drivers (which are able to more than offset drags like higher sales mix from franchised businesses), such as: 1) further improvements on overall food costs and quality thanks to greater economies of scale on rapid volume growth and continual innovations), 2) more reductions on rental expenses, due to better use of store areas (e.g. the adoption of Gemini model can both reduce area by sharing that for two different brands) and simplification of the food preparation and cooking process (e.g. from the help of ikitchen, 3) gradual improvements on labour productivity through menu innovation and the cut of SKUs, automation and centralization of different processes, introduction of more incentive plans etc. and 4) potential improvements on D&A expenses, thanks to drop in capex per store, as the satellite stores and WOW stores tend to have a lower capex but an at least higher OP margin vs the classic model.
Announcing a new store target of 30,000 or above and its time frame (by FY30E). Yum China has promised to achieve 20,000 or above stores by FY26E in the event of 2023 investor day. Based on the current pace, we are fairly confident that the Company is able to achieve this target. And this time in the event of 2025 investor day, Yum China has announced its FY30E target of having 30,000 or above stores, implying a 10% store CAGR during FY26E-30E, which is not too much slower vs the store CAGR of 11% during FY23-26E. In fact, this is better-than-expected (mostly thanks to the Pizza Hut brand), as we are forecasting a slowdown in expansion due to increasingly high base and high penetration, where the white space in China may become less and less. However, we do agree that innovations are still very important and useful, new format such as the Gemini model or even the 3-in-1 model can open up more rooms for new store expansion, as it is way more costs effective and economical, even though these store formats do require a slightly higher level of management capability.