What is Yum China?
Yum China is the largest restaurant company in China by sales, with over 30 years of history in the region. It is one of China’s major employers, managing nearly 13,000 restaurants across more than 1,800 cities and towns, spanning every province of mainland China1. Yum China’s collection of brands is extensive: it owns the exclusive rights to operate and sub-license KFC, Pizza Hut, Coffii & Joy, Taco Bell and East Dawning, in addition to owning the Little Sheep and Huang Ji Huang restaurant concepts outright. The business has also partnered with Lavazza to further develop the ‘coffee shop’ concept in China. Yum China was previously connected to the ‘Yum! Brands’ Corporation, but now exists as a separate entity.
How we found it
For us, the ability to recognise change as it occurs is critical to identifying companies that are capable of driving innovation. However, an equally important element of this process is the ability to identify where change may emerge in the future. On this basis, we had Yum China on our watch list for some time and added it to the portfolio in 2020.
As part of our investment process, we seek out areas of secular growth, such as, ‘Digitalisation’ (the growth of digital technology in business) and ‘Premiumisation’ (how evolving demographics drive demand for superior products and services). The tracking of these areas of growth means that we can identify companies that we believe are optimally positioned to benefit from them. The presence of these companies on our radar enables us to study how they respond to changes in the market, allowing us to build conviction before making the decision to invest.
Although we are not an ESG fund, Yum China presented a range of attractive features. Its ESG profile is very strong, with a female CEO and a management team that is 61% female. It was awarded the “AA” rating in the MSCI Environmental, Social and Governance (ESG) Ratings 2022, and the Gold Class Award in the Sustainability Yearbook 2022 by S&P Global, which we believe sets it apart from the bulk of its peers.
As we dug into its operations, we identified a strong opportunity for structural growth. This was, built around low penetration of their brands in lower tier cities, consumers desire for a premium products and services, menus to cater for local taste preferences and impressive digitalization of its operations, making them highly efficient.
The re-opening of businesses following pandemic-era lockdowns was likely to disproportionately benefit both fast food and premium restaurants, where demand had collapsed amid prolonged lockdowns. Yum China’s ability to pivot its brands to takeaway services (driven by the strength of its digital infrastructure) meant that it fared better than most during lockdown. However, the indiscriminate sell-off during the pandemic presented an attractive entry point for investment in the company.
How we gained conviction
We initially purchased Yum China in 2020 but sold it six months later due to changes in the market that included growing tensions between the US and China, the ADR scare, and the escalating development of COVID-19. However, we continued to observe the business and ultimately decided to repurchase it in 2022. This decision was informed, in part, by industry consolidation, which had developed as a result of the COVID-19 lockdowns pressuring smaller businesses in an already fragmented marketplace, allowing major industry players such as Yum China to increase their market share.
The company’s dominant market position allows it to wield significant purchasing power – for example, it is one of the largest consumers of poultry in China. It can exploit this scale on account of centralised procurement across all of its brands – an unusual feat in the restaurant industry driven by the effectiveness of its overarching digital infrastructure. Yum China’s establishment of centralised, standardised supply chains that encompass its constituent brands enables consistently high safety standards and is a differentiating factor for the company.
Another differentiating factor is that the broad umbrella of Yum China’s brands allow management of multiple restaurants within, or across different brands by a single manager, reducing operating costs and improving operational efficiency that enhances the company’s ability to generate cash flow, which in turn can be reinvested in R&D and innovation. We also value the company’s notable efforts to build employee loyalty – aligning the interests of its staff with those of the business by offering stock options and purchasing health insurance for the close family members of its key employees.
How is it doing?
Yum China plans to open approximately 1,100 new restaurants over the course of the coming year2, while its use of increasingly sophisticated AI-backed technology has the potential to facilitate higher rates of customer satisfaction and efficiency. We expect to see an expanded focus on localized menus that are tailored to different markets, as well as the increasing rollout of concepts such as the ‘coffee shop’, which remain relatively novel in the Chinese market. Yum China’s business is highly sustainable due to its high cash conversion as new restaurants reach maturity and profitability, thus enabling further store expansion. The efficiency of its operations, the loyalty of its staff and its track record of achieving rapid profitability of new outlets gives us strong confidence in its ability to execute its strategy and thus exceed expectations.
1 https://ir.yumchina.com/about-yum-china
2 Yum China Fourth Quarter and Fiscal Year 2022 Results Investor Presentation, 8 February 2023
Image credit: Robert – stock.adobe.com
Disclaimer
The views and opinions contained herein are those of Jane Andrews. They do not necessarily represent views expressed or reflected in other BennBridge investment communications or strategies and are subject to change.
The securities shown are for illustrative purposes only and should not be viewed as a recommendation to buy or sell.
Past performance is not indicative of future results.
