Yum! Brands, Inc. (YUM) Earnings Call Transcript & Summary

Good morning, everybody, and welcome back to day 2 of Oppenheimer's 22nd Annual Consumer Conference. I'm Brian Bittner, the restaurant analyst at Oppenheimer. And we are incredibly excited to welcome Yum! Brands back to our event today. And joining us from the company today is Chris Turner, who has been Yum! Brands' CFO since August of 2019. Chris, welcome and thank you for spending time with us today. We greatly appreciate it.

Yes, Brian, thanks so much for having us. We're really excited to be a part of the event, and look forward to chatting with you.

Great. And as an intro for everybody, Yum! Brands is the largest restaurant company in the world with over 54,000 restaurants, and we believe the company represents a globally diverse franchise growth platform with 4 business segments: KFC at about 51% of profits; Taco Bell at about 32% of profits; Pizza Hut at 18% of profits, and then the business has rounded out by Habit Burger, which was acquired in March of 2020.

So with that as an intro, Chris, I would really like to start the discussion by zooming out to a big picture kind of level at the enterprise level first, and then we can dive further into the specific brands. And I'd like to start with Yum!'s unit growth, which is, obviously, an attractive pillar of the investment story. Chris, you and the team have communicated a long-term annual target of 4% to 5% unit growth, and you've been over delivering on this goal more recently, where unit growth has been closer to that 6% range, which is incredibly impressive for a company of Yum!'s size. And it seems as though you've built the internal capabilities to make unit growth a top priority at the organization. So can you talk about what else specifically drives your confidence and Yum!'s ability to keep delivering on the unit growth equation, particularly in light of all the inflation out there being absorbed by your franchisees?

Yes. Thanks a bunch, Brian. You hit on one of the most important and impressive aspects of our business model, which is our unit growth engine. You think about our algorithm, 2% to 3% same-store sales growth, 4% to 5% net new unit growth translating to mid- to high-single-digit system sales growth and high single-digit operating profit growth as a long-term algorithm, that means that our unit development engine represents more than 50% of our sales growth. And when we think about that, there's really no better fact that represents the underlying health of the brands and our system then when our unit count is growing because that means in an asset-light model, where we're 98% franchised, that our franchisees are putting their capital to work to continue to expand our brands. And so we think that represents just incredible strength for our system and is reflective of the resiliency and the future growth potential of our business model. If you think about the drivers of that unit growth, it starts, obviously, with strong brands and strong unit economics. So all of our brands are well loved by consumers. Even in this inflationary environment that we see around the globe, our brands stand for value. QSR stands for value and our brands do a particularly good job of that within QSR. It is also reflective of us having very strong franchisees. Remember, our franchisees, on average, are larger than franchisees than most other restaurant systems. And that -- when you spend time with our franchisees, these are sophisticated, well-capitalized organizations. They tend to not make decisions around the near-term, they're thinking long-term. And our franchisees are putting capital to work. I was just in Turkey, the last few days and spent time with our franchisee there, [ Okan Sahin ], franchisee for KFC and Pizza Hut. We celebrated the opening of the 250th KFC in Turkey. A few weeks ago, he opened 20 KFCs in a single day. He's got an amazing team that he's put in place to do this. And so those are the primary drivers, plus we have great development teams that increasingly use analytics to help us identify the right locations to open our restaurants. So I think all of those factors are reflective of why we continue to drive the strong unit development story.

That's great summary. And yesterday, we were lucky enough to have Yum China present your franchisee in China, of course. And they're showcasing very strong unit opening trends, which is a contributor to your overall unit growth, but importantly, and maybe somewhat overlooked by the investment community is that your international markets outside of China have also accelerated their unit growth trends. I think ex-China grew by 5% or more last quarter. So can you talk about, excluding the big growth driver of China, what are the biggest pockets and drivers of kind of ex-China unit growth across your portfolio, if you could point anything out on that front?

Yes. So I think that's another really exciting aspect to the story. As you said, Yum China has historically been our development leader. They are in a large market, they have a wonderful leadership team and a great development capability, and they're going to continue to be the incredibly strong developer in the system. But if you go ex-China, we were plus 4% globally, if you take ex-China, ex-U.S., as you said, plus 5%. So this is a very broad-based strength. If you go back to last year, we were well north of 100 countries that had development around the globe. And of course, all of our brands have momentum on the development story in Q1. All of that added up to us opening 1,000 gross units in Q1, that's a restaurant nearly every 2 hours, which is just mind boggling. No retail or a person like myself who's worked in many different sectors within retail and consumer. It's just an incredible capability. And if you start to dig into some of those numbers outside of China, India has been particularly strong. Last year, we opened 380 units across 3 brands. So KFC, Pizza Hut and Taco Bell all had strength in India, Asia Pacific in Q1. We were plus 24%. Latin America had strength -- it's very broad-based strength. And again, I think it reflects those drivers that I mentioned at the beginning, strong brands, strong unit economics and strong franchisees who think long-term.

That's great. And when we think about staying high level for a moment before we dive into the brands, when we think about the overall long-term financial algorithm for Yum! Brands. You've talked about the combination of unit growth and low single-digit comps driving this high single-digit operating profit growth. And I know you touched on it just a moment ago, but obviously, this year, the profit growth is anticipated to be in the mid-single-digit range because of the onetime headwinds from the resolution of the Russia business and temporary China lockdowns that have happened throughout the first half of the year. So when we move past this year, can you talk a little bit more about what drives your confidence in the financial algorithm in 2023 and beyond to be able to deliver on that high single-digit range. Is there anything specific to point out? Or do you just anticipate getting back to your normalized pace of growth?

Yes. If you think about that algorithm, what we said on the Q1 call is this really one factor that's taking us off of the profit algorithm this year. And that's Russia, where you're taking about 3% of the operating profit out of the business. We said that a new profit and there, we're going to redirect towards humanitarian causes. So that's the one driver. All of the other puts and takes around the globe, we think, keep us essentially on our plan and all of the other aspects of the algorithm, we said we continue to expect to deliver. As we think long term, as I mentioned earlier, we think our brands are very, very well positioned even in this challenging environment, and will thrive in this environment. We think we're very well positioned. And so from a sales growth standpoint and from a unit growth standpoint, we continue to see that long-term trajectory to be very strong. If you think about the inflationary pressures, when you look at it, remember, only 40% of our business is in the U.S., and it's the U.S. and maybe 1 or 2 other developed markets where we're seeing dual drivers of inflation, really strong inflation. We've seen both commodity pressure and wage pressure. Most of the -- rest of the world, it's a single -- primarily a single driver. We're seeing commodity inflation, but the wage inflation really has been much more subdued. In many of those markets, our jobs are aspirational jobs and so you've got a little bit less pressure there on a big part of our footprint. So we continue to have high expectations for the growth story long-term around our brands. And then if you think about flowing that through to profit, that's -- we have a pretty simple financial model internally. That's about managing our G&A. And I think we've done a really nice job of that. If you look at our G&A plan this year, compare it to 2019, represents about 5% growth CAGR over that time period, which I think is good in an inflationary environment. And in particular, we're proud that when you dig into that, you see we've been able to get efficiencies in some legacy areas so that we can continue to invest and forward growth-driving areas like digital and technology. So that's why we have confidence in our long-term algorithm both on the growth side and the profitability side.

Thanks for that. And this is a consumer conference. So we do need to address kind of the U.S. consumer, and it's obviously a very tricky operating environment with a lot of mixed messages related to how the U.S. consumer is behaving. Do you think you could maybe unpack your kind of view on the U.S. consumer today as you see it through the lens of the brands at Yum!?

Yes. So if we take the 40% of our business that is in the U.S. and think about what we're seeing from a consumer standpoint, I've been in retail and consumer as a consultant, than in the CPG world and now in the restaurant world, it is the most complex consumer environment I've seen. It's really hard, just a couple of sense to sum up what's happening to the consumer because you really have to get to some discrete segments to understand how these pressures are impacting different groups. But I will say, in general, our consumer is hanging in there really strongly from a spending standpoint. And if you think about the frontline workforce in the U.S., they've seen some of the highest levels of wage growth over the past couple of years. Of course, a large portion of our customer base are those folks who are working in frontline jobs around the U.S. And one of the metrics that we look at is the ratio of frontline wages to the cost of our [ meals ], and that ratio really hasn't changed a lot since 2019. And so spending levels are hanging in there. Now in some markets, we do have some interesting lapse versus stimulus injections last year in the U.S., the U.K., for example. But overall, we feel like the consumer remains healthy despite these pressures. And of course, all of those factors actually set up really well for our Taco Bell business in the U.S., because they have full range pricing. They have innovation items where people can trade up and pay a bit higher price point if they want, but they also have the $2 value menu where you can get great products at a great value for customers who need to spend a little bit less from an absolute standpoint. And so these really set up well for the Taco Bell business, not quite as well for Pizza Hut and KFC, where those brands have one of the most cost-efficient ways to feed a large family or a family of 4, but fewer items at lower price points, and of course, those teams are working on strategies to deal with that. But Taco Bell represents 70% of our profit in the U.S. So in general, we feel good about the consumer setup. And in a challenging environment, we think our brands are very well positioned to serve the customer in this environment.

Appreciate that color. And before we dive into the brands, I have to touch on the digital trends that you're seeing within Yum! Brands. As of last quarter, you're seeing close to 40% digital mix across your portfolio across the globe. I mean it's, obviously, incredibly impressive to have that high of a mix, and it's much higher than your peers, by the way. So can you just talk about what the strategies are that are idiosyncratic to Yum! that you're kind of using to drive this higher mix? And what long-term benefits do you believe digital can bring to Yum!'s business moving forward?

Yes. I mentioned earlier that the development story is one of the most incredible aspects of our business. I think digital is right there with it in terms of amazing strengths and aspects of the Yum! business model. So as you mentioned, 40%, $22 billion last year, $6 billion in Q1. And we're -- even as customers start coming back to the restaurants, we're seeing those digital numbers remain sticky. And our view is that this is just the beginning. I was with our KFC CIO over the past few days. I spent time with our broader digital team. We're all thinking about why can't 100% of our business be digital? And so if you think about what's happened here, we had really good digital capabilities scattered around the globe across our brands, but we weren't well coordinated. And what we started to do in 2019 is continue to have customization and tailoring at a local market level in terms of the front-end experience for customers, but we wanted to get scale and consistency in other aspects of our technology so that we bring efficiencies for our franchisees and for our business and we increase our speed. And Clay Johnson, who joined us from Walmart, has done a really great job working with our CIOs and the brands to do that, and you're seeing that pay off. Of course, there were some tailwinds from COVID, but I think we were able to take maximum advantage of that because of the capability and the structure we had in place. The way we think about our digital strategy, we put all of our capabilities into 1 of 3 buckets: Easy experiences for our customers; easy operations for our franchisees and team members; easy insights, leveraging the data created from the first two, and we want to do all of that at scale to have advantaged economics. And in general, we're going to own more of our technology as opposed to outsource than many of our competitors because of our scale and because we think we can make our technology distinctive by doing that. And you've seen us make some acquisitions of companies that we think add distinctive competitive advantages to each of those 3 areas that further enhance capability that we have internally. So we're very excited about the future of digital and we're going to continue to run really hard on.

That's great. Yes, it is impressive to see that digital mix where it is and the fact that there's still runway left. And I think now is a good time to start talking about -- discussion at the brand level. And I'd like to start with KFC. It is your largest segment at about 51% of profits. And over 80% of the sales in KFC come from outside the U.S. And KFC now has over 27,000 units globally. It's been opening over 1,500 units a year on average in recent history. And the size of these numbers are just very impressive. And I know we talked about unit growth at the front end of the conversation, but zeroing in on KFC, how do you think about the total addressable market left in the tank for KFC globally? And how does that help frame your outlook for KFC to continue to grow at this pace despite its very large base?

Yes, the KFC brand is an amazing brand. Also happening in Turkey during my trip was a KFC General Managers Meeting. So Sabir Sami, the Global CEO of KFC, had his leadership team together. I got to spend time with them. It's an awesome, awesome leadership team. If you think about that brand, you've got an iconic brand. You go to these markets around the globe. People absolutely love the brand. And they sell a product that almost every human on the planet loves and craves for our chicken. Everyone is familiar with it. It's so easily translatable to each of our markets. And of course, the genius about the way KFC has grown over the years is they've put some guardrails in place you're going to have 11 herb and spices. You're going to have the red and white and black KFC branding. You're going to have Kernel, you're going to provide a great experience with strong food safety. But beyond those things, you can tailor to the local market. We had our Board meeting recently in person, and the Board meeting where KFC presented their global overview. And of course, that meant that because we were first one, we got to sample their food and they had this is from around the globe and biryani chicken from India that was just amazing. It had chicken with the 11 herbs and spices, with an Indian twist. So there's a lot of tailoring that happens to make the business work in each of these markets. And when you think about that, that means we can win in every market. And when you do the math on our penetration -- in our most highly penetrated markets and then compare that to other markets around the globe, you see that we've got immense white space left in that brand. Last year at the KFC Investor Day, that team said they think we can have 75,000 KFCs around the globe. So really, we're just getting started on KFC.

Yes, those numbers are quite incredible. And when we think about the same-store sales for the division outside of China, which, obviously, was having its own lockdown issues, same-store sales were up 10% in the most recent quarter. I know that's just a snapshot, but it's a good way to look at how strongly the trends are particularly outside the U.S. and China. The question is, what do you believe is the largest brand-specific contributor to the international same-store sales strength? And based on your analytics, how do you believe your global market share trends for KFC have been trending since the pandemic? Are we going to be exiting the pandemic with a lot higher share and more opportunity?

Yes. The KFC growth has been strong enough. If you kind of dig in on each quarter in different parts of the world, it's had puts and takes based on what's happening locally. And that's we're seeing that in China right now with the restrictions on movement. But if you go ex-China in the most recent quarters, the business has been very strong. You saw the developed markets where we saw significant growth last year and those development markets are continuing to perform at that raised level. And then I think the really great story is what we saw in emerging markets ex-China, which, in total, across all 4 of our brands, represent about 20% of our global business. And across all of our brands, we were plus 18 in Q1 on emerging markets ex-China, and that's a really, really important result for our business. I think there was a question 12, 18 months ago, how would these emerging markets recover from COVID? And the results that we're seeing now, they're recovering just fine. And if you go into the KFC business, you go into markets like India, you go into Latin America, you go into Turkey where I was just visiting, the restaurants are full. The brand is resonating. And so that's what's driving the strength in the brand. You couple that with, which is our strongest development engine and development team. And I think if you think about the total growth of that business against most competitors, we are gaining global share. And of course, the other thing is I don't know when the situation in China will resolve. Nobody, I think, knows the time line on that. What I am confident of is the great leadership of the Yum China team, the way they've been building units. When movement normalizes there and the consumer environment normalizes, I think there will be strong growth there at some point, and you're going to have a much broader footprint to see those sales rebound in those restaurants. So I think the future is very bright for growth potential in KFC.

Great. And why don't we kind of move forward to Taco Bell, which is the second largest business segment within Yum!, accounting for close to 32% of profits. And it's -- U.S. is the core, but I do want to start with the international business interestingly because it appears you're now making some serious headway on actually growing Taco Bell internationally. I think you saw about 26% unit growth there last quarter. You talked about 100 units in a market for Taco Bell, representing a tipping point for scale and unit economics and the ability to further accelerate unit growth for Taco Bell. So why is now the time that Yum! is looks like they're cracking the code on Taco Bell unit growth outside the U.S. What's happening? Is it something you're driving? Is the market more open to the brand? Can you just speak to that?

Yes. I think it's a product of a great brand, coupled with a great leadership team and great franchisees in these key markets who are really bought in on the brand and are making the right investments. On our team, Julie Masino took the reins on Taco Bell International a couple of years ago, and she made some important adjustments to the strategy. One, she changed the positioning to be California inspired and that's resonating really well in markets around the globe. Second, she shifted the growth strategy from one of -- growing in many markets, even if that meant a small scale in those markets. And she said, gosh, we really need to have scale in markets. We think if we can get to this 100 unit point, that's where the tipping point will be. And you say, okay why don't you need scale? Why does that matter? Well, obviously, from a marketing standpoint, unlike fried chicken, where everybody is familiar with it around the globe, you take a couple of more times of trial for people to get familiar with the brand. And so you got to do a little bit more marketing and you get more scale and marketing when you've got more restaurants and locations. People see the signs around town plus any spend that you do on traditional advertising has higher leverage when you've got more units. Another example is on supply chain. Some of these markets just don't have tortilla or chip supply chains. And for our suppliers to make the investments in line to support the business, they want to see more restaurants in the ground. So that's a couple of examples of why scale matters. Last year, we got to our first market at 100 units in Spain. This year, we think we'll get to 3 more in the U.K., India and in China. And so the strategy is paying off, and you're seeing that show up in the results. Over the last 2 quarters, Taco Bell International has outgrown units as compared to Taco Bell U.S., which is a great fact for Julie and the team, plus you're seeing same-store sales be back at 2019 levels or above. And the digital mix in the Taco Bell International business is around 40%. And digital is a big part of their story of helping to get the word out on the brand that serve customers. So I'm really excited about the momentum they have.

That's great. And turning to Taco Bell's U.S. business, same-store sales trends there have been very robust before COVID, through COVID and kind of coming out of COVID in the first quarter of '22. You're showcasing same-store sales that were mid-teens, above 2019 levels. The brand in the U.S. is a value leader. In your words or Yum!'s words, it's a category of one. The question on Taco Bell and you touched on this earlier is, if the U.S. macro were to slow, the spending environment were to slow, what tools does Taco Bell have to kind of remain best-in-class and take share in that type of environment?

Yes. The Taco Bell business in the U.S., it's such an iconic brand that really helps define key aspects of culture. Mark King and his team, Sean Tresvant, our CMO, is doing an amazing job. He came from the -- from Nike. He ran the Jordan Brand there. And he's just -- he's continuing and elevating this long tradition of great marketing and brand building at Taco Bell. Plus we have an amazing set of franchisees. I'm actually here today are going to be meeting with Taco Bell franchisees the next couple of days, along with our Taco Bell team, an awesome set of franchisees, do a great job running the business. And as you said, a category of one, it is the place to get great value on great tasting, craveable Mexican-inspired food in the U.S. with an incredibly fast and easy experience. You think about the numbers that we move through the drive-through and how quickly we do it at Taco Bell, it's just an awesome business model. So then you think about, okay, in this environment, resiliency in this environment, Taco Bell, I think will thrive. And I go back to that menu architecture where we've got a full range of the pricing, and so we can serve so many different customer occasions. If you're wanting to come in and spend a little more to get the latest innovation, you want to customize the meal, we can serve those customers for customers that have less money to spend and need an absolute lower price point. We've got the value menu, the $2 value menu. You can get a lot of food at a very reasonable price at Taco Bell. And so we can serve a broad range of customers. And then we continue to grow the digital business, which is adding new occasions to the business model. And you've seen all of that translate to long-term strength in the brand. You see it translate to really high trading multiples for our franchisees whenever they sell restaurants. So I think the returns have been very strong for our franchisees, and that's why you're continuing to see unit growth in addition to same-store sales stream in the Taco Bell brand. So I think it's a really great story in the U.S.

And when we look at the Taco Bell business, it does have over 450 company-owned stores. So company-owned margins on the four-wall margin for Taco Bell matter more for the financial model than the other segments just by default. In the first quarter, your Taco Bell margins were on par with 2019 levels, which is very favorable versus what your quick service peers are doing on the margin front. So how are you thinking about pricing and the margin outlook moving forward for Taco Bell, of course, in light of this continued difficult cost inflation environment.

Yes. You're right. In terms of our P&L, the Taco Bell stores matter a little more. Now in general, we think about unit economics a lot across all of our brands, even in ones where we own fewer stores because we know that's the lifeblood of development. So if I think about Taco Bell and how that affects our business and how we're managing that with our franchisees. One, we leverage our scale. So while Taco Bell has great scale, it has even greater scale when combined with KFC and Pizza Hut, so -- and the Habit. So in the U.S. we do our purchasing across all 4 brands through RSCS, our purchasing co-op. So we're leveraging as much scale as we can to help defend against the cost inflation and use our strategic sourcing capabilities as the sort of first layer of dealing with those developments. So then you go into, okay, how do we -- beyond what we can all set with scale, what are the other levers that we pull? And the way we think about those other levers from a commercial standpoint is we want to ensure that we always have a balance. We're doing the right thing for the customer. We're not getting too far ahead of the customer on price, and we're always providing strong relative value. While on the other hand, we're ensuring strong long-term unit economics for our franchisees, and so that's the balance that we're working. So we pull non-price commercial levers. We adjust things on the menu. You saw us do some things back during COVID, where we rationalized the menu. That also sets us up to do things like bring exciting items back like the Mexican pizza, but those are examples of some of the non-commercial levers that we pull. But then we have also taken pricing. And across our brands and in Taco Bell, we have taken significant pricing. It has stuck but we've done it in a very thoughtful way. We use analytics in each one of our brands that the brands provide to the franchisees. Of course, the franchisees in the U.S. ultimately make the call on the pricing that they set many of them layer on their own analytics on top of it. And doing that at store SKU level. And so we're trying to get that right so that we're getting that balance right for the customer. And I think our relative value has probably held firm, maybe even improved as we've gone through these challenges. And as you saw in our Q1 results, we feel really good about where unit economics are given the environment. And so hopefully that gives you a feel for how we manage it and the things we try to trade off and balance.

It does. It does. And we'll quickly move to Pizza Hut, maybe one question on that because we only have about 4 minutes left, but Pizza Hut accounts for 18% of your profits. In the domestic Pizza Hut business, it's only 7% of Yum!'s total profits, but I want to ask a question on that segment. And similar to your domestic pizza peers, you've seen some headwinds from delivery driver availability. We're seeing it everywhere in the pizza space in the U.S. And to partially address this, you did complete, I believe, an integration with third-party aggregators during early 2Q, I believe. And just can you talk about that decision at the corporate level to make that decision? And how franchisees feel about this strategy?

Yes. So the pizza business and category was, obviously, one that benefited from COVID, and we saw a lot of delivery business and families dining together. And so all of those things benefited the category, and our Pizza Hut business has been strong, both U.S. and globally. Our development numbers last year globally were outstanding. But if I take that U.S. business and go into the Q1 results, we did say, hey, we have more of a driver capacity challenge than we do a consumer demand challenge. And as you know, the labor market in all of retail in many industries has been challenging, but if you think about the place where it's been the most acute, at least in our business, it has been on driver staffing. And it's just because there are so many other options now out there for people who want to drive particularly the gig-related options. And of course, we're doing a lot of things to make our jobs more competitive with those gig opportunities, things like reducing our application time to make it easier for people to apply. But the other aspect, as you mentioned is, we see an opportunity to work with our aggregator partners to help provide another way to get product delivered, and we started that integration effort. It's started. It's going to take a while to get in place. Some of our franchisees have it in place, and those tend to be running ahead of the system because they're solving some of these capacity challenges. And when they're on the aggregator marketplace, they're also accessing new customers. So that's a strategy that you'll see play out. We want to be ubiquitous. We want to be aware of our customers want to do business with us. And if they want to do it on an aggregator platform, we'll do it. And then we, obviously, want to be able to deliver the product. And so we're using in some cases, the aggregator driver capacity to be able to deal with that. So that strategy will play out over time, but it's a more unique challenge for Pizza Hut and one that we're trying to deal with as strategically as we can.

Great. And I would like to wrap up the discussion with you talking balance sheet and capital allocation. You're about 5x levered now that -- you've been at that target kind of ever since the spin out of the China business. Does that continue to be the optimal kind of leverage target? And on top of that, can you just run through for everybody your philosophy on capital returns? I believe it's to invest in the business, maintain a healthy dividend and return excess cash to shareholders, but anything else you want to add to your philosophy?

Yes. So our capital structure remains strong. It was put to the ultimate stress test and COVID held up incredibly well. We're very proud of the cash that we have returned to shareholders through both the dividend, which continues to grow and through our repurchases. 5x leverage is our current target. We obviously test that regularly. We'll be doing another test on it coming up, just to make sure in the changing environment with interest rates, those sorts of things, that's still the right target. But as of now, that is the target. And I don't see any major swings coming in that. And then if you think about the capital allocation plan, you nailed it. The repurchases are the plug, right? So any remaining excess cash that we have, we returned to shareholders through repurchases, so the amount in any quarter depends a little bit on whether we've issued new debt that quarter or how the other parts of the equation played out, but nothing's changed in our overall approach to the capital structure. And again, we're really proud of how resilient we've been and how we continue to return cash to our shareholders.

Great. Well crazy enough with that, we are out of time, so I want to thank you, Chris, for joining us. Thank you for making time to participate in our conference. And everybody out there, thank you for joining us as well, and I hope you have a terrific day. Thank you.

Thanks so much, Brian. I appreciate it.