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

Great. We'll get started. So I'm Andrew Charles, I'm TD Cowen's restaurant analyst. I'm thrilled to be joined by CFO, Chris Turner, of Yum! Brands. Yum! is the parent company of KFC, Taco Bell, Pizza Hut and The Habit Burger with a portfolio of nearly 56,000 restaurants that is 98% franchised and spans 300 different brand-country combinations. In the audience today as well, we have Head of Investor Relations, Jodi Dyer; and Taco Bell Managing Director of North America, Scott Mezvinsky. So Chris, thanks so much for having -- for being with us today.

Yes. Thanks, Andrew. Thanks for hosting us. Thanks for putting on this amazing conference. And I appreciate everyone in the room spending time to hear the Yum! story.

Excellent. So Chris, maybe we could just start high level with kind of State of the Union of the U.S. consumer. And really, you really have a tremendous amount of insight into this, just given 18,000-plus restaurants across the U.S. And curious what you're seeing, in broad strokes, around the consumers. Are there hesitancy or willingness to spend? Trade-down in the menu to lower-priced offerings or willingness to trade up to premium offerings? Just given the complex spending backdrop in which the restaurant industry is operating.

Yes. As you say, it's a complex environment, but I think our position is incredibly strong given the environment. So first, if you think about QSR, I think that's the right place to be in virtually any sort of environment, but particularly in an environment where customers are seeking a bit more value. And then if you think about the positioning of our 4 brands, they all provide what our customers want. They've got craveable food. They're always bringing exciting innovation to bear. They're providing strong relative value. So while we've had to take some pricing given the inflationary pressures, we've used a ton of analytics to ensure that we have strong relative value versus the competition. And of course, our digital business has grown incredibly and gives us a way to have a one-to-one relationship with our customers. And that -- all of that is combining to result in tremendous resilience in our brands, and great growth. You look back at our Q1 numbers and you think about all 3 of our large global brands on a global basis had double-digit system sales growth which translated to strong profit. And so we think we will perform in any sort of economic environment, and we think we're giving customers what they want.

Excellent. I want to start first with Taco Bell U.S., your largest brand-country combination that accounts for about 1/3 of operating profits. And we've been very encouraged by the momentum in Taco Bell U.S. in same-store sales over the last 12 to 18 months. And curious, if you look backwards, if you were to rank the factors driving sales growth, between menu innovation; digital unlocks; what I'll kind of call brand buzz, which is obviously just the marketing and advertising campaign and just the other factors that go into that; as well as consumers' increased desire for value, where Taco Bell, obviously, has a lot to offer there. How would you kind of rank these factors around what's been driving the brand success?

Yes. As you mentioned, we've got Scott Mezvinsky in the room. Scott doing a great job with the Taco Bell U.S. team. You hit on the right factors. We call it the magic formula. And I don't really want to rank them because I think it's the combination of all 4 of those coming to life that's so important and has been why Taco Bell has been such a powerhouse and continues to be a powerhouse. If you think about what the brand and marketing teams there do, Sean Tresvant is our Global Chief Brand Officer. He's also leading our international business in Taco Bell. What they've done to stay at the leading edge of culture from a marketing standpoint, and always creating that buzz, is just amazing. Taco Bell is always in the conversation. You couple that with innovation. And you think about new innovation over the last couple of years, like the Grilled Cheese Burrito, an amazing product; or bringing back favorites. The Enchirito has been in restaurants, the Mexican pizza last year, incredible buzz. So there's innovation that gives customers a reason. When they come into the restaurant, they say, "Hey, I might trade up and buy something at a little higher price point." Now keep in mind, those price points still represent tremendous value. You think about the amount of food you get with a Grilled Cheese Burrito, it's an amazing value. But then we also have the value menu, and so that's the third component. We offer that to customers that are seeking a lower price point item. But on the $2 value menu at Taco Bell, you can still get a tremendous amount of craveable food. And of course, we sort of manage the mix across both of those. And then the new element the last couple of years has been the digital component that you mentioned. And Taco Bell, 2018, was really just getting started on digital. We had basically 1% digital mix back in 2018. Last year, we hit 24%. It's continuing to grow. We shared some case examples at the Investor Day back in December that showed just how much incrementality that has driven. That digital business has driven $1 billion in incremental growth for Taco Bell in the U.S. over the last few years, which has translated to big profitability gains for our franchisees and for Yum! and our shareholders.

So Chris, as great segue, I want to dive into that a little bit more, that on digital. For domestic drive-through business like Taco Bell U.S., if we were to kind of fast forward 3 to 5 years, what is the long-term vision for how you can make the brand more digital-forward in the U.S., when it's just so instinctive and convenient for the customers to use the drive-through in a traditional manner? I mean, you're off to a tremendous success of 24% of your sales. Kind of what's the next chapter, if we look over the next 3 to 5 years, look like for the brand, can go with this?

Yes. It's a great point. One of Taco Bell's greatest strengths is how fast and easy the experience has been in the drive-through, the fastest time of any large-scale QSR. Our teams do a great job from an operational standpoint driving that. So there's a natural question to say, well, how do you give customers a reason to want to use digital? And I think that's where things like our loyalty program come in. Our ability to offer new innovation a few days earlier, or in some cases, only to customers who are ordering digitally. The ability to offer value through digital gives people a reason to be on the app and build a relationship with us. But then the other thing I would think about is how do we incorporate some of our new technology innovations on a leading-edge basis into the overall experience to make it even faster, and easier and digitize it? So this is a place where AI could come to bear in our business, and we're doing some testing and piloting right now with how do we use AI in terms of order-taking at the drive-through, which would give us that digital component without the customer having to take out their app necessarily. And so that's one aspect. The other aspect is I think you're going to see some more and more automation coming to life to support our team members in making their jobs easier and making the experience even faster at the Taco Bell, including at the drive-through. So those are things that are on the horizon that our innovation teams are working on.

Excellent. Taco Bell U.S., you talked back at the December 2022 investor meeting about how you have dinner and late night volumes in line with the largest 800-pound gorilla in the space, but breakfast and lunch are still opportunities for growth. And so as we kind of look out, your [ $2 million ] sales volumes today, how do you guys internally think about the next level of sales volumes you can ultimately get to? From preserving and growing the strength at late night and dinner, but also just really seeing a catch-up, if you will, at breakfast and lunch?

Yes. So we think that presents a big opportunity. Scott and team have really gone deep on the numbers. Our dinner and late-night dayparts, as you mentioned, are incredibly strong. Late night, we are the share leaders by far in the restaurant industry. And we have really good breakfast and lunch businesses at Taco Bell, but when we look at the opportunity, we say there's a tremendous upside that we can go capture. And of course, Scott and team are working with our franchisees to continue to elevate the breakfast offerings and the breakfast experience as we've expanded opening hours coming out of COVID. And then from a lunch standpoint, the innovation in fries has proven to be really important. We understand that customers -- many customers expect to have fries as part of the experience, so the Taco Bell fries have been a big hit in driving that. In terms of how much opportunity is there, we think there's millions of dollars from an AUV standpoint. And so Scott and team are focused on using that as a big driver of continued same-store sales growth in the system and continuing to build out those dayparts.

Awesome. It's important to note that our proprietary survey data indicates superior value perceptions for Taco Bell versus quick-service peers. And so you guys, if we were to see a more challenging backdrop, I'd expect you guys to really benefit from that. But if the environment were to get extra challenging, if you will, what part of the brand's playbook would you anticipate leaning more heavily on to mitigate the impact to traffic?

Well, I really do think Taco Bell, all of those elements of that magic formula, they set up to be an incredible performer in any sort of environment. But really, the kind of scenario you're painting, I think Taco Bell is going to shine. I think all of those elements are what customers look for in that environment. The ability to get craveable food and easy experience with tremendous value all add up to, I think, success in that environment. So I think we would just continue to lean into the magic formula if those sorts of scenarios played out.

Yes. And my last question on Taco Bell U.S. I mean, can you touch on the decision to bring back Volcano Menu at Taco Bell at the end of June? This is the third reincarnation of the menu in the brand's history. I'm curious, what we can expect from the platform.

Yes. So it's exciting to see Volcano coming back later this month. I think from the customer research, the Mexican pizza, there was a ton of buzz about bringing it back. But I think the Volcano Menu was right there neck and neck with Mexican pizza in terms of things that customers wanted to see return to the menu. So I think it's going to be a tremendous addition to the Taco Bell offering. I know I'm personally excited to get back in there and get those spicier offerings that are part of that menu, and the Taco Bell team is excited about driving to.

That makes 2 of us excited to get the spicier offerings there. There we go. I'm pleased we could talk about Taco Bell International, where you've actually seen more unit growth of last 6 or 7 quarters versus the Taco Bell U.S. And so at the Investor Day, you talked about a bold goal to get to 25,000 global locations for Taco Bell International. How do you see that shaping up? Like I know that you've seen a lot of success just getting markets to 100 stores. That's been the key focus now. But if we can fast-forward a couple of years, how does that strategy start to look as you get really in the rhythm here of getting to the 25,000 stores?

Yes. Yes. It's been great to see the progress that Taco Bell International has made. Of course, you compare them to Taco Bell U.S., Taco Bell U.S. has put up great development numbers the last couple of years. I think amongst all restaurant companies in the U.S., we've been in the top 3 to 4 the last couple of years, so doing a great job there. But yes, Taco Bell International has now exceeded that. We're now north of 1,000 restaurants internationally. You referenced the strategy shift a few years ago where we said, "Let's focus on a set of markets where we want to get to scale." The reason we did that, it does take a little more trial for Taco Bell in international markets than, say, KFC, where people are just so familiar with the product. And in order to do that, you're going to do a little marketing. Well, you need more restaurants for that marketing to have leverage in terms of the expense there. We also had some practical constraints. In these markets, you got to have suppliers who set up tortilla lines, chip lines at the right efficiencies, and you need scale to do that. And then of course digital. Taco Bell International really is being born as a digital brand, 40% mix. And of course, you get scale benefits whenever you have more restaurants with those fixed cost investments in technology. So that's why we shifted the strategy. You mentioned the 4 markets that are at 100 units. There's a next wave. I'd think about markets like Canada, Malaysia, Australia, that we're going to be focused on, continuing to grow. Sean Tresvant, now with leadership over the international business, he's been out in the field. He and I were in the U.K. earlier this year, meeting with the team, talking about their growth plans. So I think the sky is the limit. Someday, there should be tens of thousands of Taco Bell restaurants around the globe, and we're really excited that, that growth opportunity is coming to life.

Excellent. I love the enthusiasm. That's great. Want to zoom out on development. It's been very encouraging to see the long-term annual development guidance for the last 5 years increase from 3% to 4% pre-COVID; going to 4% to 5% post COVID; and most recently, increased to 5% during the investor meeting at the end of last year. Following 2 consecutive years of growing close to 6% across the portfolio, can you talk about the decision to guide to 5% ongoing growth?

Yes. Look, the -- if you think back to coming out of the Yum! transformation in 2016, we had set a goal of getting to 4%. I give a lot of that credit to David Gibbs, who's the most passionate person on the planet, our CEO. I started more than 30 years ago in Taco Bell in real estate. And he's the most passionate unit developer anywhere on the planet. And David said, "We can do more." He set the aspiration. Now we set the goal then at 4%, but that was never the idea, was to get to 4% and stop, right? The idea was we can always do more. We then raised the algorithm from 4% to 5%, but again, that wasn't the end goal. We've now raised it to 5%, and we want to make sure that we continue to drive more and more development. We'll talk in a minute about the things that underpin that, but we're not going to be satisfied with there. But we also want to make sure that we've got an algorithm that we have high confidence in delivering on an annual basis over the long term. But it's our job every day to come in and find ways to beat the algorithm and to, in the long run hopefully, raise it. The things that underpin it, though, are what we spend our time and energy on. First and foremost, strong unit economics. We shared at our Investor Day, 80% of our restaurants around the globe opened over the last couple of years, are in markets with paybacks of 5 years or less. You got to have strong unit economics. Our teams stay focused on that. Our 3C franchise partners, they are capable, well-capitalized and highly committed. And they have done an incredible job partnering with us in building these restaurants and they've got tremendous development capabilities. And of course, internally, we have the best development teams anywhere in the industry, and they are increasingly using leading-edge analytical tools that we've built to help us identify those white space opportunities where we'll build. In total, we said at the Investor Day, we think there can be another 100,000 restaurants across our 4 brands in the future, and we're going out and pursuing that day in and day out.

Fantastic. I want to focus on domestic development for a second here. Just given the impact of inflation and rising rates that's allowing lenders to be more choiceful with their loans, how has this impacted domestic franchisees' willingness and ability to develop Taco Bell? And to a lesser degree of magnitude, KFC and Pizza Hut?

Yes. Well, I'll hit the U.S. briefly, then I want to step back globally because our development story is truly a global one. In the U.S., Taco Bell is our largest developer. As I mentioned, they've put up great numbers the last couple of years. The unit economics in Taco Bell are very strong. Our franchisees, I'll be with them next week at one of our franchise meetings. You think about the margins you see in our company stores there, in the 23%, 24% range, are actually higher than they were pre-COVID. The economics in the Taco Bell business are just outstanding. And so there's significant demand to continue to build. That's why you see them putting up the numbers. And these are very sophisticated, well-capitalized organizations that have the capital to grow. Now if you go globally and you think about the big global growth numbers, last 2 years, 8,600 new restaurants, a new restaurant every 2 hours for the last 2 years, only 7% of that is in the U.S. 93% is outside, 80% is in emerging markets. And you say, okay, how will the global interest rate environment affect us? I actually think this turns into a big competitive advantage for us relative to our competition. So competitors who have smaller franchisees that aren't as well capitalized, they probably are going to have more challenges accessing capital at good rates. 60% of our global development is done by 15 publicly traded franchisees. You guys can go look at their balance sheets. On a weighted average basis, they have less than 1x of leverage. The largest 2, Yum! China and Americana, cash balances, virtually no debt. And so this just isn't a big constraint on our system. And as other competitors are constrained, I think it's going to create even more opportunities for our franchisees to be developing units.

Excellent. I know you're very excited, obviously, about global development. Maybe just to focus on KFC for a second. We think of that as the development engine for Yum! that's the most globally diversified, and only 37% penetrated to long-term targets for 75,000 restaurants. The brand has seen particular strength in China and India and Turkey, really opening the most amount of stores in those markets. And really, I want to just get your thoughts on just ranking the magnitude of -- within the targets for the next 50,000 locations, kind of the regions that you're most excited about? I mean, Latin America, Southeast Asia, Africa, all markets I kind of point to where the brand obviously has a really long canvas for growth. How do you think about the regions that really could matter most within that 75,000 store target?

All of them. There's no constraint that we're putting on where KFC can or should grow. You think about fried chicken as a product offering, a craveable food. If you're a human on this planet and you're not a vegetarian, you've probably had fried chicken and you probably loved it. And if you think about outside of the U.S., we talk about Taco Bell in the U.S. as a category of one. There's really one major Mexican QSR player in that space. KFC International is really a category of one in many of these markets in which we operate. And it is the powerhouse brand. The customers resonate with the brand in all of its many markets around the globe. So the -- there is no constraint on where KFC can succeed. Then you think about those things I mentioned earlier, unit economics, strong franchisees in every corner of the world and great development teams. Their mission is to go add units in every country where we can. On growth last year, we had more than 100 countries that had positive development. I think that's the thing that gets me really excited about our long-term development trajectory, is it's not driven by a small number of markets, it's very, very broad-based. And KFC is the best and leading example of that.

Great. I want to talk a little bit about the model in a second. But maybe just first, Yum!, I learned this in your Investor Day last year. RED Labs, I believe is what it's called, is the technology team. How does that operate in terms of what they look at in terms of digital and what they test? And basically, what kind of direction? What I'm looking to learn is, how do they set direction within that, just given how big your digital ecosystem's become and how much more opportunity you guys have for future innovation?

Yes. So the bulk of our technology teams and resources are focused on the broad digital strategy. We think it's distinctive. We talked about the reasons it's distinctive. We're going to own more of the technology than many of our competitors do because of our scale. We think truly end-to-end and comprehensive in the capabilities that we are building. All those things will make us faster, allow us to implement changes more quickly, and of course, should lead to more profitable growth for our franchisees and for us. And we center those capabilities around easy experiences for our customers, easy operations for our franchisees and team members and easy insights, leveraging the data that's generated. That word easy is the critical part of our technology strategy. Now the innovation team partners with all of our technology leaders, but it's really focused on the leading-edge elements that we think someday could have an impact on the system, but require some testing, some piloting in order to figure out which ones are truly going to be impactful and lead to more profitable growth, versus which ones may be bright and shiny objects right now but that don't really end up impacting us in the long run. They also have built a set of labs for each of our restaurant brands. So we've got lines set up where we can go and test new robotics, we can test different automation, we can test AI-oriented vision and voice in a live environment in the lab to help us understand the impact that it could have in supporting our team members, supporting restaurant economics. So that's what they're focused on. We have robotics experts, we have engineers, we increasingly have AI experts on that team. It's really exciting when you go down and spend time with them on what they're looking at and how they're bringing it to light.

Very good. Now talk about some of the less sexy stuff in AI and automation. But just on the model, we view Yum! as an efficient growth company, and I know the plan is remaining efficient with G&A. If we think historically about the target for 1.7% of system sales, is that still the level that you guys internally talk about now that you're beyond the initial legwork to build the digital infrastructure?

Yes. If I think about our economic model, we think it's a really powerful one. And of course, if you think about the way we talk about our long-term algorithm, which we made a raise to at the Investor Day back in December, we think about 5% net new unit growth. As we talked about earlier, we're always looking for ways to over-deliver that. We think about that translating to 7% system sales growth and then at least 8% core operating profit growth. So that implies leverage in the model, and of course, it's important for us to drive leverage, and that's our expectation, to drive leverage on our cost base as we continue to grow the system. And we think about delivering that on a long-term basis and on an annual basis. The G&A component of that, we said at the Investor Day, we take a lean approach. We want to be investing in the things that our customers care about, that our franchisees care about, and that will drive long-term growth and health in the business. But anything that doesn't do that, we want to be as lean and efficient as possible, and we're constantly driving productivity on that front. This year, we talked about a plan on the Q1 call. Still, as we looked at the plan then, we said, "Hey, this year, we think we'll land approximately $1.15 billion from a G&A standpoint." Of course, you know from our history that, to the extent we were to over-deliver on our targets going into the year, we would have some incentive compensation that might add to that core G&A element. But in general, we're guided by that long-term algorithm, and it's our expectation to drive leverage on our growth over time, which will translate to that 8% or higher operating profit growth.

Yes. I want to talk about the debt for a second. Yum!'s free cash flow generation can clearly and capably support your roughly 5x leverage level. And I know you talked at the Investor Day about how this leverage level is frequently evaluated. And curious, what you would need to happen to actively reduce it? Just given 94% effectively at fixed rate interest and no maturities until 2026 that really essentially eliminates any risk in the medium term.

Yes, so you're right. The way we think about this is we're constantly optimizing shareholder returns. Now some people interpreted that the last few years as, oh, Yum! has a strategy to be at 5x. Our strategy was to optimize shareholder returns. It just happened that, given the inputs and the way they worked through the model, 5x was the right number. There's one element that's really changed as we look at the environment right now, which is the increase in interest rates. We still think, from a multiple standpoint, there's tremendous upside in the stock, so that's not what's driving a change in the approach. What's driving the change in the approach is the increase in interest rates. At this point, we just don't think it makes [ time ] to issue the incremental debt to buy back the stock. If that environment were to change, we would obviously adjust so that we're optimizing for shareholder returns. Now we don't have to take any actions to go do that. We'll just simply not be issuing the new debt. That will float us into a lower leverage environment. Of course, we can continue to do some repurchases out of the cash flow generated by the business, but that's the thing that's going on right now. We just think it's the right way to optimize for the shareholders.

Excellent. As you look to the future of Yum!, obviously, there's plenty on your plate, but the door is certainly open to future acquisitions on the brands side. I mean, certainly, you've built a digital infrastructure, potentially more to go there, but I'm thinking more on the brand side. Would you say that there's -- would you say, in terms of what you guys look at, what is that checklist you go through in your head to determine if a concept is ripe for acquisition or not?

Yes. So it's a great question. We've done a number of acquisitions the last few years, many of them on the enabler side. I know you're asking about brands, but I don't want to lose the fact that from our technology strategy standpoint, we've made key acquisitions in each of the areas of the easy technology strategy, and they have all been absolute home runs and built our capabilities. The Collider, the -- our marketing and consumer insights team, Heartstyles, which helps us continue to elevate our talent and culture. So we've had a lot of success from an M&A standpoint. And of course, we acquired The Habit in 2020. If we look forward, we still think the thesis of scale mattering in the industry is true. We think we are uniquely positioned to unlock growth in brands. And so whenever we see those 2 things, an opportunity to apply those 2 things with a brand, we're going to go investigate it. I think any brand that we acquire would be, first, grounded in a growth opportunity that we can help to unlock. Second, I think it'd be a really healthy business. It's going to be a RED brand in our language, relevant, easy and distinctive. And it would have strong unit economics. I think third, there would be a really logical path or how do you leverage the scale in our system? Whether that's our franchise partners, whether it's our purchasing scale or whether it's our technology. And then fourth, I'd say there has to be a very clear shareholder value creation opportunity. And so we've seen some brands the last couple of years that have met the first 3 criteria, but valuations just didn't quite make sense. There wasn't enough room to create value for our shareholders. But if we find something that meets those criteria, we'll dig in deeply. It's a high bar, but we will certainly keep our eyes open for those opportunities.

Excellent. Sticking with your existing brands for a second. Pizza Hut U.S., I think in 2022, I articulate that you guys really identified the voids that you had on the brand that -- and really introduced some solutions for it. So third-party delivery, delivery as a service, helping to address the labor shortage that was common in the pizza industry. Melts as well, offering single value rather than abundant value for the pizzas. So I guess as you think about Pizza Hut U.S., obviously, the brand has shown a nice improvement trajectory in sales. Are there any other voids or any other solutions that you have plans to really help address any potential voids on their menu?

Look, the Pizza Hut U.S. business is -- if you go back to 2018, 2019, the team has done a great job improving the fundamental health of that brand. Our franchisees are in a much better position than they were now. Greg Flynn and the Flynn Restaurant Group is our largest franchisee in the Pizza Hut system, doing a great job improving operations in their restaurants. Our innovation engine, as you mentioned, talked about the Melts. We brought the Melts in because it gave us a new category use occasion. David Graves, Aaron Powell championed that. You saw the results in Q4 -- towards the end of Q4 and then into Q1. It also gave us a lower price point on the menu for customers that just had a little less to spend. The marketing has a new kick. You saw the Crunch coming to life in the Melts commercials, and we continue the asset transformation. Now we still got further to go on that. As I'm sure people know, we've been on this long journey to shift from the dine-in-focused asset estate to modern DelCo off premise-focused assets. And of course last year, as you mentioned, we had the labor challenges that we had to deal with. Now part of that, the way that we dealt with it was working with the aggregators. That wasn't something we decided to do just in response to the labor challenges last year. Think back to the strategy that the leadership team had in 2017, 2018. Remember, we made an investment in GrubHub, which wasn't a financially motivated investment. It was to learn about this aggregator space and how would it change the restaurant industry. Of course, the person we put on the board of GrubHub at that time was the CEO of Pizza Hut. So this is something we had been contemplating, we felt like last year was the right time to do that. We saw incremental customers, plus we got incremental delivery capacity, which helped us deal with those labor challenges that were being felt not only in the restaurant industry, but industries broadly when it came to driver talent. So all of that has added up to a lot of strength in the Pizza Hut U.S. system. We're pleased with the performance there. But it's a very competitive category. So you've got good, strong competitors, so we're always going to be competing really vigorously in that category. And there's still work to be done, but we're pleased with the progress they're making.

Super. Chris, I think this is a great place to end off. Thank you for the time and insights today. Really appreciate it. Thanks, everyone, for joining us.

Thanks so much, Andrew. I appreciate it.

Thank you. You got it.