Yum China Holdings, Inc. (YUMC) Earnings Call Transcript & Summary

Good day, everyone, and thank you for standing by. Welcome to Yum China's Second Quarter 2026 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. Now it's my pleasure to hand the conference to Florence Flip, Senior Director of Investor Relations. Please proceed. .

Thank you, operator. Hello, everyone, and welcome to Yum China's Second Quarter 2026 Earnings Conference Call. With me on the call are our CEO, Ms. Joey Wat, and our CFO, Mr. Adrian Ding. Before we begin, I will remind everyone that our remarks and investment materials contain forward-looking statements. These are subject to future events and uncertainties and and actual results may differ materially. Please refer to these forward-looking statements, together with the cautionary statement in our earnings release and the risk factors included in our SEC filings. We'll also be talking about non-GAAP financial measures. We encourage you to review the comparable GAAP measures along with the reconciliation of non-GAAP and GAAP measures provided in our earnings release, which is available on our Investor Relations website at ir.yumchina.com. You can also find both the webcast replay and our PowerPoint presentation on our IR website. Please note that all year-over-year growth rates discussed today exclude the impact of foreign currency unless we mention otherwise. With that, I'll now turn the call over to Joey Wat, CEO of Yum China. Joey?

Hello, everyone, and thank you for joining us. We delivered strong second quarter results. For the ninth consecutive quarter, we achieved system sales growth, operating profit growth and OP margin expansion at the same time. I would like to thank our team again for making this possible. Revenue grew 13%, and Operating profit increased 14% and diluted EPS rose 21% year-over-year, partially supported by favorable foreign exchange impact. Excluding foreign exchange impact, system sales grew 6% in quarter 2, up from 4% in quarter 1 and continued to outperform the catering industry. . Same-store sales growth also improved sequentially to 1%, driven by the 14th consecutive quarter of same-store transaction growth. We opened 560 net new stores with expansion accelerating year-over-year across both equity and franchise stores. With our dual focus on innovation and operational efficiency, Q2 restaurant margins and OP margins stayed resilient despite significant cost pressure from a higher delivery mix. Our breakthrough side-by-side modules are scaling rapidly, especially in higher-tier cities. KFC's KCOFFEE Cafe and KPRO are effectively capturing new customer occasions. Pizza Hut's new burger bar was well received by our customers. At the same time, KFC's small time model and Pizza Hut WOW are helping us penetrate lower-tier cities quickly. Together with innovation in our core menus, these initiatives are unlocking new opportunities for us. Let me start with Pizza Hut, which made significant progress in quarter 2. Pizza Hut's same-store sales growth returned to positive at 1%, while new store openings accelerated almost double what we did in quarter 2 last year. This brings net new store openings to 381 in the first half, nearly matching our 2025 total. In April, we launched [indiscernible] and Shakshuka on the spring menu to enrich Pizza Hut protein platforms and enhance the dying experience. In May, we extended our pizza category into lighter meal occasions with a new multigrain crust and new protein and vegetable topics, [indiscernible] pizza. The pizza's colorful look, nutrient-pack profile and grain-rich texture, make it our best-selling crust since launch in June. We also introduced an individual sized multigrain pizza with less than 500 calories, helping us attract more solo and light meal diners. Beyond pizza, we are taking Pizza Hut's burger category to the next level with a new side by fine module, Pizza Hut Burger Bar, In just 6 months, it has expanded to more than 200 locations, contributing double-digit incremental sales and meaningful profit to parent stores. Pizza Hut Burger bar features a tight menu centered on made-to-order burgers from an open kitchen. Our buns are baked fresh [indiscernible] every day, [indiscernible] and our parties construct of the grid, releasing a rich savory aroma. Great tasting burgers, amazing value for money and a quick service model have proved very appealing to young consumers and solo diners. With light investment and by utilizing space in existing stores, we believe Pizza Hut burger bar can unlock significant growth opportunities for Pizza Hut. We plan to accelerate the rollout in the second half, reaching 500 to 600 locations by the end of 2026. That would represent around 10% of Pizza Hut's nearly 5,000 store portfolio. And we are about to reach a major breakthrough by becoming the owner of the Pizza Hut brand in Mainland China. After operating the brand in the market for 36 years, in the near term, the savings in license fees will enhance store economics and make Pizza Hut's restaurant margin closer to KFC. This will enable more potential new stores to meet our payback requirement of 2 to 3 years. Over the longer term, brand ownership will give us greater strategic flexibility and allow us to respond more nimbly to market opportunities and consumer needs. While we are still reviewing our growth plan, our initial assessment points to accelerate store openings beginning next year. In 2027 and 2028, we now expect net new openings to exceed 800 per year, up from our original target of over 600. As we step up our efforts at Pizza Hut, KFC continues to be our #1 growth driver, delivering strong results. In quarter 2, both system sales and core operating profit grew 7% year-over-year. Same-store sales grew 1%. In the first half, KFC opened nearly 800 net new stores, around 200 more than in the first half last year. KFC's hero products and their expansions continued to drive strong sales and repeat purchases. Whole chicken has become a major platform for home consumption, generating over CNY 2 billion in sales last year. This category has delivered double-digit growth every year since its launch in 2021 and and remains on track for double-digit growth in 2026. In April, we add the aromatic paper rep roast chicken, [indiscernible] to the permanent menu, is super juicy and high in protein, appealing to consumers seeking lighter meals. [indiscernible] is another top selling platform for. In quarter 2, we introduced the limited time offer, more fragrance, spicier zinger, [indiscernible]. The extra bit chicken side, Secret sauce and toasted sesame aroma attracted younger customers. Sales were especially strong in spicy loving [indiscernible] such as [indiscernible]. With more regional flavors to come, we see strong potential for the Zinger category to exceed CNY 5 billion in sales by end of 2026. The KFC side-by-side models, KCOFFEE Cafe and KPRO continue to gain momentum and deliver incremental sales and profit. KCOFFEE Cafe grew to more than 3,300 locations, and we are on track to reach 5,000 locations by the end of 2027. In addition to coffee offerings, KCOFFEE Cafe is broadening its key and food options, including more top flavors and breakfast pairing to expand its addressable market. KPRO has expanded to over 450 locations and has proven more promising than we expected. Earlier this year, we raised our year-end rollout target from 400 to 600 locations, and we now expect to reach around 800 locations. Following its success in higher-tier cities, we are expanding KPRO into select lower-tier cities. Beyond increasing its footprint, we are capturing the growing demand for lighter meals through menu innovation. In addition to our signature energy bowls, we recently launched sandwiches, featuring whole wheat buns and chia seeds and high protein ingredients. The sandwiches became an instant hit with good repeat purchases, in fact, more than 80% of KPRO sales came from KFC members, showing the power of cross-selling and membership. Combined with our trusted food quality standards and strong value for money, KPRO is well positioned to become a leading player in China's light new business. Aside from new modules, KFC is also rolling out car side pickup service to improve convenience for customers who drive. More than 8,000 KFC stores now offer either drive-through or car side pickup. While our restaurant staff bring order to designated pull-up areas. While customer awareness and habits are still in the early stage, the service is gaining traction, supported by strong repeat purchases. Over 7 million members have used this service this year, yes, that still represents only 3% of our active member base, leaving significant room for growth. Let me now turn the call over to Adrian.

Thank you, Joy. Let me update key highlights by brand, starting with KFC. In quarter 2, both KFC same-store sales growth and system sales growth improved sequentially. System sales grew 7%, up from 5% in quarter 1. Same-store sales grew 1%, the fifth consecutive quarter of growth. Same-store transaction grew 4%. [indiscernible] offset the ticket average decrease of 3%. Ticket average was CNY 36 lower year-on-year, mainly due to incremental smaller orders from new customer segments and locations such as KCOFFEE and KPRO. Despite significant rider cost headwinds, KFC's restaurant margin expanded 20 basis points to 17.1% in quarter 2. OP margin also expanded by 20 basis points, once again demonstrating KFC's strong execution and nimble operations at scale. KFC's side-by-side modules continue to drive incremental sales and profit, while improving store economics through model iteration. KCOFFEE Cafe delivered around mid-single-digit sales uplift to its parent stores while KPRO delivered around 20%. CapEx for both KCOFFEE Cafe and KPRO has come down by around half from earlier modules last year, and both are showing solid margin improvement. Now moving on to Pizza Hut. In quarter 2, system sales grew 6% year-over-year, accelerating from 4% in quarter 1, driven by the sequential improvement in same-store sales growth to 1%. Same-store transactions grew strongly by 13% in quarter 2, marking the 14th consecutive quarter of growth, offsetting an 11% ticket average decrease. Ticket average was CNY 68 in moving closer to our target range of CNY 60 to CNY 70 in line with our mass market strategy, mainly driven by better value for money and incremental smaller orders including those from solo diners and burger bar. Pizza Hut restaurant margin was down 40 basis points, mainly due to the increased costs associated with the higher delivery sales mix, better value for money and expenses related to the launch of the Pizza Hut burger bar. The new initiatives successfully drove incremental sales and profit with a modest margin investment. In the first half, restaurant margin was up 10 basis points year-over-year. OP margin expanded by 60 basis points, mainly driven by lower closure and impairment expenses, reflecting improved store performance. In the second half, we expect greater year-on-year improvement versus the first half in Pizza Hut's restaurant margin as efficiency continue to improve, and rider cost headwinds soften. Moving on to store opening. We opened around 1,200 new stores in the first half, about double the pace of the same period last year, and enter more than 200 new cities. Both equity and franchise store openings accelerated year-over-year. In the high-tier cities, we continue to densify our network, primarily through equity stores to sustain our powerful brand momentum and operational mode. At the same time, franchisees, which accounted for 40% of total net new opening in the first half are unlocking incremental opportunities for us. They provide additional resources to help us expand into lower-tier cities, remote areas and strategic locations. With franchise stores accounting for only 18% of total Yum China, we're confident there are significant opportunities ahead. Let me now go through our quarter 2 P&L. System sales grew 6% year-on-year. Same-store sales grew 1% sequentially improved from quarter 1. Our restaurant margin was 16.1%, in line with the prior year level. Improvements in occupancy and other costs offset growth in cost of sales and cost of labor. Cost of sales were 31.5%, 50 basis points higher year-over-year, mainly due to better value for money offerings, increased packaging costs due to higher delivery sales mix and Pizza Hut's new menu items, which have higher COS and are still being optimized. Commodity prices remain favorable, though the benefit was smaller than before. We also improved our procurement efficiency through menu innovation and dynamic price management. Cost of labor was 27.6%, 40 basis points higher year-on-year. Rider costs continued to increase year-on-year in quarter 2 driven by the strong growth in delivery sales mix, which rose from 45% last year to 54% this year. The margin impact from rider cost was 140 basis points, slightly lower than quarter 1, and we offset most of that through enhanced store operations. Occupancy and other was 24.8%, 90 basis points lower year-over-year. The rent ratio improved through lease renegotiations and more favorable rents in lower-tier cities. We also implemented other initiatives to enhance operational efficiency. Our OP margin was 11.1%, 20 basis points higher year-over-year achieving the ninth consecutive quarter of OP margin expansion. Savings and G&A expenses helped improve OP margins. Operating profit was $348 million, a second quarter record, growing 7% year-on-year. Net income was $244 million, up 6% year-on-year. Excluding our investment in Mainland, net income grew 3% year-on-year. Our investment in Mainland had a negative impact of $6 million in quarter 2 compared to a negative impact of $14 million in quarter 2 last year. As a reminder, we recognized $13 million less in interest income in quarter 2 this year due to a lower cash balance, resulting from the cash we returned to shareholders and lower interest rates. Diluted EPS was $0.70, 14% higher year-on-year or up 10% excluding our investment in Mainland. Now moving on to our 2026 outlook. Let me start with sales. Since June, we have been lapping a higher delivery sales pace, and that tougher sales comparison will continue through the second half. That said, given our disciplined execution last year and multiple growth drivers, we remain confident in our ability to lead the catering industry in China. July tracked broadly in line with our expectations. We are working hard to maintain positive same-store sales growth in quarter 3 and deliver the 15th consecutive quarter of positive same-store transaction growth. Moving on to margins. Before considering the impact of the Pizza Hut deal, we expect quarter 3 restaurant margin to be stable to slightly positive year-on-year. Relative to the first half, incremental rider cost pressure is expected to moderate slightly as delivery sales mix already increased to 51% in quarter 3 last year. Our continued efforts to improve operational efficiency and optimize store costs, including rent, labor productivity and CapEx are expected to support margins, giving us room to reinvest in growth. We expect OP margin to be roughly in line with quarter 3 last year. There was a positive margin impact of about 20 basis points from some Ad Hoc government subsidies in quarter 3 2025 and that are not expected to repeat in quarter 3 this year. Some similar subsidies were already recognized in the first half of this year, though in smaller amounts. For the full year, without considering the impact of the Pizza Hut deal, we're confident in meeting our 2026 targets, which are consistent with the range we shared at our Investor Day last year and in February. These include same-store sales index of 100 to 102, mid- to high single-digit system sales growth, high single-digit operating profit growth, double-digit EPS growth, and a slight improvement in restaurant OP margins from Yum China. Additionally, we remain on track to reach 20,000 stores by year-end. Now let's turn to the Pizza Hut deal, which is on track to close in August. We plan to fund this transaction primarily with that. We expect to borrow an offshore bridge loan of around $1.2 billion equivalent for up to 12 months. For longer-term financing, all options remain on the table. We will proceed in the best interest of our shareholders and execute financing when market conditions are appropriate. We'll provide an update once our financing plan is finalized. The savings in the 3% license fee payment to Yum Brands are expected to add 2.8% to Pizza Hut's restaurant OP margins after taking VAT into account. This translates to approximately 60 basis points for Yum China overall. For quarter 3, we expect around 30 to 40 basis points positive impact to both Yum China's restaurant and OP margins, and for the 2026 full year, around 20 to 30 basis points. After accounting for deal-related costs, financing interest expense, parts and without considering the potential higher growth of Pizza Hut, we expect the deal to be accretive to diluted EPS, slightly accretive in 2026 and mid-single-digit accretive in 2027 and 2028. In terms of capital returns to shareholders, we remain on track to return $1.5 billion to shareholders in 2026, equivalent to around 10% of our current market cap. In the first half, we returned $718 million, including $515 million through share repurchases and $203 million through quarterly cash dividends. We stepped up share repurchases in quarter 2, reflecting what we believe was a relatively attractive share price. From 2027 onwards, we remain committed to returning around 100% of annual free cash flow after subsidiaries' dividend payment to noncontrolling interests. This translates to an average of $900 million to $1 billion plus in 2027 and 2028, and exceed $1 billion in 2028 and beyond. With ownership of Pizza Hut brands supporting faster growth, we also see potential upside to our future free cash flow. With that, let me hand it back to Joey for his closing remarks.

Thank you, Adrian. Looking ahead, we are firing on all cylinders to drive sales and expand our addressable market. A number of our initiatives have each reached or are about to reach the meaningful milestone of CNY 1 billion in sales or around 1% of Yum China sales. KCOFFEE Cafe generate around CNY 1 billion in sales last year. We target to double that to nearly CNY 2 billion this year. KPRO is expected to quadruple in sales year-over-year this year and exceed CNY 1 billion in sales next year. . KFC's drive-through and car side pick up are gaining strong momentum. We target to reach CNY 1 billion in sales this year. Pizza Hut Burgers, a category we introduced 2 years ago is also gaining popularity. We now target over CNY 1 billion in sales this year or around 5% to 6% of Pizza Hut sales. We remain confident in the strength of our brands and our ability to deliver sustainable growth even in the current dynamic environment, and we continue to see significant long-term growth potential in China. Together with our team, I look forward to achieving our growth targets for 2026 and beyond. Now let me pass it back to Florence. .

Thanks, Joey. We will open the call for questions. In order to give more people the chance to ask questions, please limit your questions to 1 at a time. Operator, please start the Q&A. .

[Operator Instructions] Our first question is from Michelle Cheng with Goldman Sachs.. .

Congrats again for the very solid results. My question is about the overall consumption environment and also the pricing on trend. So we actually heard from many customer companies and also looking at the macro data, second quarter market has been turning softer. And even into third quarter, it's not exciting. And definitely, the weather didn't help at all. But you still deliver a very solid result in second quarter, so can you share with us your observation on the overall consumption trend? And I remember a few quarters ago, you mentioned the promotional activities have -- has been better in China. But given these kind of consumption trend, do you see any risks on the reemergence of this pricing trend or promotion activities in the market. And since we know we have an easier base on margins, so still [indiscernible] your thought how to balance this pricing trend and promotion activities to drive the sales growth. .

Thank you, Michelle. We are encouraged to see the rebound in June retail sales compared that with May actually. And as Adrian mentioned earlier in prepared remarks, July trapped broadly in line with our expectations. There was some extreme weather, but it was temporary and it has sort of a regional impact in July. Coming back to the few trends, there are few things here worth noting. Consumers are still willing to spend on certain occasions. They are still growing nicely and present attractive opportunities such as coffee, like meal, and they're willing to spend money on innovative products and experiences, strong value for money and emotional value. And then additional interesting trend is we see some stabilization in pricing trends. More players are willing to take pricing, reflecting stable consumer environment. And the competition between the delivery platform is more rational. So these are positive. And on top of that, we continue to see ongoing increase, what we call chain application, China restaurant chain, the percentage has grown from 20% to 30% plus it's still relatively low compared with 60% plus in mature market investment. There's also another one little trend going on. Since April the government has tightened oversight of the food delivery related to what is called Gold kitchen. We view this as a positive environment raising the standards of the industry, and we expect to benefit from our well-established food safety, which is a strategic moat for us. Thus, Michelle, Yum China team. We are working hard traffic, sales and profit all at the same time, and we target to maintain positive same-store sales growth in quarter 3 and deliver 15 quarter of same for transaction growth as well.

Our next question comes from Chen Luo with Bank of America. .

Joey, Adrian and Florence, congrats again on the strong result for Q2. My question is focused on our Pizza Hut China brand acquisition. Just now, Adrian mentioned that there will be a 12-month bridge loan. But regarding the future refinancing plan, do we have any options in mind that we can share with investors, say whether these options may include significant loans or even CB. In particular, there have been some market concerns from some investors that if we are opting for CB, whether this will have some negative impact either in terms of dilution or in terms of the share price performance. I understand that we are always trying to take a very disciplined approach or we're trying to maximize shareholder value. So any color or comment on our future refinancing plan would be appreciated.

Sure. Thank you, Luo Chen. So indeed, as I mentioned in the prepared remarks, we expect to take a bridge loan of approximately $1.2 billion equivalent of up to 12 months to close the transaction first. And by the way, the closing will take place order as I mentioned. The bridge loan interest rate will be approximately 2%. So it's -- it will be quite favorable. And your question is actually focused on the take-out financing or the long-term refinancing. Indeed, we think all options currently are on the table, including syndicated loans, including bonds, including CB, et cetera, et cetera. And given you specifically asked about CB, although it's actually pretty preliminary, and we don't have any inclination on which instrument we take, but speaking for CB specifically, let's say, even if we choose to take CB take our financing options, there are different ways to minimize or reduce the dilution meaningfully -- potential dilution meaningfully. For instance, the issuer can take a top core option, thereby to increase the conversion premium from 20%, 30% to as much as 70% or 80%. That means the share price when it only gets to 70%, 80% premium versus the time when they issue the CB, then the dilution will occur in which the shareholders will be pretty happy, right? The share price is 80% up. And even at that point in time, there is still an option to use net share settlement meaning that only the [indiscernible] money portion of the CB will be used -- will be issuing shares. So the dilution, all in all, will be very limited. So that's about CB. And you can see some of the other big technology companies, actually, they are quite similar things to what I mentioned to minimize the dilution impact. Again, we're still studying the different long-term refinancing options and all the different options are on the table. But I just want to share more color given the last part of CB.

Our next question comes from Lillian Lou with Morgan Stanley. .

Joey, Adrian and Florence, yes, congrats again on the strong result. My question is focusing on Pizza Hut again. I think in the previous statement, you mentioned second half, Pizza Hut margin will see some improvement. Just a little bit of clarification, does that include the buyback, the margin accretion from the loyalty fee or its underlying margin improvement. That's more technical question to clarify. And the major question is more on the Pizza Hut store expansion acceleration. How do you balance this store expansion pace versus maintaining a positive same-store?

Yes. I'll take the question, Lillian. So on your clarification question, obviously, our guidance, as we mentioned in the prepared remarks, disregarding or without taking into account the Pizza Hut view, we do expect the restaurant margin for Pizza Hut in the second half will enjoy a greater expansion compared to the first half. And the key reason is the moderation of rider cost pressure. Obviously, in the second half of last year, the delivery sales mix in the base was a bit more normal or comparable to what we see currently. . Obviously, in the second half of this year, there will still be a delivery sales mix increase, but the delta year-over-year will be much less, meaning the rider cost pressure will be more manageable in the second half. Other cost line items, I think the trend will be kind of similar. For COS, on the second half for Pizza Hut, it will be broadly stable year-over-year. In our last earnings release, we guided a full year approximately 34% U.S. for Pizza Hut. I think we should be able to deliver consistent results compared to our guidance on Pizza Hut U.S. On the long term, U.S. for pizza will be 31% plus or minus 1%, as we always commented. All in all, we do see opportunity for expansion there. So that's on the first question. The second part of the question is the relationship between store opening and comp sales, for Pizza Hut, specifically, I think you mentioned. I think over the past few quarters or even the past few years, we are always trying to balance the different factors, right, like comp sales, store opening, margin, profit growth. And hopefully, it's fair to say that we successfully delivered right or proper balance in most of the quarters or hopefully in the past few years in a consistent manner. And indeed, we see lots of untapped opportunities for Pizza Hut here in China, obviously, for KFC too, but you asked about Pizza Hut. So we will open the stores. We will not slow down the store opening. And in terms of store opening, we do open stores across different tiers, high tier city, low-tier city. For Pizza particularly, the lower-tier city penetration. There are actually lots of opportunities, right? We are kind of underrepresented there compared to where we are for KFC and compared to some of the local Chinese QSR brands there. And for high-tier city, we will also continue to defend our market leadership and open stores in higher-tier city. And I think you focus on the relationship between store opening and comp sales, there are different ways where we can manage or reduce the sales transfer by store opening. For instance, when we open stores in strategic channels like hospitals, university campuses, the sales transfer will be rather limited, right, because it's kind of a close trade zone. For instance, when we open stores in lower-tier cities, because there are a lot of white space, the sales transfer will be rather limited. And also that's similarly true for [indiscernible] areas in high-tier cities, too. So -- as always, we'll try to balance the different metrics and hopefully deliver a set of results that satisfactory to our shareholders. Thank you. .

Our next question comes from Anne Ling with Jefferies .

Also on the Pizza Hut side, we see pizza -- the burger having very good momentum. And we are like expanding to more locations. But for me, I would like to understand like because we're offering Burger, the product itself, something similar to that of Pizza. So how do we like prevent from cannibalization? And it seems that like we do have like incremental sales. So as a customer, possibly even when they go to the store, I might want to go for a burger. So in that case, like how do we -- like maintain or prevent the cannibalization? And also for the incremental growth coming out from the Burger Bar , where do you think the market share is coming out from? What is the customers that you have attracted that are new to you. Yes, that's my question.

Cannibalization with what end? .