February 8, 2018 / 4:31 AM / 8 months ago

Breakingviews - Yum China looks appetising despite iffy pizza

HONG KONG (Reuters Breakingviews) - Look past the iffy pizza and Yum China remains delicious. On Wednesday evening, the mainland operator of KFC reported its first full set of annual results since spinning off from parent Yum Brands in late 2016. The smaller Pizza Hut business is still a work in progress, but shows signs of improvement. Meanwhile, the $17 billion parent looks like a straightforward, fast-growing and fairly cheap bet on the rise of the Chinese consumer.

A man walks past a logo of KFC, outside a restaurant in Shanghai, China, July 30, 2015. REUTERS/Aly Song/File Photo

Yum China made $782 million of operating profit excluding one-offs last year, on revenue of $7.1 billion. Ignoring currency moves, those figures translate to solid annual growth of 23 percent and 8 percent, respectively. As ever, the details highlight some unique aspects to operating in China. KFC’s menu now offers durian egg-tarts to accompany its signature fried chicken; more than half of payments come through smartphones; 11 percent of KFC meals are delivered. The company is present in an incredible 1,200-odd cities.

However, the picture was slightly less encouraging in same-store sales, a crucial measure for tracking the progress of outlets open more than one year. While these rose a respectable 5 percent at KFC, the pricier Pizza Hut eked out just 1 percent growth. The company has singled out Pizza Hut as one of the big challenges for 2018.

That is slightly worrying. However, the flagship brand matters considerably more: with 5,488 restaurants, KFC is roughly 2.5 times bigger. Also, same-store growth at Pizza Hut is moving in the right direction after three years of shrinkage. Yum looks focused on the problem, experimenting with everything from menus to store formats and an increased emphasis on delivery.

For foreign investors hungry for a Chinese consumption play with Western-style governance, there is not much else on the menu. And despite a rally since the spinoff, the shares still look reasonably valued. Analysts expect robust EBITDA growth of 12 percent a year out to 2020, broadly in line with Starbucks. Yet Yum China trades at an enterprise value of about 11 times expected EBITDA, whereas the coffee giant is above 13 times, Eikon shows. That sounds tasty.

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