Yum China Holdings might not be a familiar name to many investors here, but the brands it runs in China will be: KFC, Pizza Hut and Taco Bell. As the largest restaurant chain operator in China, its ability to capture growing spending power of what is one of the world’s largest consumer markets is why Louis Wong, director of Phillip Securities Hong Kong, likes this stock.
Besides operating the familiar Western brands, Yum China also holds a trio of Chinese-themed cuisine brands selling the familiar taste of home to local consumers. They are East Dawning, a Chinese fast food chain serving boiled dumplings; Huang Ji Huang, offering food in a simmering pot; and Little Sheep, a famous steamboat brand.
Recognising the growing popularity of coffee in a country that gave the world tea, Yum China runs the COFFii & JOY chain featuring specialty hand-dripped coffee, as well as the Lavazza Italian coffee franchise.
The combined total store count for all the brands, as of Sept 30 last year, was more than 10,150 across some 1,400 cities. The company has a stated target of 20,000 stores. Wong notes that despite the pandemic, Yum China was going ahead with a strategy of growing earnings by opening new stores either organically or via franchises. For the January to September 2020 period, the company opened a total of 660 new stores. Nearly half of these new stores, or 312, were opened in the third quarter alone — suggesting an accelerated expansion pace as China’s economy rebounded strongly from the pandemic that started early last year.
Wong says that Yum China’s revenue has been trending up over the past three years. “We don’t see the kind of sharp jump; it is slow and steady,” he says. Between FY2017 and FY2019, the company’s total revenue increased from US$7.7 billion to US$8.77 billion. However, with the pandemic, both revenue and earnings were affected earlier last year, although things have picked up since. For its 3QFY2020 ended Sept 30, Yum China’s revenue was up just 1% y-o-y to US$2.35 billion ($3.11 billion). On a same store basis, it was down 6% y-o-y. However, its adjusted net income, which excluded one-off items, increased 17% y-o-y to US$263 million.
From Wong’s perspective, the company has another highlight: instead of just relying on walk-in customers to dine at its stores, Yum China has been actively growing the volume of delivery orders, relying on its own team to get the food to its customers, as well as tapping on the third-party delivery platforms such as Meituan and Eleme, part of the Alibaba Group. It is also active in generating a growing proportion of digital orders, where customers place orders and/or reservations online. For 3QFY2020, Yum China generated 78% of its sales via digital orders, up from 56% in 3QFY2019. “Yum China is quite ahead compared to its competitors in digital development,” says Wong.
Yum China was originally listed in New York in 2016 but in September 2020, it had a secondary listing in Hong Kong, where it raised some US$2.2 billion in proceeds, which boosted its cash and equivalent balance as at end-September 2020 to around US$4.2 billion. As a further sweetener, the company has no debt.
Wong says the company has been tapping this war chest to fund further digitalisation efforts, expand its network, and create new product offerings to keep its existing customers coming back for more and to reach out to new ones. Some recent new items added to the Pizza Hut menu included salted egg yolk volcano cake, and Wuhan-style hot dry noodles with crayfish. Another new item was Chinese-style braised beef whose cooking style is borrowed from a famous braised pork dish named after Su Dong Po, a famous Chinese poet from the Song Dynasty.
Following the blip last year in its earnings trajectory, Wong expects Yum China to be back in the growth mode this year, with a forecast revenue growth of 19.8% to US$9.8 billion and earnings growth of 34% to US$840 million in the same period.
In addition to being a growth story, Yum China is relatively attractive as a dividend play. Its quarterly payout, according to Wong, has been increasing at around 10% a year. Due to the pandemic, the quarterly payout was suspended for two quarters in 2020, but on Oct 28, the company announced it is resuming a payout of 12 US cents for that quarter. “This year, as their business continues to recover, we expect payout more in dividends to shareholders,” says Wong, who has a target price of US$69 for the stock, or, for those trading Hong Kong, HK$545. Yum China closed Feb 1 at HK$445.20.
China’s V-shaped recovery
Consumer plays like Yum China are closely linked to the country’s economy. To this end, it is a positive correlation. China’s economy has defied earlier worries to stage a V-shaped recovery. The first quarter of 2020, with the virus spreading rapidly, prompted the government to go into a lockdown mode. China’s GDP suffered its first quarterly contraction in decades.
However, growth rebounded in the subsequent 2Q and further improved with a 4.9% growth in 3Q, as not just consumer spending resumed, but also higher industrial production output, thanks to robust export growth, says Wong.
The “Li Keqiang” index, named after China’s premier, never dropped below zero. This index takes into account three key indicators: 40% bank loans, 40% electricity production, and 20% rail freight, and is deemed by market observers to be more sensitive and more volatile than GDP growth.
In contrast, the UK’s economy plunged by 20% in 3Q, while the US is down by nearly 10%. The International Monetary Fund estimates that China’s economy had grown by 1.9% in 2020 versus a global average of 4.4% contraction. This year, China’s export sector is seen to remain as a major growth engine. That’s on top of the so-called “dual circulation” initiative conjured by the government to spur further growth in domestic demand. Wong expects China’s GDP growth this year to reach between 8% and 9%. If so, this would be the fastest expansion pace since 2011’s 9.2%.
There’s also the ongoing structural shift that’s positive for stocks like Yum China. “Consumption does not yet play as large a role in China’s economy as in most developed countries, but this transformation towards a domestic-demand driven economy is well under way and will continue, offering opportunities to investors,” says Andy Rothman, investment strategist at Matthews Asia.
Geely Auto
Another stock flagged by Wong was Geely Automobile Holdings, a Hong Kong-listed entity that is part of the bigger Zhejiang Geely Holding Group, privately-held by Li Shufu, who before building cars, was making refrigerators. Geely’s recent expansion plans have focused on markets such as Russia, the Philippines, Kuwait and Saudi Arabia. Even Myanmar has emerged as a bright spot for Geely: this market grew 25% for Geely in 2020. For 2020, Geely’s unit sales hit 1.32 million, higher than the already revised target of 1.31 million units. For this current year, Geely has adjusted its sales forecast up 16% to 1.53 million units.
Geely is the first Chinese car brand to reach a cumulative 10 million vehicles sold. This description excludes the numerous, much more established and older joint venture China-based car makers, which had been enjoying much higher sales. There are a few key developments at various stages of implementation, which makes Wong “quite upbeat” about Geely’s outlook for the rest of this year.
For example, there is the joint development of vehicle models with Volvo, the Swedish premium brand that Li also owns, ranging from compact models to sedans to SUVs. More exciting is the recent news that Geely will be cooperating with China’s internet giant Baidu, sometimes dubbed China’s answer to Google, to develop “intelligent driving” capabilities. “This will be the next growth engine for Geely,” says Wong.
In another development, Geely has plans to be listed on the STAR market, famous in recent years as the bourse for high-tech companies. If the listing is successful, Geely will be the first car maker to be listed on this bourse that’s part of the Shanghai Stock Exchange. According to Wong, Geely aims to raise nearly US$3 billion from this listing so as to fund new vehicles and develop new technological capabilities. Early last year, Geely was in merger talks with Volvo. Both entities are separately controlled by Li’s Zhejiang Geely Holding Group. When the pandemic broke, talks were halted, but are expected to resume within this quarter. “If the merger takes place, Geely’s competitiveness would be increased,” says Wong.
When Wong made the call to buy Geely last October, it was trading at around HK$15 ($2.56), which then surged from the end of last year to close at HK$28.75 on Feb 1. He notes that many analysts have in recent weeks raised their target price of Geely to the HK$50 mark. Given this big run in such a short time, Wong is urging some caution. For investors who already own this stock, there’s no harm holding on and riding the momentum triggered by the wave of positive calls — but perhaps not for those yet to have a position. “I don’t recommend those who do not own the stock yet to go in,” says Wong.
