KFC loaded waffle fries
Yum! Brands executives explain positive outlook for the company's China business.

LOUISVILLE, Ky. – The numbers didn't say it all for Yum! Brands Inc.'s financial performance.

The company reported a 9 percent decline in net income for the first quarter, and its China Division continued to struggle as system sales declined 6 percent. But executives with Yum! say the story behind the numbers is reason to feel confident that a second-half transformation is in the making.

In an earnings call with analysts, CEO Greg Creed said the combination of improving same-store sales, customer metrics and restaurant margins in the company's China business gives confidence in a first half/second half performance transformation.

“Same-store sales declined 12 percent for the quarter, but that doesn't tell the whole story,” Creed said. “The fact is that the business is clearly improving. Same-store sales and customer metrics continue to move in the right direction. In addition, the team has done an impressive job managing costs and delivered restaurant margins of nearly 19 percent in the quarter.”

Pat Grismer, Yum! Brands CFO, said sales were strong during the Chinese New Year period. Restaurant margins of 4.5 percentage points lower than a year ago represented a significant improvement over the 7 point decline the company experienced in the previous quarter.

Additionally, Grismer said pricing and labor productivity more than offset inflation in food and labor costs.

“What this means is that restaurant level profit flow-through is actually getting stronger thanks to the hard work of our local team to deploy labor more efficiently and to manage a more profitable mix of menu items,” Grismer explained. “More importantly, this bolsters our belief that China division restaurant margins will return to the 20 percent range as sales are recovered, and that this recovery has the potential to unlock approximately $600 million of operating profit.”
Creed and Sam Su, vice chairman and CEO of Yum! Restaurants China, convened a task force from other parts of the KFC China business to share insights and best practices to improve the business. The task force also reviewed marketing plans for China which left Creed feeling more confident about Yum! Brands’ future in China.

At KFC China: “We recently launched the first of our two menu revamps planned for the year,” he said. “This initiative will be phasing over the next three months and includes eight new products focused on lunch and dinner.

“In addition to traditional KFC offerings, this revamp includes products aimed at consumers interested in healthy alternatives such as herbal tea and seafood.”

KFC China's foray into premium coffee will continue on expectations the offering will provide an additional platform for growth. Initial results show an incremental weekly sales layer of about $300 per store. Prices for KFC coffee are 40 percent below Starbucks and 20 percent less than McCafe. By the end of the first quarter, Yum! introduced premium coffee sales in 1,300 stores across 10 cities. By year-end, the company expects to have premium coffee in almost 2,500 stores.

“And we continue to innovate on all fronts, not just our menu,” Creed added. “This includes accelerating asset enhancements, digital marketing and leveraging our online delivery platform. Clearly, there's a lot to be excited about with the KFC China.”

Creed also noted same-store sales improvement at Pizza Hut in China. The company is leveraging all dayparts with addition of breakfast. The unit continues to expand late-night offerings such as fajitas, which the company recently launched.

In addition to the Pizza Hut casual dining business, Yum! continues expanding its home service offering which has grown to almost 300 units in China.

“This business offers a diverse menu with Chinese food comprising nearly half of its products,” Creed said. “Any way you look at it, the Pizza Hut business has a long runway for growth in China.”

Also driving growth for the company is new unit development. Yum! opened 171 new restaurants in China during the first quarter. The company expects to open 700 additional units in 2015.

Grismer said “because we continue to shift our development focus to lower tier cities, tighten our site criteria and improve our investment model, we've been able to maintain a high rate of new store openings despite the temporary softness we've seen in topline results.”

“...Also, with the breadth of our market presence and the scale of our development team, we have the ability to capitalize on China's expanding economy in a way that no one else can in our sector,” Grismer said.