Yum China : 2023 Investor Day – Transcript

Florence Lip, Senior Director, Investor Relations, Yum China:

Hello ladies and gentlemen. I'm Florence Lip, Senior Director of Investor Relations. It's a great pleasure to welcome you to Yum China's 2023 Investor Day. We have a full agenda today and tomorrow. First, our management team will update our latest strategy this morning, followed by site visits in the afternoon and tomorrow morning.

Before we get started, I would like to go through some administrative items.

Today's presentation materials will be in English. Some of our management team will speak in Chinese. Simultaneous translation from Chinese to English will be provided. For our guests here in Xi'an, you need a headset to listen to the simultaneous translation. If you need a headset and haven't got one, please let our staff know. For our webcast audience, you can also choose the channel, just follow the instructions online.

Our Investor Day presentations contain forward-looking statements, which should be considered in conjunction with the cautionary statement in our presentation deck and the risk factor included in our filings to the SEC. You can find the webcast of our presentation on our IR website. Without further ado, let's get started.

[Video playing]

Joey Wat, CEO, Yum China:

Welcome, welcome, welcome! It almost feels a bit emotional to see so many friends after all these years, but a very big welcome to Yum China's 2023 Investor Day. On behalf of Yum China, a huge "Thank You" - to our roughly 430,000 employees, our shareholders, hundreds of millions of our loyal customers, and of course all of you today. It is wonderful to see everyone in person. I hope you have a good time in Xi'an. Your trust and support got us through the three-year pandemic and we believe that we have emerged stronger and more resilient. Today's presentations will provide you with updates on our progress, our opportunities, and strategies going forward. I'm excited to unveil our ambitious targets for the next three years, which I'll do in my closing remarks, so I'm going to make you wait a little bit. I will do it after Andy's presentation. Let's start with a brief recap of our RGM strategy. RGM stands for "Resilience, Growth, and Moat." It also pays tribute to the most important people in our company, the Restaurant General Managers. As you may recall, we introduced our RGM strategy at our 2021 Investor Day. Suiting the times, we put a very strong focus on Resilience, and yet, we did not back off from our commitments to Growth

and investing to deepen our strategic Moat. The last three years were pretty tough, but our RGM strategy served us well. Over the last three years, we have transformed our business. We added more than 4,400 net new stores. We opened a lot more than that, and we closed under-performing ones, achieving 4,400 net new stores. And we were also profitable. We generated over $3.6 billion in operating profits and were profitable each and every quarter, returning over $1.3 billion US dollars to shareholders over the past three years.

Winston Churchill once said, "Never let a good crisis go to waste." Indeed, there are very few good things to say about the pandemic, but we made the most of it, and we strongly believe that every great company is the child of winter. We would like to believe that we have worked very hard in order to get close to being that great company.

There are three areas I would like to highlight. First, we transformed our store portfolio. There's a lot of focus on same-store sales compared to 2019. However, we actually have expanded our store network by 55% over the past four years. So for our store portfolio right now, a lot of growth is coming from the stores we opened after 2019. And at the same time, when we opened these many stores, quality is still the most important criteria. We maintained a two-year payback for KFC for new stores opened, and we reduced the payback for new stores opened for Pizza Hut to three years.

Secondly, customers now enter 90% of their orders digitally, while off-premise consumption, which is a combination of delivery and takeaway, is over 60% of our sales. Why is this important to us? Because that is resiliency. We learned it from the pandemic. Even when some of the stores could not open, we still can keep our business going. And even when dine-in businesses were not operating properly, there was sales transferred from the dine-in business to delivery. Therefore, even during Q4 of 2022, which was a very difficult quarter, we still delivered a profit to our shareholders.

We also rebased our cost, and the focus here is fixed cost. You will hear a lot more about that today. We reduced our top three store-level fixed costs by as much as 20-25% over the past four years, which lowered our cash investment per store by more than 35%. This comes back to the point on why we can open so many stores, with such profitability. Because the investment is lower. And also it lowered the operating cost. As a result of our transformation, as you can see here, not only did

we avert disaster and perform during the pandemic, it also enabled us to become a stronger and better company. Compared to the first half of 2022 last year, our revenue (in 1H 2023) grew 16%. Only 16% not 50%, because we did not lose 50% during 2022, right? So, same-store sales is always a mirror of last year. Our restaurant margins improved by 530 basis points, and our operating profits doubled. Compared to the first half of 2019, we've improved significantly on virtually every measure, store count, revenues, margins, and overall operating profits. We're bigger, stronger, leaner and more profitable.

Going forward, we are shifting the emphasis of our RGM strategy from Resilience to Growth. I think that's very natural to do, because right now we are able to do business on a daily basis, which we are very, very happy about. We're calling it RGM

2.0. It centers on three primary areas for growth: One, expanding our store footprint. Two, increasing sales. Three, boosting profits. Looking back at Yum China's history, We started our first store back in 1987. It took us 16 years to get to 1,000 stores. Now when we look back at it we feel it's a bit slow. But it's always very difficult for a new brand to establish. And then, it took another nine years to get to 5,000. But from 2012, from 5,000, it took a few years to get to 10,000 by 2020 in the middle of pandemic, and right now we are at over 13,600 stores. And that makes us one of the world's largest QSR operator by equity store count, because a lot of restaurant companies are actually franchised based, and we actually run the business ourselves, which has a slightly different level of sophistication and challenges.

And, the interesting chart here is, while our stores accelerated very fast in last three years, the GDP growth actually came down, from double-digit to high-single-digit, and then right now at mid-single-digit. However, let's remind ourselves that China still is one of the fastest-growing economies in the world. And, the big question in this room is, can we continue the acceleration of store opening when the GDP is slowing down? How does it work? The answer is Yes. We are actually, this is the first big news we are going to share today, we are setting an ambitious goal of 20,000 stores by 2026, just three years from now. Because now, you know, things are back to normal, we can see things a bit more in a predictable way. So we feel confident that we can put forward an ambitious target. And that means we are adding about 1,800 net new stores annually for the next three years.

So, the scale of the economy, as you can see, when it comes to 2023, the scale of the economy is something incredibly important for the consumer industry and in particular for our business here. Right now, China is about 18% of global GDP, it's

about $17 trillion, and of course population exceeds 1.4 billion. And we believe that the combination of the scale economy, even with modest growth, is more than enough to fuel the growth of our business. Let's put things into perspective. 5% growth of China GDP adds nearly about $900 billion to our economy, and that is more than double the size of Vietnam's GDP. So we are adding 2x of the Vietnam GDP to our China economy every year, even with 5% growth, because the scale is so big already. And with 5% GDP growth and $900 billion, it contributes about 30% of the total GDP growth worldwide. The number might be slightly different, but it shouldn't be too far off.

And then secondly, we look at the urbanization. It's still happening. The number of cities is still growing. Right now, China has about 14 million people moving to urban areas, and that's about one-and-a-half New York City populations moving to China's cities annually. When we look at the middle class population, which is also addressable market. You can call it 450 million, 500 million, not too far off. And interestingly, this number is quite similar to our total membership size of Yum China right now. Our membership stands at 445 million. So if we look at the glass half full/half empty situation, what does that mean? That means while we already have 445 million loyal customers - and KFC is a very accessible brand, it's affordable, it's convenient - that means there are nearly 1 billion Chinese consumers who still today don't have convenient access to our stores, or find our prices still beyond their reach in particular area like Henan or Guizhou or Guangxi, or for other reasons. So the opportunity is still there.

Just to reinforce our conviction on growth potential is the fact that the penetration of China's QSR is still very low. I mean, we are talking about only 7 stores per million people, and when we compare to the lovely country of Japan, the penetration is 24 stores per million people. I mean Japanese food is very good, Chinese food is very good, but among these wonderful Chinese foods and Japanese foods, there's still a big appetite for our type of convenient and good foods. So, the conclusion is, the demand is still way way bigger than the supply in our industry in China.

After looking at the market potential, let's turn focus back to Yum China. The question is, are we ready for this aggressive, ambitious growth target? Absolutely! Let's look at the capex. This is over a longer time period, from 2014 to 2022. Why 2014? Because I joined at that time. So I'd like to look at, just back to almost ten years ago. We reduced the capex per store by as much as 50% or 60% for KFC and Pizza Hut independently. What does that mean here? Remember, in the capex, it has

the components of sunk costs and equipment. For the equipment that we invested in, we can always move it around. If one store doesn't work, we move the equipment to the other stores. And then the other part is the sunk costs. When we reduced the total investment by this much, you bet, we achieved a large reduction in sunk costs over 8 or 9 years' time. And that resulted in what? Lower depreciation of our operating margin. And also, strategically, it has lowered the cost of making mistakes, which is very good.

Secondly, each brand has developed their own primary store designs and supplementary modules, like drive-thru,"to-go," coffee trucks and even pop-up

stores during holidays or night markets( 夜市). This approach ensures brand

consistency with customization, and also it allows us to open stores in locations where we could not open before. What does that mean? Either a store we could not afford before because the investment is too much or the shape of the store is too odd and didn't work. But now we can do it, as long as the location is right and the unit economics works, we can open these stores. This makes us more flexible to adapt to the market.

Third, franchising. We've planned to unlock opportunities in strategic locations with about 15-20% of our new builds from franchising. All of you here know that we were reasonably conservative about franchising before. Why? Because we are very protective of our food safety. And I will talk about that later when I talk about our investment in end-to-end digitalization. We now have full visibility of our inventory system in each store. So now we feel that we can effectively manage food safety in all of our franchise stores, and therefore we are ready to have more franchise stores.

Here are some very interesting numbers. With the pandemic, food safety has become more important. We have the opportunity to open stores in Zhejiang University, Fudan University, Shanghai Jiaotong University, and more to come with over 3,000 universities in China. And then, with highway service stations, we have signed quite a significant number of agreements with our strategic partners to open stores in these service centers. If you drive through Hainan, you can experience how it feels to stop at every single important service station and see a beautiful KFC store there compared to a local store where you might not want to put that food into your kid's mouth. And a lot of these highway stations and tourist locations are doing well in China right now.