Fast food chain on track to separate its China business by October 31st, 2016
Yum! Brands Inc. (NYSE: YUM), owner of the Pizza Hut, KFC, and Taco Bell fast-food chains, and the largest fast-food chain in China, announced on Tuesday, October 11th, 2016, that it will more than double returns to shareholders by 2019, as part of a share buyback program started in 2015. Ahead of its separation from its China division at the end of October 2016, Yum! plans to increase its share buyback and dividends to $13.5 billion. So far in 2016, Yum! has already bought back about $5.5 billion worth of its common shares as part of a previously announced $6.2 billion capital return program that has reduced its share count by about 16%.
Back in October 2015, Yum! had agreed to hive off its China business from its U.S. operations after giving in to pressure from activist-investor Keith Meister, founder of Corvex Management. Meister is also a member of Yum!’s board of directors and was of the view that by separating the Chinese unit, Yum! could be able to better focus on the Asian markets.
Divestment of China unit on track
Yum! Brands remains on track to finalize the separation of its China business by around October 31st, 2016, aimed at creating two independent, focused growth companies. The Company is looking to sell just 20% of its China unit (including 7,200 stores) and more of the unit’s shares through an IPO later this year in Hong Kong or New York. The entire China unit is valued between $8 billion-$11 billion.
More importantly, the divestment is part of the Company’s plan of gradually reducing exposure in a business with shrinking market share and move from owning restaurants towards pure franchising. According to CEO, Greg Creed, the Company plans to have at least 95% of its restaurants worldwide owned and operated by franchisees by the end of 2017. Yum!’s board had decided that the sales proceeds from the China unit could be used to fund a dividend and share buyback program.
Yum!’s 30-year-old China business is its cash cow, and accounted for about 53% of the Company’s revenue in 2015, according to Bloomberg. However, in recent years, Yum! has been facing major headwinds in its Chinese operations as a result of food-safety scares, cutthroat industry environment, and lack of supply chain control. Despite remaining the market leader in China, Yum! has witnessed a steady decline in market share to 24% in 2015 from 39% in 2010, and has been steadily ceding market share to rival McDonald’s Corp. (NYSE: MCD). In a bid to regain its supremacy, Yum plans to add 600 outlets in 2016.
Yum! China – higher growth with lower risk
Yum! stated that franchisees will own 93% of the nearly 36,000 Yum! restaurants remaining in the company after the China unit separation. Currently, franchisees own 77% of the total restaurant count, partly because Yum China owns most of its restaurants. By the end of 2018, Yum! Brands aims to have at least 98% of its restaurants owned by franchisees, which would lower costs and increase its dependence on more stable franchise and license fees.
Yum!’s China business will assume the name Yum China Holdings Inc., and will begin trading on November 1st, 2016, on the New York Stock Exchange with the ticker symbol “YUMC”. The new company will become a licensee of Yum Brands in Mainland China and will have exclusive rights to the KFC, Pizza Hut, and Taco Bell brand names. China’s contribution to Yum! Brands earnings, which now stand at 45%, are expected to fall to 14% after the spinoff, when it will begin paying Yum! Brands a license fee of 3% of restaurant system sales.
Yum! Brands plans to reduce annual capital expenditures to about $100 million in 2019 from about $500 million in 2015. The Company is also aiming to cut general and administrative expenses by a cumulative $300 million by 2019, half of which would come from shifting restaurant expenses to new franchisees, while the remainder would come from job eliminations and tighter expense controls.
Yum! China set to triple restaurant count
Micky Pant, CEO of Yum!’s China division, said that the Company would triple the number of restaurants and have 12 KFC restaurants per million people in China. Yum now has more than 7,300 KFC and Pizza Hut outlets. Yum China is targeting a 15% earnings expansion, and open restaurants in mega cities, major transportation hubs, and new shopping malls. Currently, China has about 4 KFC stores per million people versus 13 stores per million people in the U.S.
Q3 FY16 financial highlights
Yum reported its Q3 FY16 results on October 5th, 2016. The Company’s total revenue fell 3.2% Y-o-Y to $3.32 billion. On the other hand, Yum!’s bottom-line jumped to $702 million, or $1.09 per share, from $629 million, or $1.00 per share, in the year-ago period. Most importantly, the China division’s comps were down 1% for the first time in five quarters, which the Company attributed to anti-U.S. protests after an international court rejected China’s claim to historic rights in the South China Sea. Comps at both KFC and Pizza Hut Casual Dining witnessed a decline of 1% and 4%, respectively, during Q3 FY16. On a brighter note, China core operating profit grew 14% during the quarter under review.
Yum! Brands’ stock ended the day at $89.37, gaining marginally 0.48%, at the close on Thursday, October 13th, 2016, having vacillated between an intraday high of $90.03 and a low of $88.36 during the session. The stock’s trading volume was at 4,174,997 for the day. The Company’s market cap was at $34.73 billion as of Thursday’s close.