China Lower-Tier Expansion And K-Coffee Ventures Will Create New Opportunities

Key Takeaways

• Strategic expansion into lower-tier cities and coffee market efforts aim to boost revenue, margins, and customer base.
  
• Efficiency projects and capital returns focus on improving net margins and enhancing EPS growth.
  
• The company's focus on delivery and strategic closures may pressure margins and revenue growth amid complex market conditions and consumer spending behavior.

Catalysts

Owns, operates, and franchises restaurants in the People’s Republic of China.

• Yum China's ongoing expansion into lower-tier cities with smaller, more efficient store formats aims to capture new markets, potentially driving long-term revenue growth and expanding the company's customer base.
  
• The introduction and rapid expansion of K-Coffee cafes within KFC outlets are expected to capitalize on the growing coffee market in China, contributing positively to same-store sales growth and incremental profits.
  
• Pizza Hut's continued menu innovation and the use of simpler, more efficient store formats like WOW stores are enhancements likely to improve restaurant margins and expand Pizza Hut's addressable market over the mid-to-long term.
  
• The company's focus on automation and operational efficiency projects, such as Project Fresh Eye and Project Red Eye, are anticipated to sustain or further improve net margins by reducing labor costs and streamlining operations.
  
• Yum China's commitment to significant capital returns to shareholders, including an 8% to 9% return annually of market capitalization, alongside steady cash flow from operations, is positioned to enhance earnings per share (EPS) growth.

Yum China Holdings Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Yum China Holdings's revenue will grow by 6.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from 8.1% today to 8.3% in 3 years time.
• Analysts expect earnings to reach $1.1 billion (and earnings per share of $3.29) by about April 2028, up from $911.0 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $1.3 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 22.9x on those 2028 earnings, up from 19.1x today. This future PE is greater than the current PE for the US Hospitality industry at 22.6x.
• Analysts expect the number of shares outstanding to decline by 3.53% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.04%, as per the Simply Wall St company report.

Yum China Holdings Future Earnings Per Share Growth

Risks

• The focus on rapid delivery growth has increased overall rider costs as a percentage of sales, which could pressure net margins if not offset by operational efficiencies.
  
• While system sales growth was moderate this quarter, the strategic closure of more stores to enhance portfolio strength may lead to short-term fluctuations in revenue growth.
  
• The decrease in ticket average (TA) for both KFC and Pizza Hut indicates a reliance on lower-priced items and promotions which could impact overall revenue growth and long-term earnings if not balanced with higher-value sales.
  
• The market remains complex and consumer spending rational, which presents a risk of fluctuations in same-store sales and overall revenue due to unpredictable consumer behavior.
  
• Continued pressures from wage inflation and delivery costs could affect net margins if not adequately offset by automation and centralization efforts.

Valuation

• The analysts have a consensus price target of $60.26 for Yum China Holdings based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $76.0, and the most bearish reporting a price target of just $53.5.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $13.6 billion, earnings will come to $1.1 billion, and it would be trading on a PE ratio of 22.9x, assuming you use a discount rate of 9.0%.
  
• Given the current share price of $46.68, the analyst price target of $60.26 is 22.5% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.