Yum Brands (YUM) and Yum China (YUMC)

With coronavirus cases picking up again across the US and much of Europe, a shudder has gone through the restaurant industry as it did during the start of the pandemic back in March. While a mid-year comeback was sweet relief for food providores it has unfortunately been shortlived, as cities go back into lockdown and restrictions are again placed on the number of people you can safely have in the one establishment.

For today’s stock report subjects, Yum Brands and Yum China, March was a terrible shock to the system. It harked back to the devastation caused by the spoiled chicken scandal that rocked China back in 2014 and caused the split of Yum Brands into two separate entities. Here a supplier to Yum Brand business KFC was found to be supplying rotting meat to the chicken franchise, as well as to other big names such as McDonald’s, by falsifying expiration dates. It was a disaster for the fast-food industry in the country.

Since this time Yum Brands has focussed on building up its empire of 43,600 restaurants in over 135 countries, while Yum China now operates over 10,000 restaurants in more than 1,400 cities throughout mainland China. Both offer the big three franchises under the Yum Brands name, KFC, Taco Bell and Pizza Hut. Yum Brands also operates The Habit Burger Grill and Wing Street brands worldwide, while Yum China also has East Dawning and Little Sheep under its banner in locations including the US, Canada, Indonesia, and Japan.

Other than a little hiccup back in 2018 when they ran out of chicken in the UK and 600 KFC outlets had to be a shutdown it’s been rather smooth sailing since then (you can see the apology it made to clients below). Up until 2020 that is. Yum China same-store sales fell by 15% in the first quarter and another 10% in the second. Yum Brands sales dropped by only 7% in the first quarter, the pandemic didn’t take hold in the US and much of Europe until late in March, but by the second quarter, it had lost a further 15%.

Store closures in areas that introduced stay-at-home orders were obviously devastating. Almost everywhere else implemented social distance regulations that either left dine-in options closed or at least heavily reduced. Shorter operating hours had a large impact on sales, while extra expenses from employee wages and benefits, and introducing safety requirements for workers, impacted profit margins.

But in a time of crisis, there have also been silver linings. Yum Brands strategic decision to move away from owning and operating its own stores to become a full franchisee operation has been beneficial during the period. Refranchising reduces risks to the business, where reducing ownership reduces capital requirements and increases profit margins. Yum China runs on a fully franchised model while Yum brands have around 95% franchisees and self own only around 3,000 stores.

With dining indoors being restricted across the globe, both entities have focussed on growing digital sales and online ordering, increasing their delivery networks, as well as introducing contactless curbside pickup options. In the US online orders have increased by more than 25% during 2020. While in China online orders and deliveries accounted for 78% of total sales with KFC accounting for 84% and Pizza Hut 65%.

Yum China’s loyalty program has been a major reason for this. It is estimated more than 285 million customers belong to the service. That’s up from 230 million a year ago. Here customers have an unlimited delivery subscription plan which makes them eligible for free delivery up to twice a day, every day of the year. Each member can see a personalised menu which allows for cross-promotions and an easy upsell. In the US the system is much smaller but there are big plans to make the programme as successful in the US as it is in China.

In the third quarter of this year, both Yum Brands and Yum China saw sales continue to fall but at a much slower pace. Yum Brands same-store sales fell 2%, while revenue rose by 8%, and in China revenue increased by 1% while same-store sales fell by 6%. Both easily beat analyst estimates on both the top and bottom line. They were both solid results, and impressive ones considering the hurdles they have faced throughout 2020.

I see the last few months as allowing both entities to set themselves up for the future. Yes, the coronavirus is still around, and yes cases are rising and may impact store openings and operations in the near future. But we also know that there are vaccines coming, and it is only a matter of time before they are rolled out to the globe. There are expectations that by the middle of 2021 we will be right on track to get back to the way of life we knew before 2020.

So while I suspect both Yum Brands and Yum China might be in for a rough few months, over the long term they are both great businesses with important strategies to take them into the future. If I had to choose between investing in the two I would err on the side of Yum China because of its solid following and its growth potential, but I like both. I would be looking closely for any share price weakness over the next few months to use as a buying opportunity for a long term hold.