Yum China Holdings, Inc.

Good day and thank you for standing by. Welcome to Yum! China's second quarter 2021 earnings conference call. At this time, all participants are in listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to our first speaker today, Ms. Michelle Shen, thank you. Please go ahead.

Thank you, Davina. Hello, everyone, and thank you for joining YamChina's second quarter 2021 earnings conference call. Joining us on today's call are our CEO, Ms. Joey Hua, and our CFO, Ms. Andy Yun. Before we get started, I'd like to remind you that our earnings call and investor presentation contain forward-looking statements, which are subject to future events and uncertainty. Our actual results may differ materially from these forward-looking statements. All forward-looking statements should be considered in conjunction with the cautionary statement in our earnings release and the risk factors included in our findings with SEC. This call also includes certain non-GAAP financial measures. You should carefully consider the comparable GAAP measures. Reconciliation of non-GAAP and the GAAP measures is included in our earnings release. Today's call includes three sections. Joey will provide an update regarding recent developments and our second quarter 2021 results. Andy will then cover the financial performance in greater detail. Finally, we will open the call to questions. You can find the webcast of this call in the PowerPoint presentation, which contains operational and financial information for the quarter on our IR website. Now, I would like to turn the call over to Ms. Zhou Yiwa, CEO of Yum China. Zhou Yi.

Thank you, Michelle. Hello, everyone, and thank you for joining us today. Our business has recovered remarkably well, although the pandemic is still impacting our business and will continue to do so. We have learned to live with it, and we are focusing on the future. We focus on our core, good food, great value and customer experience. We penetrate further into lower tier cities. We increase our store network density to suit the shift to off-premise dining post-pandemic. KFC remains resilient and continues to grow at a very fast pace. Pizza Hut achieved stellar performance and expected to become another growth engine of Yum China. Kofi and Joe and Lavazza are making good progress. We delivered a solid second quarter. System sales grew 14%. Operating profits grew 83%. We expanded the store footprint at an accelerated pace, opening 404 new stores in the quarter. In less than one year, we added more than 1,000 net new stores and increased total store count to over 11,000. Our team is laser-focused on driving sales. Our powerful digital platform enables us to swiftly adjust our marketing campaigns. We can reach members directly with targeted offers. In a quarter, we recruit over 10 million new members, ending the quarter with over 330 million members. Notably, off-premise and home consumption are becoming more popular in a post-pandemic era. Our delivery sales grew over 60% compared to 2019. We also launched retail products across our brands, leveraging our online and offline assets. We intend to learn and innovate to address evolving consumer needs. Let me update you on our core brands. First, let's start with KFC. KFC led our new store openings. We increased store density in existing cities and entered over 100 new cities in the last 12 months. With 280 new stores opened in a quarter, we now have over 7,600 stores across China. More impressively, new store cash payback and profitability remain very healthy across city tiers. System sales grew 14%, led by same-store sales growth and accelerated new store openings. KFC successfully navigated this tough operating environment with reduced volume at transportation and tourist locations. Our operating profit grew by 50% to $240 million. It goes without saying the crucial role good food plays in our business. In the second quarter, KFC adds the Wagyu and Angus beef burgers to the permanent menu. KFC also launched the Bo Dan, a meaty, bunless chicken sandwich, as a limited-time offer. These innovations generated strong social buzz and are well-received by consumers. We know our consumers well and cater to local taste buds. KFC has introduced regional menu items such as hot dry noodles, and steamed dumplings in Hanzhou. We also launched a Sichuan spicy plant-based beef wrap and an oat milk latte to provide more choices to consumers. With our good food, we also offer great value. Throughout the quarter, we launched attractive promotions to dry traffic. Our main Labor Day holiday buckets are the first-ever mix-and-match buckets for die-in locations. On the digital front, we focus on growing our member base and driving their spending. We launched a new privileged subscription plan, giving our members their choice of perks from a range of offerings. This provides flexibility for our members and drives incremental sales, We sold 8 million privileged memberships in the quarter. Every spending of our privileged members doubled that of regular members. Now let's move on to Pizza Hut. Our transformative initiatives in the last four years have yielded great results. Compared to pre-COVID levels back to 2019, same-store sales continue to recover. system sales growth turned positive, operating profit more than doubled from the same period last year. We accelerate our new openings and add 17 net new builds in the first half of this year. This is the highest total net new units we add in the first half since 2016. It shows our confidence in the business model now. Hub & Spoke and other small store formats have proven to be successful. and now account for most of our new stores. Store economics continue to improve. New store payback remains healthy, in particular for the help of small stores. We will continue to increase density and penetrate into more new cities. In the March new menu, we changed 40% of the menu items compared to the previous year. In the second quarter, we continue to improve our product offerings for a better customer experience. In June, we upgrade our hand-tossed dough with more premium flour and low temperature, long fermentation. This makes the pizza dough crispy outside and soft inside. It tastes particularly good and very, very suitable for delivery. We also launched sirloin steak with Parmesan cheese And knife-sliced noodle, not the very proper translation, but the Chinese name is called Dao Shao Mian, is a traditional specialty noodle of Shaanxi province. This is a great fusion product combining elements of East and West. To enable value proposition and enhance our value proposition, Pizza Hut has expanded the price range of its pizza offerings. In June, we launched 13 new pizza flavors at more affordable price points, mainly for the new upgraded hand-tossed dough. We also launched another successful All-You-Can-Eat campaign offering abundant value. The Pizza Hut membership reached a significant milestone of 100 million members. Member sales now account for over half of system sales. Digital and technology continue to play an important role in driving sales. Digital ordering increased to 84% of sales from just 29% two years ago. Delivery and table-side mobile ordering became more popular. Coffee. Our coffee business is making good progress. Lavazza tripled its store count, although the base is a bit small, in the second quarter. Initial results of our new store opening are encouraging. We now have 14 of our other stores in Shanghai, and we are opening our first beautiful store in Hangzhou, which is the first store outside China, in about one hour today. We are confident in the potential of this 126 years old Italian coffee brand. Coffee Enjoy Double is per unit sales compared to 2019 and had a meaningful number of stores breaking even at the end of the quarter. We are reinforcing a specialty coffee brand positioning, expanding their part with more food choices, broadening the customer base, and have better value for money. To conclude, my professor, we are well positioned to capture the market opportunities in China. Our store network is growing at an unprecedented pace. We are investing ahead to fortify and future-proof our infrastructure and digitization. At Yum China, we are committed and confident to achieving sustainable growth in the many years to come. With that, I will turn the call over to Andy.

Thank you, Zoe, and hello, everyone. Let me now provide additional details on our second quarter financials. and then share our perspective on this year's outlook. Unless looked at otherwise, all percentage changes are before the effects of foreign exchange. Let me first cover our second quarter financial results. Total revenue grew 17% year-over-year and reached $2.45 billion. System sales increased 14%, led by same-store sale growth of 5% and accelerated new unit developments. Similar to last quarter, we are providing performance measures here for convenient comparison with 2019. Same-source cells recovered to approximately 94% of the second quarter 2019. System cells grew roughly 9%, benefiting from new units and the consolidation of Long-G1. Cells were recovering in April and May, but the trajectory was disrupted by the Delta variant outbreak in Guangdong province at the end of May. Guangdong province is the largest economy in China and one of the largest markets, housing two of the four tier-one cities. The outbreak led to temporary closures in the region and affected consumer behavior across China. Same-store die-in volume is still well below 2019 levels. while off-premise occasions continue to grow rapidly. KFC remained resilient and delivered robust growth. On a year-over-year basis, system sales of KFC grew 14%, led by strong unit growth and same-store sales growth. On a two-year basis, system sales grew an impressive 7%, years at 2% faster than the Chinese restaurant industry growth of 5%. Despite subdued traffic at transportation and tourist locations, same-store sales recovered to approximately 93%, with the same-store traffic at approximately 86%. Average ticket grew roughly 8% versus 2019, mainly due to the increase in delivery mix. PISA has delivered exceptional performance. On a year-over-year basis, system sales grew 16%, same-store sales grew 11%. On a two-year basis, system sales growth in the quarter returned to positive. Same-store sales recovered to approximately 97%, a two-point sequential improvement from the first quarter 2021. It was led by a 9% increase in traffic, driven mainly by more delivery and breakfast sales. Restaurant margin was 15.8%, up 210 basis points compared to last year. This was mainly driven by sales leverage, favorable commodity prices, and operational excellence. Cost of sales was 30.7%, 220 basis points lower than last year. Commodity prices declined by 7% year-over-year, mainly helped by lower grocery prices. Cost of labor was 24.2%, 150 basis points higher than last year. This was mostly due to lapping of COVID-related government subsidies received in 2020, and wage inflation of 3%. Labor productivity and labor shortage partially offset the increase. Occupancy and order was 29.3%, 140 basis points lower than last year, mainly attributable to sales leverage, savings in offering costs. G&A expenditure increased 10% year-over-year, mainly due to high compensation costs, consolidation of Suzhou KFC, and the resumption of some business travel. Offering profits grew to $233 million. a 65% increase year-over-year, or a 6% increase compared to 2019. The increase was mainly driven by system sales growth and restaurant margin improvement. Our effective tax rate of 24.8% is similar to last year. We expect four-year effective tax rate to be 27 to 29%. Net income was $181 million, Adjusted net income was $185 million. Excluding $5 million net investment gain, it was $180 million, up 55% year-over-year. Saluted EPS increased to $0.42 from $0.34 a year ago, despite enlarging our share base by roughly 11% as part of our secondary listing in Hong Kong last year. Now, let's turn our attention to the outlook. As we continue to drive sales growth and accelerate store network expansion, we need to be mindful of the near-term challenges. It may sound like a cliche, but we continue to expect the impact of COVID-19 to linger, and that there would be periodic regional outbreaks.

So full recovery of same-store sales to pre-recorded level will take time.

Sales recovery will continue to be uneven and nonlinear, impacted by a few factors. One, subdued traffic at transportation and tourist locations. Two, some health measures and restriction on mobility to remain in place that will continue to impact die-in traffic. Three, shortened school holidays. Offering profits and margins have improved year on year. In the first half, benefiting from sales leverage, variable commodity prices, moderate wage increase, and labor productivity improvement. We expect certain tailwinds to turn into perhaps headwinds in the second half. First, cost of sales. which will be pressured by our focus on value campaigns and increasing commodity prices. We have already seen an uptick in post-year prices and will lap the low prices in the prior year. Therefore, the commodity prices will potentially turn into inflationary pressure later this year. Second, cost of labor. Cost of labor will increase in the second half of 2021, for two reasons. First, most of our stores have increased restaurant staff wages in June and July. Therefore, wage increase will be higher in the second half compared to 3% in the first half. Second, we are also increasing staffing levels to ensure customer services. As a reminder, the speedy recovery last year creates a tougher comparison in the second half of this year. Now, despite these challenges, we remain confident in the long-term potential of China. We're accelerating store network expansion with increased store density to capture market opportunity and to better serve the shifting demands to our premise. We now expect to open around 1,300 new stores in 2021. We also will incubate our emerging brand for future growth. To support this growth, we will continue to invest ahead in technology and infrastructure to further solidify our competitive position. We now expect four-year capital expenditure of approximately $700 to $800 million. As we step up investment, restaurant margins, as well as G&A, will reflect high depreciation costs. Finally, following an assessment of the COVID situation, our financial position, the board has approved the resumption of share repurchases. There's over $690 million remaining under the current authorization. We're committed to drive long-term returns for our shareholders, With that, I will pass you back to Michelle to start the Q&A. Michelle?

Thank you, Andy. We'll now open the call for questions. In order to give as many people as possible the chance to ask questions, please limit your questions to one at a time. Sabina, please start the Q&A.

As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, please press the band or hash key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Michelle Chang from Goldman Sachs. Please ask your question.

Hi, Joy and Andy. Congrats for the very good results, again, during this environment. My question is about the labor cost and also the new guidelines from government to protect delivery riders' interest. So we all understand that Yancey has been taking care of the employees. But still want to hear management thoughts on the future labor cost management. And more specifically, given we have high revenue contribution from delivery business, so how should we think about the delivery cost increase due to government's requirement? And also, since we are also talking about the delivery 3.0 to enhance the efficiency, so like can we expect some efficiency upside to offset this potential cost increase? Thank you. Okay, Libby.

Hi, Michelle. This is Andy. Let me first give you some color on the cost of labor. As we have mentioned in prior quarters, we were facing labor shortage in some of our restaurants. And then we also have moderate wage increase over the past year because of the pandemic situations. Now, we have decided, you know, early on in the second quarter to, you know, increase wages at our market for the restaurant staff. And so, as I mentioned on my prepared remark, we have, you know, increased wages in June and July, you know, in China. So, obviously, we rolled it out, you know, as I mentioned, over the two-month period across China. And so... And as a result, we do expect that the ratio increase will be higher. And so we're approximately 7%, which is going to be roughly normal to, you know, returning to the pre-COVID level of, you know, ratio increase. And so as a result, you know, as I mentioned, we should expect, you know, higher COL in the second half because of the ratio increase. Now, of course, we, you know, as a company, we always, you know, want to pay our staff more, higher salary and higher wages. We always follow this step, you know, with, you know, focus on also maintaining profitability and delivering value for our shareholder. Therefore, we have to invest over the years, you know, and then we'll continue to invest in technologies, in tools, our efficiency in operations, in investment in automations. so that can continue to drive that labor productivity improvement. So hopefully in the long run, we can continue to pay our staff more at the same time, maintain a reasonable margin for our business.

Thank you, Andy. Michelle, I've just had one comment about the labor cost, and then I'll address your question. I'll write the labor law and deliver 3.0. We increased our delivery sales mix from 11% to right now over 30% since 2016. I think you can see from our P&L statement that we managed to manage the overall delivery rider cost and also to find a saving to fund that and also to continue to deliver the profit margin for our shareholders. We have done it in the last five years as proven in the numbers, and I believe that Andy also gave you some view about what continues to do that in the near future as well. So let me address the Rider-Labor law question and then Delivery 3.0. For the Rider-Labor law question, I would like to make three comments. One is we are compliant to applicable laws and regulations, and we also require our service provider to sign a Yamchina supplier code of conduct to ensure they are legally compliant with all applicable laws and regulations. Second is, regarding the rider safety, we have a very comprehensive delivery management system, clear guidelines, and we conduct regular audits to ensure foot safety and rider safety. Of course, we also provide our riders training and equipment with safety measures. Third, very important, we actually work with our service provider to manage riders' wear intensity. Our riders, unlike other riders in the market, they are dedicated to serve only Yum China brands, so KFC, Pizza Hut, and we focus on service quality. And one thing rather different, which we have been criticized in the past, but now I think we can see the beauty of it is our order density for a rider is roughly 30% lower than the platform. So you will ask the question, so how do we make sure we pay the rider well so that we can keep them? Well, we pay our riders more per transaction. They got paid a bit more money. So net-net, the take-home pay for the rider is competitive. On top of that, our riders enjoy stable income with less stressful work intensity. In the short term, it might sound like a disadvantage to our course, but remember, as I mentioned earlier, we manage the course okay. But that's absolutely the right thing to do for the long term with happier riders, better service quality, and protect our brand in the long term. So let me move on to your question about delivery 3.0. We upgrade our rider platform in 2020 to optimize our delivery trade zone and rider routing. As of right now, this platform covers 75% of KFC stores. And by the end of 2021, we will complete the rollout for all the KFC stores. At the same time, we are On top of, you know, we share the rider within a few stores or few KFC stores within the same trade zone, we are also trying and going through the testing phase to share the rider with Pizza Hut as well. So all these work will continue in 2021. We do expect the improvement in the trade zone optimization, the routing will result in improving in rider cost. Of course, there are more to be done as delivery business continues to grow, but the progress is good. Thank you, Michelle.

Thank you, Joy. You're very clear.

Our next question comes from the line of Shapo Wei from Citi. Please ask your question.

Good morning, Joey and Andy. Can you hear me? Yes, Shapo. Go ahead. Thank you. My question is on Pizza Hut. We are glad to see the strong recovery both in sales and the margin in Pizza Hut. As we know that cattle dining has been a very difficult segment for years for everybody. According to the public information, one or a few of your competitors actually did a very weak performance in the kind of dining sector, but you guys really surprised the market on the upside. I know that Julian and team have done a lot for the Pizza Hut in the past four years, products, delivery, innovation, et cetera. What do you think is the most important factor that contributing to the surprise on the upside, and why it suddenly take off, and how long this kind of recovery, strong recovery, can be sustainable? Thank you.

Thank you, Xiaopu. Well, I would say there's no sudden recovery. It's really the hard work of the last four years, but, you know, it's hard to translate, but I think a Chinese way called is a good way to describe it. You work on it for over four years, day by day, on all the key areas, and then finally we get to the inflation point that the results start to speak for itself. You know, let me comment on the path so far we have taken, but also what is next. Well, you know, I think it's fair to say that our four-year revitalization program have yield great results almost in all the key dimensions from same-store sales traffic same-store sales, system sales, margin, operating profit, and right now, new store opening. They're all trending to the right direction. I'm not going to repeat the numbers, which you all have it. We, if you remember, when we started Journey, we had a variable goal to turn the same-store sales positive within 24 months. And we did. We delivered that. We turned the same store traffic positive first, then same store sales. And in terms of which particular, you know, analytically, we like to say there are few focus. In reality, when we come to turnaround business, I have to be honest that we have to work on four areas. There's no such luxury of just focusing on one or two factors. And we've roughly categorize them into four pillars, the fundamentals, delivery, digital, and store format, which you guys should be more than familiar, if not bored, with the repeat focus. So all of them, all of them have delivered. But if I really, really am pressed to single out one or two, I would have to say is the great food with great value. As simple as that. Food right now is fantastic with great value for money. You know, my recent favorite chicken curry, well, curry vegetable, it's hard to imagine that, but that's a national dish for British people. And then the pizza has improved a lot, not only the topping, but the dough. Right now, as of now, we are having pizza toppings that's with baozi and henou, so that's the abalone sauce with Wagyu beef, and that's a Michelin star recipe. But the price is very, very good, so that has to be a key attraction and turnaround. On top of that, you know, we have really worked hard to improve the technology, the digital ordering, and then the delivery, etc., So I'm not going to go through all the detail about the four pillars. What I would like to comment is what's next? Well, you know, we now have confidence in the Pizza Hut business, and we are very clear that we want to make it another solid growth engine. What is next? Well, you guys are familiar with that, too. The next is resilience and high growth. We want the Pizza Hut business as resilient as KFC business so that it makes money during good time, but it also makes money during bad time. That's the best way to protect the jobs of our staff in this big market. And also, now we have good food, good value for money, but we also have found a way with the new store opening has industry-leading cash payback and install profitability that's even comparable to that of KFC. What a fantastic thing to have, particularly for the satellite store and small store. Therefore, you can expect we are going to pursue high growth for these very profitable stores to pursue profitable growth now and in the future. So focus on four plus in the last four years. Going forward, we're going to focus on resilience and growth, in particularly profitable growth. Thank you, Xiaopu.

Thank you, Julie.

Our next question comes from the line of Chen Lu from Bank of America. Please ask your question.

Hi, Joey and Andy. Again, congratulations on another strong set of results. I also have some follow-up questions on Pizza Hut. I noticed that in the announcement, Joey described Pizza Hut as another growth engine. We have not seen this level of confidence on Pizza Hut in the past few years. And just now, Joey also elaborated on a lot of initiatives regarding Pizza Hut. And in particular, I noticed that Joey mentioned that for those satellite stores, the payback could be similar to that of KFC. So can you actually elaborate on the unit economics of those satellite stores? And also, among the 1,300 store addition target this year, can we offer a rough breakdown between our brands such as KFC, Pizza Hut, and other brands. And also lastly, in terms of margins, is it fair to say that we can, our median normalized restaurant margin for Pizza Hut could possibly return to the level that we saw during the years of 2017 or 2018 before we started to turn around the Pizza Hut business. Thank you.

Luotan, thank you. I'll comment on the Pizza Hut confidence and then the payback for the stores, and then Andy will address the other two questions that you asked. I hope you can see our increasing confidence on our business, on our Pizza Hut business in the last four years. But we did take the prudent approach, and it's very clear what are the steps that we have taken. Traffic first, and then sales, and then profit. And when we get to the point that we can get all three, then we will grow more. It's just like, as I mentioned in previous earning calls, sales is vanity. Profit is sanity, and we like both sales and profit. What is even better is even more profit, right? So that's the growth that come in. The confidence of the piece of high business model, it does not come from one or two quarter positive results. It comes from the fact that we have been working very hard on improving fundamentals of the business. The pain of working on the fundamental is good things does take time. And the joy of the fundamental improvement is the benefit is long lasting. It will help our business model for the many years to come. It's not because of one-off promotion or et cetera. It's because the improvement in food, value for money, store, I mean, the majority of our stores is very, very nice looking right now. I mean, unfortunately, you guys cannot see because it's very difficult for you guys to travel from Hong Kong to China. I really look forward for your visit to our new stores. It might be a bit too feminine for gentlemen, but it's okay. We care about the ladies because they make the critical purchasing decision most of the time. So, the improvement at all fronts and the technology and now the customer like it. And last year, the challenge on COVID-19 further challenged our business model. And we took the challenge positively and with great results. Give you an example, you know, last year with the big impact on our dying business, our Pizza Hut business took the opportunity to make the virtual out of necessity, to use our existing ingredients to make very high-value food, such as one-person meal, and that right now is bringing in incremental sales because our party size traditionally has been big, but the one-person meal is incremental business to Pizza Hut. And also, because of the pandemic, we push ourselves to grow the new retail business. Not only we deliver cooked steak, but we also sell raw steak, marinated raw steak that yourself or your IE cannot destroy. So all these are the result of hard work in the last four years, and particularly last year, And therefore, we are at the point that we can be very responsible with our view that we believe Pizza Hut is another growth engine. Given the size of the store, right? We have over 2,400 stores of Pizza Hut and in over 500 cities with fantastic brands, particularly in casual dining businesses. So that's the fundamental. And for the payback, for the small store, particularly Hub & Spoke store, which is the business model I introduced to our shareholder investor back to 2019 March. So much lower investment. It really supplement our current Pizza Hut store density. It also... help to make our current Pizza Hut store, which are not too small, make it a real asset because the original stores will be what we call mother stores. These are the big stores, and they will be helping to open the kid store, which is the satellite store, to provide better convenience to our customers, focusing on off-premise consumptions. So now the satellite store, together with our original casual dining store, it's a fantastic network. It's a great way to grow our business. You know, it's not like we have to go to... We go very far away, and we're just putting one satellite store, and logistically, it's very difficult. No, we have stores there already. We have the casual dining store there already. We're just going to increase the density of our stores to help the delivery of off-premise business. And when I say the cash payback is good, comparable to KFC, and our numbers show that the success rate is very high because the investment is very low, And the payback is about two years. So that's fantastic.

Okay. So, Luo-Cheng, hi. Let me address, you know, the question about, you know, the $1,300 new bill that we're looking at for this year. I think, you know, if you look at, you know, the breakdown, I think it would, you know, obviously somewhat similar to before, Mainly, you know, KFC is a very strong, powerful machine. It continues to generate very strong cash payback. So we should continue to expect very robust growth for KFC, and it's going to continue to be the lion's share of, you know, the new store build. As Joey mentioned, you know, like, you know, we continue to gain confidence in, you know, the economics for Pizza Hut. And then especially for the satellite store and the smaller store format. So you should see some accelerations on Pizza Hut's new store opening in the second half as well. We also – you probably have – and Julie has mentioned on her prepared remarks, we're seeing obviously very strong consumer reception for Lavasa. We tripled our store count, almost tripled, from about five stores to 14 stores in the second quarter. I mean, we also have a number of stores in the pipeline, so you should also expect, you know, a lobster coffee business to be a driver. And then historically, you know, the Chinese cuisine business, hot pot business also would see, you know, an uptake in store opening in the second half. So that's generally the composition, you know, of those 1,300 stores. But again, you know, like I mentioned that, you know, usually... the start opening will be probably faster in the latter part of the year. So that's generally the trend before the Chinese New Year. And so it's not completely linear, but that's generally you should see some acceleration in the start growth, start new start opening. Now, in terms of Pizza Hut margins, I think we're very pleased with Pizza Hut's improvement. As Sri mentioned, it's not only It grew very strongly on SSG, on system growth, on the traffic. And then so the biggest driver, obviously, for much improvement is self-leverage. And so the other part is for and also labor productivity improvement in the storm economic model. And so if you look at the first half, though, we did benefit from, as I mentioned, two factors. One, low commodity prices. And two, we have more moderate labor cost increase that help improve the margins in the first half. Now, in second half, I think similar to KFC and Pizza Hut, we have rollout wage increase across China in June and July for our restaurant staff, and also likely to increase hiring as well. So you should expect an increase in labor costs there. And then the other part is that we're also seeing commodity prices will be less favorable. And it was very favorable in the first half. Commodity prices are down 7% year over year. And I think we have seen, for example, poultry prices, which is low in the first quarter, and then have been rising since. And so we do expect that, you know, commodity prices also would do some pressure there and then perhaps, you know, come into, you know, a, you know, inflationary pressure year over year. But, you know, those are the long-term, you know, headwinds that we see. But I think for Pizza Hut, we have, you know, continued to, you know, Drive, I think the priority for them, obviously, is to drive traffic, drive sales back to the store. We're still at a recovery phase for the pandemic, so the number one thing for them, obviously, is continuing to focus on making sure that customers will come back to the store, come back to, and then increase spending, and then we will continue to drive that possible improvement as business returns continue. And then we'll also look into driving that long-term profit improvement for Pizza Hut, but that should be a longer-term point of view. It shouldn't be taken as immediately to try to squeeze profit. So in terms of the New South economics, I think I think there's a couple of things. One is that the stores are generally smaller. The satellite store is a small store, as the name would imply. So the throughput per store for a new store is probably lower than the DeSoCo existing portfolio. However, the profit margin is good, and then we have lower output investment. So the overall return is very strong. As Joey mentioned, for a satellite store, it's almost comparable to what KFP can do. So that's a very strong return. So hopefully with that we address your questions. Thank you.

Yes. Thank you, Joey, and Andy. This is really helpful.

Operator.

Our next question comes from the line of Anne Ling from Jefferies. Please ask your question.

Okay, thank you very much. Most of my questions have been answered, but just one follow-up question on the cost side. Andy, you mentioned about the cost increase, you know, for commodity as well as labor. In the past, you know, you share with us that in terms of quantifying it, like, you know, for example, in the beginning of year 2021, you mentioned about labor cost increase by a single digit. Now we're into second half. Maybe I've missed it, but would you share with us, like, you know, the cost increase for commodity side, labor cost as well as G&A? And also, maybe a breakdown in terms of the capex for the $700 to $800 million capex, which is the revised number. Thanks.

OK. Hi, Anne. So let me address the first questions about commodity price and wage increase. Commodity prices, I think if you look at the first half, we benefited from the lower commodity prices by almost 7% year-over-year. As I mentioned, we have seen commodity prices, especially post-year prices, which is, I guess, the recent low in the first quarter and have been rising. So we're going to see less benefit, much less benefit of the lower commodity prices in the third quarter compared to the first half. Obviously, the commodity prices are very hard to predict, but the current trends suggest that, based on our contract prices and whatnot, suggest that maybe perhaps in the later part of this year, the commodity prices could turn from a favorable 7% year-over-year inflationary pressure to an inflationary pressure. That's our, you know, our near-term outlook for commodity prices. Now, in terms of labor costs, you know, in the first half, you know, our wage increase was about a wage cost compared to last year was about 3% increase. As I mentioned, we have decided, you know, to adjust, you know, our restaurant staff wage, and so we have rolled out that wage increases in June and July, and that is about approximately 7% year-over-year, you know, increase there. So that's the second part of that. And then the third part, I think, for the cost of labor is twofold. One is that, obviously, you know, delivery continues to be a higher mix of that, and then if you look at the hiring, I think we also have mentioned over the past two quarters that, you know, there's some labor shortage, and hopefully with the you know, the salary and wage increase over there will ease that situation as well. So we're going to increase hiring. Now, obviously, as Julie mentioned, we continue to look for ways, you know, savings to pay for that. And then, you know, we'll continue to do so in the second half to look at, you know, productivity improvement, how we can better utilize, you know, our IT technologies to help that. And then, as Julie also mentioned, we continue to try to improve our delivery operation as well and drive efficiency. But that's a short-term outlook for us in terms of both COF and COPL. Now, the second question is about the $700 million to $800 million CapEx for this year. I think, obviously, the lion's share of that – is going to be in new store, new build. And then the second part is going to be for remodeling. Remodeling continues to be an important part of our tax program. We want to keep our restaurant fresh. And so we genuinely have a pretty robust remodeling program. And then the third one, obviously, is investment in our IT and infrastructure. And then those are the main categories of our spending, roughly in that order. And then in terms of, what's the question?

GNA.

Oh, GNA, right. GNA. Yeah, so obviously on a year-over-year basis, GNA, one is we will have less government-related subsidies. Last year, as you remember, there was general reductions in the Social Security insurance payment for workers here in China, and so that has expired. The other part is that, obviously, we also have moderate salary and wage increase, compensation increase for our staff. The third one, and it's very important, and hopefully folks don't forget, is that last year we have two... acquisitions. One is the consolidation, you know, of our social operations. The other one is the acquisition of 1G1. Both of them, you know, we would absorb that G&A expenses. And then finally, and then, you know, last year, because of the pandemic, we basically would have stopped almost all the business travel. And with the improvement in the current situations, there will be some return to some, not all, but some return to some business travel. I think that's a normal path. Hopefully, that gives you some ideas about the expense and cost environment that we're facing right now. Thank you, Anne.

Thank you. Our next question comes from the line of Lillian Liu from Morgan Stanley. Please ask your question.

Thanks, Joey and Andy, for the very detailed explanation. I have a question on the new store expansion because I think so far you've been doing a very good job in terms of managing both very fast store expansion and margin improvement. So I just want to understand more in detail about the increase of store density impact to the existing stores. Does that have any impact on the same-store sales growth of the existing stores? That's one side. And the other side is, yes, the payback and return of new store are quite good. So how are we going to look in the future with continued store increase, especially we uplift the target again? what kind of dynamic we should look at in terms of the new store margin and also the impact to the existing stores. Thank you.

Hi, Lillian. Well, thank you for your questions. Obviously, we are very pleased with the pace of store opening. With that, we continue to capture the market opportunities that this presents to us. especially, you know, in the lower tier cities, but also, you know, and also allow us to better serve our existing market. And we have designed, as we mentioned, our store network in the existing market so that, you know, we can increase the density and better serve customers' needs for, you know, delivery and takeaway. So, you know, obviously when you open a new store, especially, you know, increasing the density, it's natural to see, you know, some sales transfer. You know, new store opening, you know, but, you know, that also the impact is not the same, you know, everywhere. And, you know, today, if you look at, you know, SSG impact, I think the pandemic obviously is far most, you know, the most important one right now. You know, the sales overall, SSG sales overall is quite sensitive to, you know, for example, some of the regional outbreaks as we have seen you know, in the first quarter and as we have seen in June. And so we have, you know, always asked, you know, analysts and investors, you know, to sort of like, you know, pay attention to, you know, the regional outbreak as we are. We don't need to be, you know, overly alarmed by that, but, you know, we need to stay alert because, you know, our experience tell us that periodic regional outbreak is to be expected. You know, we have seen that, you know, in December, January, We have seen that in June in Guangdong. Now, we're seeing a potential outbreak here in Nanjing. And, you know, that is still a weapon-solving situation. So, while it's driving SSG, you know, there's many impacts, many, many different factors there. But, again, like, going back to the main point here, which is, you know, some – so, you know, for a lower-key city, there will be some impact, but if you look at lower-key city overall, you know, the SSG growth is actually faster, right? And, you know, for some urban area, I think, you know, as we design our network, you know, one thing that will impact SG is, you know, to reduce that, you know, delivery trade zone. So, you know, for example, you know, if you have a store that was, you know, five kilometers before, now you can shrink it to three kilometers because, you know, you want to have better delivery services. and whatnot, and so that would naturally, with that increased density, we're able to cover that, you know, able to do that to serve our customer better. But that would naturally mean that, you know, we would have to shrink some of the delivery trace notes or some of the exceeding stuff. So, but I think, you know, would that have, like, an impact on SG? Probably a little bit. But is that the right thing to do? Absolutely. And especially when we look at, you know, some of these changes that have been accelerated by COVID-19, one of them stand out is obviously delivery sales, right, you know, off-premise consumption or at-home consumption. So this is, you know, something that I think when we mentioned, you know, the store opening and SSG, I think it's something to be aware of. The other one is, what's the other one here? Payback in the future with increased targets.

With increased store target.

In store target. So, you know, if you look at, you know, our store opening, we always have a very disciplined process. And, you know, that has been so for, you know, past many years. And then it continues to be so and will continue to be in the future. That's why, you know, when Joey mentioned, you know, we're going to try to accelerate growth. to put a special emphasis on possible growth. If you look at our payback period for both KFC and Pizza Hut, they have been very robust and very stable. For KFC, roughly two years, and for Pizza Hut, roughly three to four years. As Julie mentioned, for some of the smaller stores and satellite stores nowadays, the payback period could be even shorter than that. We'll continue to do that, maintain a balance between faster growth to capture market opportunity to better serve our customer, but also maintain our financial discipline for profitable growth.

Thank you, Andy. I just want to add three highlights to your question. First of all, we would really like to reiterate our focus on system sales growth. in the short term and in the long term, because this is not a mature market yet. There's still a developing market with huge opportunity to open new stores. We are only in 1,600 cities in China, and there's still a few hundred cities for KFC, and there's 1,000 cities for Pizza Hut. So let's look at the systems in the short term and long term. And margin, we always... have the balance on the profitable margin growth. And I would like to add three things. One is, in the past few years, both KFC and Pizza Hut, particularly KFC, we have made ourselves very flexible. And that flexibility is part of resilience for us to open more stores within the gap of existing stores and to open more stores in the new cities. I'll give you a few drivers here, Andy. I mentioned it, and I would just like to touch upon it. Well, the tie-in traffic is subdued right now. It probably will stay. We see that. Therefore, what are we doing? We try to grow incremental growth from the day part. You know, for example, late night, Shenyang Zijia is the chicken bone from Shenyang. You know, it's fantastic new product innovation that really drives the sales of the late nights. Is it enough to fill the gap of the Da Yin? No. But, you know, for now, the Da Yin business is challenging probably with state, but we see the opportunity for incremental business. We also see the opportunity in regional menu, which we have not, you know, further explored the opportunity. For example, you know, the Wuhan Le Gan Mian, it's not only selling well in Wuhan. Actually, it's selling even better in Jiangxi and Shenzhen because for Wuhan people in Jiangxi and Shenzhen, KFC is the only place that they can buy the le gan mian, hot dry noodle. And we also start a new retail that's across all the brands. That is a fantastic incremental business to delivery business as well as off-premise business. So that's internal Internally, we become more flexible, stronger, that allow us to take advantage of more store locations, to open more stores. Well, secondly, we have become a better tenant. If you think about last year, what happened is we are one of the very few food retailers that can continue to pay rent, and we did not lay off any people. And tenant, you know, whether you're a good tenant or not is decided by the landlord. And the landlord right now really likes us and, if not, loves us, particularly in the lower tier cities. We are a clear, you know, traffic driver and anchor tenant. And the rent that we are getting at lower tier cities is fantastic. And that helps the economic of the new store openings. And then we also have become more clear with our new franchise strategy, the channel franchise strategy, the remote area franchise strategy, so that we are helping our franchisee to open more stores in the area that we can still do it, but it's not as efficient for the franchisee to run the operation locally in the remote area. So with the three combined factors, we believe that we can continue to pursue system sales, which is a combination of profitable new store opening and the recovery of SSG. And then also protect the margin, because it will not be right for our shareholders in the short term and in the long term if we buy market share. We don't. It's a discipline. We only pursue profitable new store growth industry-leading cash payback and in-store profitability. Thank you, Lillian.

Thank you, Lillian.

Thanks a lot, Joey and Andy.

Thank you. Thank you.

Go ahead, operator.

Yes, thank you, Davina.

Go ahead. Please go ahead. Okay, our last question comes from the line of Christine Bank from UBS. Please ask your question.

Thank you, Joey and Andy, to share so many colors on your company's latest operation as well as management sorts towards many questions investors have been asking the analysts about. So I have a question regarding the coffee business. I think Joey mentioned coffee. briefly about the latest operations about Lavazza, Coffee and Joy. I remember when I was in China, end of last year, I visited the store of Lavazza in your office. And when I look at some of the commentary on the social media platform, I realized there has been a lot of changes to Lavazza, newly operated stores in China compared with one I visited last year. end of last year. So Joey, maybe can you share with us more colors about the latest progress you're making to Lavazza, especially how you think about the long-term positioning of the brand compared with existing competitors such as Starbucks. And if you can share with us some of the financial details such as the economics, that'd be even more appreciated. Thank you.

Thank you, Christine. I hope one day you can try our Wuhan Le Gan Mian and see whether you like it as a local person. Come back to the coffee bit. Let's take a step back. We have three coffee brands in Yum China, K-Coffee, C&J, and Lavazza. I'll come to Lavazza a bit. I'm very happy to report K-Coffee for 2021 first half, we increased the sales of coffee per cup by as much as 30% compared to the pre-pandemic 2019 number. And that shows that our focus on good coffee at affordable price is a viable strategy. It's good for the coffee business, good for KFC, Save Yourself, right? J&J, we have been working on it. Now we have 38 stores, and we've been very transparent that we are learning the operation side of a business of a new business we have huge respect towards new business and I'm happy to report that we are there because you know a meaningful number of stores will be breaking even by end of this quarter and more will be by end of year end and that allows us to build the people business is about people without good people there's no business So we build our operation people and we become sharper with our marketing positioning and pricing, et cetera. And these learning are all helpful, very helpful when it comes to the experience of building Lavazza brand in China. It takes much less time compared to CNJ for us to get the operation right, to get the marketing right, and also with our Fantastic partner, Lavazza has helped to get the food right, to get the Italian flavor of the whole environment, the food, the drink, etc. So Lavazza, Andy said it earlier, I'm going to emphasize, we are going to have an accelerated pace of development for the second half of the year compared to first half. So first half, we moved from five stores to today 15 stores. mainly in Shanghai and now one store in Hangzhou. So for the second half, we accelerated the store opening pace and we'll enter into more cities in China. So that's in terms of footprint. And in terms of business model, right now, we so far have in Shanghai for the 14th store, we have half of the store, what we call large store to build the brand. And then the other half are either smaller, slightly smaller store or meaning store. These are the stores with much better economics to make the money faster. So a combination of flagship store to build a brand and then smaller store to build a sales, that seems the right thing to do. And we are very happy with the initial results. So that's the second. Third is we already... encouraged by the initial result, and working on day parts, menu combo, delivery, and others. Our off-premise sales mix right now is over 50% for Lavazza store. And that's good, right? Because we know that right now the off-premise is the trend. And for Lavazza, obviously, finally, my comment is the positioning is premium. It's authentic Italian-style coffee with a nice environment. We believe that Chinese consumers can have a choice, can have an alternative other than one single choice in this beautiful premium coffee segment. So that's where we are right now, and we cannot wait to see more beautiful stores with fantastic food. I suppose it's hard to get our Italian partner to produce bad Italian food, and we are not complaining about it. So we really look forward to have opportunity for our investors and for analysts to try our Lavazza coffee and food in China. Thank you very much, Christine. And hopefully in Hong Kong one day, by the way.

Thank you. Thank you, Christine. Before we end today's call, please know that we will host a virtual investor day on the morning of September 23rd, Shanghai time. We will announce more details as we get closer to today. With that, we will conclude today's call. Thank you for joining. Have a great day.

Thank you, everyone. Thank you, operator.

This concludes today's conference call. Thank you for participating. You may