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spk03: Thank you for standing by and welcome to the Yum China third quarter 2022 earnings conference call. All participants are in a listen only mode. There will be a presentation followed by a question and answer session. If you wish to ask a question, you will need to press the star key followed by the number one on your telephone keypad. I would now like to hand the conference over to Ms. Michelle Shen, Director of Investor Relations. Please go ahead.
spk07: Thank you, Ashley. Hello, everyone. Thank you for joining Yum! China's third quarter 2022 earnings conference call. On today's call are our CEO, Ms. Joey Watt, and our CFO, Ms. Andy Young. We are diving in from different locations today. If we experience any technical difficulties during the call, please remain on the line as we reconnect. Before we get started, I'd like to remind you that our earnings call and investor materials contain forward-looking statements. which are subject to future events and uncertainties. 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 GAAP measures is included in our earnings release. Today's call includes three sections. Joey will provide an update regarding our performance in the third quarter. Andy will then cover the financial performance and outlook in greater detail. Finally, we'll open the call to questions. You can find a webcast of this call in the PowerPoint presentation, which contains operational and financial information for the quarter on our IR website. Also on the site, you can find a video we prepared that that showcases our latest stores, offers, and activities. Now I would like to turn the call over to Ms. Joey Watt, CEO of Yum China. Joey?
spk12: Thank you, Michelle. Hello, everyone, and thank you for joining us today. We achieved outstanding performance in the third quarter with fantastic growth, both top line and bottom line. Let's demonstrate our ability to operate in an uncertain environment by learning, adapting, and strengthening business fundamentals. During tough times, our resilient business model and agility help us manage the negative impact. As COVID conditions were relatively calmer in July and August, we captured sales opportunities during the peak summer season. System sales recovered with 5% year-over-year growth. Operating profit surged 77% year-over-year to $360 million, even higher than 2019 level. Great teamwork makes this possible. Key elements in our winning formula include our in-house and tailor-made supply chain, industry-leading digital and delivery capabilities, cost restructuring, and solid execution. Let's move to KFC and Pizza Hut. We have been innovating new products to satisfy customer cravings. In the past two years, we have established strong presence in new categories, such as beef burger, whole chicken, and durian pizza. This was enabled by our powerful supply chain by securing supply at scale, streamlining production, and optimizing costs. Let me share our success stories. At KFC, our extra juicy beef burgers rapidly capture meaningful market share. Since adding them to the permanent menu in May 2021, we have sold over 100 million burgers. That's about five beef burgers every second. For the full year, we expect to generate close to 2 billion yen in sales from beef burgers. We cater to Chinese taste by making the patty super juicy using our specialty oven. Customers love our burgers for their great taste and value for money. We source our Wagyu beef, Longjiang Henou locally from northeastern China and have signed a multi-year contract to secure a price and surprise. Our juicy whole chicken has also quickly gained popularity since it launched late last year. Year-to-date, we have sold over 18 million whole chickens. Whole chicken is a versatile product, good for both dining and take-home consumption. We use a different breed of smaller chicken with better cost that is the perfect size for an individual meal and particularly juicy. And it's good for sharing on the dining table at home as well. A pizza hut. Durian pizza has become a customer favorite. In fact, during Q3's promotion, every fourth pizza we sold was a durian pizza. Our limited-time durian trio pizza, with three types of durian, was especially popular with durian lovers. Customers are increasingly value cautious, yet we do not compromise on quality. Last quarter, we shared about KFC's wildly popular Crazy Thursday campaign, 瘋狂星期四. Since 2018, we have been offering delicious food, including the latest innovations, at amazing value. The campaign continues to be a phenomenal event, generating a significant boost in sales every Thursday. Our customers create witty and playful social media content using the crazy Thursday theme. Many of these postings have gone viral, creating huge hype for us. Now, to drive weekend traffic for families and kids, we have introduced a Sunday Buy More Save More campaign in July. Customers can get a bigger discount when they buy more, up to 50% off for eight items. This new promotion platform has built wonderful momentum with good value perception while protecting our ticket average. Apart from abundant value, we also launched a Golden Star Chicken Breast Burger, Huang Jing's Bar Ji Pai Bao. This is our first successful chicken breast burger. We add an extra step in the preparation process to make the breast meat super juicy and tender. This entry-price burger widens our choices for customers and is a great product for lower-tier cities. We try to keep our brand appealing to youthful customers. In September, we transformed select Pizza Hut stores into social hubs for gamers. Partnering with the popular RPG game Jensen Impact, we decorated stores, outfitted restaurant crews, and offered Exclusive gifts. The campaign generated extraordinary social buzz. In just three minutes, we sold over 300,000 themed combo meals. And our super app recorded its highest activity ever. I'm looking forward to more successful events with this partnership. Let's move to digital and delivery. We have been enhancing our delivery and digital ecosystem to make our business fundamentally stronger. Customers love convenience. Delivery sales are growing fast. Empowered by our dedicated delivery riders and leading digital capabilities, delivery grew 19% year over year and reached 38% of sales mix in quarter three. Together with takeaway, off-premise sales were over 60%. Our ability to capture off-premise demand not only enable us to flexibly serve customers, but also cushion store closure impact due to COVID conditions. This 60% off-premise sales is so fundamental to our business model because it really protects our downside in both sales and profit, despite the fluid situation. We have been maximizing delivery coverage and flexibility using AI technology. Most recently, we launched Smart Delivery to dynamically adjust delivery coverage for each store by data, taking into account the operating hours of nearby stores. The upgrade system helps us serve more customers more efficiently. Our digital capabilities serve as key touchpoints with customers. In quarter three, we reached two milestones in our digital ecosystem. One, our loyalty program reached 400 million members. And two, cumulatively since 2018, KFC sold over 100 million privileged subscriptions. Our privileged subscriptions are of great value for money and have been an effective tool in driving frequency and spending. Our digital capabilities are also crucial to streamlining restaurant efficiency. Digital orders optimize in-store labor efficiency and account for more than 90% of sales in the quarter. Pizza Hut's table-sized mobile ordering sales have grown exponentially from just 2% at its launch in 2018 to 45% in Quarter 3, 2022. This helps mitigate rising wage inflation and frees up crew members to enhance customer service. To improve digital experience, we introduced intelligent order sequencing at KFC, 智能订单交付. In the third quarter, this system automatically arranges orders to shorten customer wait times. Now let's move on to coffee, our third growth engine. Lavazza is making solid progress along its clear four pillar strategy. The pillars include brand building, menu upgrades, expanded digital and delivery capabilities, and store development. Here's how we built these out. Branding. Lavazza has a century-long reputation for coffee expertise. We will continue to accentuate its brand positioning as the leading Italian coffee brand offering an authentic Italian experience. Menu upgrades. We are broadening food and drink offerings with more unique Italian products, including cover premium single-origin beans and tagliatelle, which is an Italian flatbread with meat or egg stuffing, something like our Chinese loziamo. We also launched localized products, such as coconut latte, buffalo milk latte, and even osmanthus latte. Osmanthus, guihua, is a very lovely fragrant flower used in many Chinese desserts. These new products capture the latest coffee trends and have been well received by our customers. Digital and delivery. We are building our membership program and digital fundamentals to improve customer experience and attract online traffic. Delivery reached almost 40% of sales mix in quarter three. Store development. Now with 78 stores, we have further refined our store models, paving the way for growth. We have made great progress so far, but work remains. Good things do take time. We want to grow this brand right with every step at the right time. In close partnership with Lavazza Group, we are confident to build a successful Lavazza business in China. We decided to wind down our coffee and joint operation. From branding to site selection to operation and more, we learned a lot with coffee and joint. This invaluable learning experience will help us capture growing opportunities in the coffee market. Going forward, we will grow our coffee business with two distinct market positionings, K-Coffee, focused on value and convenience, and Lavazza, focused on authentic Italian coffee. To summarize, our innovations and hard work in the pandemic years have made our business fundamentally stronger. We are confident in our team's ability to find opportunities in adversity and unlock further potential in China. We will continue to execute our RGM, which stands for resiliency, growth, and mode framework to strengthen our competitive position and capture long-term growth. With that, I will turn the call over to Andy. Andy?
spk01: Thank you, Joey, and hello, everyone. Let me now go through the third quarter performance in details. We saw sequential improvement in the third quarter. System sales returned to growth year-over-year, and restaurant margin was highest since 2018, well above our expectations. We focused on driving sales through new products and compelling value. Same-source sales recovered to the same level a year ago. From a timing perspective, the trend remains volatile, impacted by frequent COVID outbreaks. In July and August, we saw a sequential recovery in same-cell cells, and all this exceeding the prior years. This was mainly due to lapping the Delta variant outbreak in August 2021, which heavily impacted eastern China. However, in September, same-cell cells declined mid-single digits, as COVID-related health measures tightened in many areas. Around 900 stores were temporarily closed or provided limited services in September, compared to around 400 stores on average in July and August. On the margin side, we continue to identify cost-saving opportunities, drive labor productivity, and rebase our cost structure. Let me go through the financials and our cost-control initiative, unless noted otherwise. All percentage changes are before the effect of foreign exchange. Foreign exchange had a negative impact of approximately 6% in the quarter. Third quarter total revenues increased 5% year-over-year in reported currency to $2.68 billion due to the contribution of new units and the consolidation of Hangzhou KFC. This was partially offset by temporary stock closure and foreign exchange translation. In constant currency, total revenue grew 11 percent. System sales grew 5 percent. Same-saw sales were flat year-over-year. By brand, KFC same-saw sales were flat, with same-saw traffic at 93 percent of prior year's level. Ticket average grew 8 percent due to the increase in delivery mix, which has a higher ticket average than Diem. Abundant value campaigns like the Family Bucket and Buy More, Save More also contributed to higher tickets. Pizza Hut same-source sales grew 2% year-over-year. Same-source traffic grew by 2%, while ticket average was flat. High delivery mix, which has a lower ticket average than dine-in, was offset by discount management. Rational margin was 18.8%, 660 basis points higher than last year. The year-over-year increase was mainly due to high productivity, temporary relief, and sales leveraging. These were partially offset by inflation in commodity, wage, and utility costs. Water costs also increased due to high delivery volume. Our team worked diligently to improve our cost structure. So let me next go through each expand line item and the actions we have taken. Cost of sales was 30.7%, 150 basis points lower than last year. We focused on the most effective campaign to drive traffic that allowed us to be more cost efficient while ensuring quick value for money. We also managed commodity price inflation to low single digits. Cost of labor was 23.5%, 210 basis points lower than last year. This was mainly due to improvement in labor productivity and relief recognized in the third quarter of $17 million. These were partially offset by increasing wider costs from higher delivery sales mix and wage inflation of 2%. We improved labor productivity by one, optimizing staff scheduling and hiring, two, sharing restaurant management teams across stores, and three, leveraging digital tools to automate processes such as digital ordering and inventory management. There was also a lapping impact due to high staffing levels in 2021 caused by the Southern Delta variant outbreak. Occupancy in others was 27% 300 basis points lower than last year. This was mainly due to our cost saving initiative and lower rental expense as a percentage of sales. In addition, we pulled back on marketing and advertising. Rental expenses were lower in the quarter due to one, rental relief of $13 million, two, smaller store format with lower upfront investment and better store economics, and three, negotiating more rental relief with wearable components. G&A expenses increased 16% year-over-year, mainly due to increased compensation and benefit expenses, consolidation of Hangzhou KFC, and incremental expenses from emerging brands. There were also one-time expenses associated with primary listing conversions in Hong Kong. Operating profit was $316 million, a 77% increase over a year. The net contribution for Poncho KFC consolidation was 6% of total operating profit in the quarter. It included amortization of intangible assets acquired, which was roughly $16 million per quarter. This will run through the end of this year. Below the operating line, we incur a $13 million mark-to-market net loss on our aggregate investment in May 2020 in the quarter. It was lower than $32 million net loss in the same period last year. The effective tax rate was 29.9 percent, 160 basis points higher than last year, due to Hangzhou KFC consolidation. Prior to consolidation, the aggregate income from JVs was not subject to tax, resulting in a lower tax rate. We expect the four-year effective tax rate to come in around low 30s. Their income was $206 million, a 72% increase year-over-year. Diluted EPS was 49 cents, more than double the prior year period. The mark-to-market loss in Meituan negatively impacted diluted EPS by 3 cents. We have returned around $560 million to shareholders in cash, dividends, and share repurchases year-to-date. We temporarily slowed repurchases in the third quarter prior to the dual primary conversions. Powered by our strong balance sheets, we will continue to execute our disciplined and balanced capital allocation strategy. Our operating cash flow remains strong. In the third quarter, we generated free cash flow of $558 million. Let us take a look at the fourth quarter outlook. The external environment remains challenging. COVID-related preventive health measures escalated in October. In October, around 1,400 of our stores on average were temporarily closed or offered limited services. Downward pressures on the economy cautious consumer spending and inflationary environment are also headwinds that we continue to face. Our same-saw sales in third quarter were below the pre-pandemic level. We expect a full recovery of sales of same-saw sales will take time and the path to remain uneven and nonlinear. I would also like to remind everyone that, one, Fourth quarter is seasonally a lower quarter in terms of sales and profit, so sales volatility could have a more pronounced impact on profitability. Two, there was around $30 million temporary relief in the third quarter, most of which is unlikely to repeat in the fourth quarter. Three, the appreciation of US dollar against the yuan may negatively affect our reported numbers. And fourth, we continue to dial back some austerity measures to balance cost reduction and service level. Now, despite the headwinds, in the third quarter, we resumed the pace of store openings and opened 621 net new stores year-to-date. By relentlessly optimizing store economics with lower upfront investment, our new store performance continued to be strong. Store payback remained healthy, at two years for KFC and three years for Pizza Hut. This gives us strong confidence for further expansion. We will continue to implement our disciplined and systematic store opening approach, opening new and profitable stores at a robust pace. As the fourth quarter is usually the peak season for store opening, we are confident in reaching the four-year target of 1,000 to 1,200 net new stores. Lastly, let me touch on our primary listing conversion in Hong Kong. It became effective on October 24th, along with our inclusion in the sell-bound Stock Connect. We expect the new status will provide additional access to investors, broaden our shareholder base, and increase liquidity. To round up, We have learned to navigate through uncertainties and in the past two years. COVID conditions will continue to remain challenging, but we are adapting to the new normal. Our resilient business model and agility allow us to pivot quickly and effectively develop new strengths. When the market is relatively calmer, we are able to capture the upside and deliver strong results. In the third quarter, we have once again demonstrated our transformative fundamentals, cost control, and solid execution. We're confident in our ability to achieve long-term growth in China and generate sustainable returns to shareholders. With that, I will pass you back to Michelle to start the Q&A. Michelle?
spk07: Thank you, Andy. We'll now open the call for questions. In order to give more people the chance to ask questions, please limit your questions to one at a time. Ashley, please start the Q&A.
spk03: Thank you. If you wish to ask a question, please press star 1 on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star 2. If you're on a speakerphone, please pick up the handset to ask your question. Your first question comes from Chen Lu with Bank of America. Please go ahead.
spk05: Hi, Joanne. Congratulations on the very strong Q3 result. Given the very fluid situation amid the COVID outbreak and restrictions in China, my question will focus on margins. We have seen very impressive margin expansion in Q3 result. And over the past three years, we also observed a pattern that usually during the first few quarters of a big COVID outbreak, such as the Wuhan one, or the Delta outbreak in Q3 last year, and the Omicron outbreak early this year, we might see a few quarters of margin erosion. But then after our very agile and quick adaptation, in the following quarters, we actually would manage to achieve margins that could be even higher than the pre-pandemic level. And let's assume that next year, we are not going to see another big wave of outbreak that would lead to massive lockdowns in our core markets such as eastern China. Is it fair to say that we can actually achieve a restaurant margin that is largely comparable to the pre-pandemic level, which is around 15? So this is my question. Thank you.
spk01: Chen, thank you for your questions. Obviously, our team has done a fantastic job to deliver solid margins amidst very difficult and challenging situations. Now, our margin improvement, obviously, some of these are fundamental transformations that would last going forward. Some of this is more temporary, and some of this austerity measure may be dialed back as things returning to normal. Now, you know, if you look at, you know, our margin improvement was largely constituted by high productivity, right, and also, you know, for the quarter, you know, some temporary relief and self-leveraging. Now, so when we look at, you know, the initiative that we have undertaken, you know, over the past couple years, we have mentioned, you know, over the past two quarters, you know, we have taken initiative to re-base our cost structure and also, you know, to drive efficiency gains. So you see a lot of new product innovations, you know, in terms of how we manage, you know, the pricing and also the cost inflation in commodity prices. We also offer our supply chain team continuity, you know, our core, you know, strength in terms of managing supply and, you know, and robustness of our supply chain. and also mitigate partially some of those impacts, sometimes commodity prices, and allow us to continue to innovate and quickly to roll out new products that meet the consumer demand. The other one is obviously you look at the labor productivity. For example, we have deployed technologies. We have continued to invest in technologies to automate system processes to help improve labor productivity. As we have mentioned probably last quarter, we're beginning to roll out a management pool for our store. So our management team for the store can be used across multiple stores. And if you look at our rental, for example, obviously we see some rental relief, but we also have over the past two years and especially over the past couple of years to work very hard to restructure the rental cost structure with landlords. not only seeing lower rental costs, but also more wearable and flexible rent structure. And so those fundamental transformations will continue going forward. Same thing for our digital investment. Over the past two years, we have continued to invest heavily in digital that allow us to, for example, during the pandemic, have direct outreach to our consumers, roll out new products, new marketing campaigns efficiently. you know, and also allow us to, you know, you look at our membership program, continue to be a very strong foundation, you know, for ourselves. Membership program now account for, you know, north of 60% of our sales. So, you know, those will continue to help us going forward to maintain, you know, efficiencies and operating efficiency. However, as we mentioned before, some of these are temporary. For example, you know, the rental relief, you know, some of the relief in, you know, labor costs, especially, some of the government incentives or relief, as well as the delay in wage increase in the market in the third quarter. Usually we adjust wages in the third quarter for our market labor force, but because of the pandemic impact this year, many markets have delayed wage increase. So some of this may come back, and also some of the standard programs. So all in all, I think, you know, Looking forward, I think you can expect some of these fundamental changes would stay, and then some of these temporary measures may subside over time.
spk12: I would like to just add some color in terms of our management team thinking and also the business model, why that helps protect the margin now and in the future. Well, we do believe that this company and this team, this management team, is an anti-fragile company. Whatever stones throw at us, we possibly could convert these stones into our stepping stones to go further and higher. That's what we believe, and that our team keeps trying to do the right thing. In terms of business model, as I mentioned in my presentation earlier, it's very important to recognize that our off-premise business right now is 60%. What does that mean? Well, if we look at by brand, KFC is actually 65% off-premise. And that is up from last year, which was 60%. Pizza Hut tells an even more amazing story. Pizza Hut, the off-premise, sales is 50%. Before pandemic, it was only 30%. From 30% to 50. So our business, our off-premise business in Pizza Hut is much, much stronger and higher. Given the fluid situation in pandemic, these are incredibly important numbers because when we are in sort of more tougher situation in terms of lockdowns, that 60% will become higher because there will be naturally some sales transfer from die-in to additional off-premise business. So with the 60% as sort of the off-premise influence situation, that percent will go higher. That naturally protects our business, our sales, because it's very difficult to have a strong margin when the sales leverage is not there. So it's not only... All the margin lines that we protect, as Andy has comprehensively pointed out, but on the other side, the sales side that we have also protected, and that's a lot of hard work in the last three years, and the team has done a great job. Thank you, Lawton.
spk05: Thank you, Joya and Andy. Your margin management capability is really impressive. Congratulations again. Thank you. Thank you.
spk03: Your next. question comes from Lillian Lu with Morgan Stanley. Please go ahead.
spk10: Thanks a lot, Joey and Andy, for your very detailed explanation. My question is also a follow-up question on margin management, but maybe from a different angle, because Joey and Andy, you mentioned about the sales leverage and also the line items management on cost side. So maybe look at all the initiatives in the third quarter and also during the pandemic in this three years, you've been focusing on really kind of rejuvenize the menu and the new product launch and smaller stores, very effective promotional campaign. So when you all define this, what's your thinking behind, especially trying to understand that with our new stores now, incrementally higher portion of small stores, would that actually fundamentally change our margin profile going forward? And also, especially third quarter, you have more promotional campaign. But in return, actually, it didn't suffer a margin. Instead, it's on the opposite side. They improved the margin. So we're trying to understand a little bit further how you achieve that from this effort. Thank you.
spk01: Thank you, William. I think, you know, in terms of margins, I think I want to emphasize, you know, at least in the short term, because of the COVID situations, we see fluctuations in our sales. It's impacted in high correlation with the COVID situation. So, you know, the biggest lever of the leveraging impact when things come down is actually sales, right? The higher the store sales, you know, generally will drive, you know, higher restaurant margins. And we can see that, you know, even without the pandemic, you know, normal time, you'll see that, you know, margin fluctuate through the year, you know, during the first quarter and the third quarter, which generally is higher sales period for us, and we also see higher margin. And then, you know, second quarter and especially the fourth quarter, generally a lower sales season for us, and you also see lower margin. So I want to emphasize, you know, echo what Joey had mentioned earlier, you know, sales is very important for us in terms of driving margins and public leverage. Now, in terms of our store format, you know, our store format remains, you know, very, very healthy. Store economics probably, you know, best in, you know, the recent years. This is, you know, not just, you know, come naturally, but a lot of hard work to have put into, you know, the store format design, operations, and then also the manual mix, etc., to make it work. Now our thought format obviously right now is geared toward two areas, largely. One is on the green field. So we still have a lot of cities and townships that we can serve, and then we have a format for that. We also have a format for catering to work you know to a you know the urban area where we increasing density and cater to a high mix of delivery and take away business and so but they all have one thing in common is that our small format in terms of up an investment a journey of lower so compared to a few years ago we spending on average two and a half million after two and a half million RMB per store now we're part spending net less than you know, $2 million. Closely, like, you know, maybe driving down to, like, you know, $1.6, $1.7 million per store. So that helped us, you know, sort of, like, be more agile, more limbo, and reduce up on investment. That allowed us to continue to see very strong, you know, unit economics for the new store that we opened. Now, as I mentioned on a prepared remark, you know, you look at our payback period for KFC. It's still very healthy at two years. Obviously, there may be some fluctuations. depending on the pandemic. And for Pizza Hut, it's three years. If you look at a satellite store model, as we mentioned before, its performance is very close to what we can achieve with KFC already. And so that's what gives us confidence in terms of robust store expansion. And I don't think we're too concerned about, at least from the store economics, that would have a material impact on our margin mix going forward. So that's the STAW format and then also our STAW economics for new STAW. Joey, do you have anything to add to it?
spk12: Yeah, let me again add some color in terms of the relation between promotion and margin management. we, as we mentioned earlier, we consolidate our promotion mechanism and we focus on fewer and more impactful, such as solar home pumping, like buy more, save more. That helps drive our sales during weekends, which is quite effective. But at the same time, we are very, very careful to manage our sales For example, the whole chicken. I'll give you one example. You guys will get it. Sometimes it's more detailed. We'll get it. We sell 80 million whole chickens so far this year. It's roast chicken. Why not fried chicken? Well, here's the reason why. Oil this year is very expensive. So if we do roast chicken, it has two benefits. One, it's healthier. Two, it costs less. Customer love it. So we go through every little detail, make sure that it has both great product but at good cost. And that works for not only dying but at home consumption. So just a small example to give a sense. And in terms of margin protection, I would like to share another belief which results in very good results. Back to Q2, it was a very difficult quarter. We reiterate our commitment to protect our staff jobs, no layoffs. We look at every single way to manage our cost structure, our margins, except layoffs. We want to protect our employees' jobs during the tough times. Everyone needs some sense of security during very through a situation. And our staff, our 400,000 strong team, they appreciate it and everyone, everyone go for every single innovation that we can achieve to protect our company. I'll pause here. Let's move on to the next question.
spk03: Your next question comes from Xiaopo Wei with Citi. Please go ahead.
spk06: Hi, good morning, Julie and Andy. I also asked a question about the margin, but I will take another approach with a bigger picture of what happened in the past two years. If we look at what happened in the past two years since COVID, we are seeing open more stores. But in the third quarter, it's the first time that we are seeing amazing rational margin with some very short window of rebound about all the consumption, etc. But I can see that you greatly capture that upside of the consumption rebound. Shall we say that actually the new store opening, which was the investment for the future, starting working well in a situation looking forward when the COVID is facing out, actually our new store contribution to our probability actually be more pronounced than before. And another question related to this is if we look at a delivery sales contribution, the KFC hit 37%, which is amazing, very close to Pizza Hut. I still remember years ago when I first met Julie, I had the impression that KFC would never be that high in terms of delivery sales contribution for Pizza Hut. But now we are seeing Pizza Hut and KFC having a very close delivery sales contribution. Shall we say that looking forward, KFC fundamentally has transformed and we are expecting actually higher than expected delivery sales contribution looking forward, approaching 40%.
spk00: Thank you. Thank you. So I think there's a lot of questions about margin today.
spk01: Obviously, we're very pleased with our margin performance in the third quarter. As you mentioned, the sales leveraging, when the time comes, we're not only able to capture not only the sales upside, but also able to, you know, regain that self-leveraging. We also, obviously, as we mentioned before, you know, there's a number of fundamental transformations that we have undergone rebasing our cost structure, you know, some of the initiatives. But I think, you know, what you, you know, are asking about is about two things, right? One is, you know, the new store margins and, you know, The other one is the delivery sales makes what's the percentage going forward. Now I think when we look at the new store economics, I think one thing to remember is that for any new store, generally it takes a couple of years for it to ramp up sales and margins to a maturity level. So the other part is that Obviously, we're very pleased, as we mentioned, when we look at our new store performance, they continue to be very robust, very strong. If we look at the margin fund that I mentioned, it's a ramp-up period, but even for the store that we opened this year, a large majority of them turned to restaurant for even or better within three months of time, which is tracking on par or slightly better than, you know, a softball level. And so, I mean, there's a couple things that are happening there, right? One is, as we mentioned, we have worked very hard to find a way for that, not just reducing the size. The size is obviously important, but, you know, but also the operations, you know, the whole offering and the menu mix. So all these, you know, work in conjunction with that. We also, as we mentioned, we have worked hard on changing the outside, like restaurant management structure. We have developed a management labor pool that can share with the store to make it productivity improvement. And then also, if you look at the rental, for a new store, obviously, we have worked very hard to lower the rental cost as a sales. But more importantly, to keep us resilient, we continue to, you know, work with Landlocked to develop a higher proportion of, you know, wearable cost components. And so that allows us to be, you know, more resilient over time. So I think, you know, our approach to new start opening is very disciplined and systematic, as I mentioned before. And we'll continue to, you know, drive that, you know, that discipline so that, you know, during when we will open a new store, as we continue as a variable price base and likely accelerate during the fourth quarter, we will continue to open not only new stores, but profitable stores. And so I think, you know, the portfolio contribution for new stores is important, obviously, over time. But I think, you know, the economic self, I think, is on par, as we mentioned, pay-per-period, two-year for KFC, three-year for Pizza Hut, which is pretty consistent. So that's the new store margins and possibility. In terms of delivery sales mix, obviously in the short term, you know, you're going to be, depending on, you know, COVID situation, tighter measures, you're going to see a higher delivery mix shift. And then you all, sometimes you see that things calmer, and then dying traffic will come back. But all in all, I think, you know, you can see there's a big change in our business. Delivery mix right now, and off-premise right now, It comes for a majority of our sales now. So that's why when we're developing small format, as we mentioned before, for the smaller urban format, we do those more catering to deliver and take away business. So how it develops, I think, really depends on the consumer. If they want more, we'll deliver more, and we have the format and system how to achieve that, especially with the digital side. We have our own app to drive traffic, so the consumer can audit whenever they want, and we have a spot to serve them.
spk00: Thank you.
spk03: Your next question comes from Michelle Ching with Goldman Sachs. Please go ahead.
spk09: Hi, Joanne. My question is about store expansion. Given this very strong profit margin, do you have any initial thoughts on the expansion plan into 2023? Any chance we could further accelerate expansion given we know all the smaller players are suffering? And also more specifically by brands, so aside from KFC, Pizza Hut maintaining a relatively stronger momentum on expansion, How do you think about other brands since we're actually reshuffling other brands quite aggressively in the past few quarters? Thank you.
spk00: Hi, Michelle. Thank you for the question.
spk01: So about new store and, you know, as I mentioned, you know, our new store performance continues to be strong. So and also, you know, as I mentioned before, we generally, I mean, each year we set a target thing what is reasonable but ultimately is, for the market and the fundamentals that would try, you know, how many stores that would be open, and then also sometimes get impacted by COVID. So we'll continue to maintain that discipline and systematic approach. So, you know, when the economics are good, we'll, you know, the system will do some acceleration because more so we propose and more so we approve. You know, obviously when, you know, the market or like the economics are more moderate, impacted then you will see some deceleration of medical because you know it's due into the model and assumption itself we refresh that you know very regularly so we will maintain that very disciplined approach obviously we continue to see very strong fundamentals for saw opening we see you know as I mentioned before there are greenfield we have for KFC we're only in you know the more than 1700 cities we see probably another you know thousands of that potentially we can enter. If we look at Pizza Hut, you know, like almost a thousand stores that KFC already in, we don't have a Pizza Hut store. So there's a lot of greenfield opportunity. So we still continue to feel very good about, you know, store expansion, store network expansion and opportunity there. Now, in terms of, you know, obviously, you know, we'll continue to have to work hard on the store format, right? There's a consumer demand continue to change. And, you know, we see, obviously, opportunities right now. Our pipeline is very strong because, you know, we're one of the few very attractive tenants right now in the restaurant industry. After two, three years of pandemic, we continue to be, you know, perform very well, pay our rent on time and everything. So, you know, we move from attractively, even more attractive tenants, so we have more opportunities. But our emphasis, again, is on discipline and systematic approach to make sure that we not only open a new store, but open new and possible stores. And so that's important. Now, as you mentioned, we did some portfolio management on our brand. As Joey mentioned earlier, we're running down CNJ to focus our resources on the coffee side on La Baza, which we see very good opportunities, a lot of potential there. And so that's a disciplined approach. We also, early part of this year, we also wanted to, you know, their East Dawning business. And, you know, East Dawning, you know, have been, you know, a homegrown brand for more, for close to a decade now. Unfortunately, its market positioning is in the transportation and tourist locations. Now, that business has been very, very challenging over the past three years, as you can imagine. Currently, we don't see with the new normal improvement in any short time. So we decided to wind that business down. So again, back to that discipline and systematic approach, be it in startup expansion, be it in portfolio management, we're very disciplined about that. And so we'll continue that going forward about the brand development. So thank you, Lillian. Michelle, thank you, Michelle.
spk12: Michelle, I'll just add. few comments about the store expansion. First, we certainly are opening even more smaller stores. So for Pizza Hut alone, 75% of the new stores opened this year are either smaller or satellite stores, and KFC is about half. And these smaller stores work particularly well in lower tier cities, and that's where we will continue our store expansion. And the result is pretty exciting, promising. So that's comment number one. Comment number two is opening new, the smaller stores also require focus on the product and operations side. And we are giving that support to the new smaller stores. For example, chicken breast burger, spa chicken robot, The price is very good. It's 9.9 Yen. It's brilliant. It's amazing for the lower tier cities to use it as an introduction to our business. There are other products like Yansuji. We developed these products with lower price points specifically for lower tier cities and specifically for the introduction of new stores. And at the same time, we also continue to innovate in terms of operating process within the smaller store. Well, one example, you know, smaller store, we only can accommodate fewer number of staff, which is a great deal for shareholders. But that also requires changes in terms of operating process. How to still make it work to protect our product quality for safety, you name it. So, you know, not only just the course of opening new stores, but also the product and the operating process that we are focusing on. Thank you, Michelle. Next question.
spk03: Your next question comes from Anne Ling with Jefferies. Please go ahead.
spk08: Thank you. Thank you for giving me the opportunity for asking a question. Hi. the cost side. We track the chicken price, which we saw a 20-odd percent increase, and also at the same time, flour costs also increased. I understand that management has a really great way in terms of making use of the chicken parts, but moving into year 2023, When do you see that, you know, this increase in terms of the cost, the chicken cost or the other commodity cost, kicking into your P&L? Or maybe you can share with us, you know, what is your current agreement with your supplier? Thank you.
spk12: Hi, Anne.
spk00: Thank you for your question.
spk12: Yeah.
spk01: Julie, you want to?
spk12: No, no, no. Go on.
spk01: Okay.
spk12: Thanks.
spk01: So, when we look at our SOAS, obviously, I think we do have to comment on how fantastic job our product innovation team have done to help us manage that cost inflation. Commodity price inflation, as you mentioned, is very real, and it's real globally, and it's true also in China as well. Albeit in China, we see a more moderate inflationary pressure, but still, you know, we see a commodity price increase escalating over the past, you know, probably like a year. You know, we see a very favorable, you know, pricing last year, 2021. We're beginning to see that commodity pricing pressure building up, you know, and right now in China, it's probably at mid to uh high single digit uh now food commodity pricing increase and as you mentioned we obviously post your price increase so as i mentioned before you know like this is going to come here be a happening uh and and we'll continue to work hard to to to solve mitigate it the other one i want to mention is that as we have mentioned before our supplies in january locked down most of the supply you know a quarter to a half time so that would be some you know lacking impact on the inflationary side And obviously, you know, because we're in a inflationary environment, our supply chain also deploy long-term contracts, try to do whatever is possible to lock in pricing a little bit longer. For example, coffee, they have done a fantastic job locking in, you know, a longer-term pricing contract. But, you know, some of the commodity, you cannot lock in for such a longer time. So we will see some, you know, commodity pricing pressure building up in the coming quarter as well. Now, as you mentioned, to deal with community pricing pressures, besides of the supply chain and the efficiency there, is also on product innovations, as Joey has mentioned. The team has done a fantastic job developing new products that utilize a given part of the resources that we already have, chicken, beef. For folks in the US, when people talk about chicken sandwich or chicken burger, Genuinely, that would refer to chicken breast. But as we have mentioned before, for Chinese consumers, genuinely, they like dark meat more than light meat because dark meat is more tender and more flavorful. So for example, this quarter, as Joey mentioned, we have developed a fantastic chicken sandwich, a chicken burger that is very successful while received by consumers. Now, that kind of product innovation both satisfy consumer demand and also help us to manage commodity prices will be very key for long-term managing that COS. So, yeah, so that commodity pricing inflation and then also, obviously, how do we manage our marketing campaign, how do we manage other costs, weight station, all that, will be also important for us in the long term to manage that COS. Now, for labor inflation, as we mentioned before, generally, you know, bad times, good times, we'll likely see labor costs increase. You know, sometimes it will delay, sometimes it's more moderate. But in China, the long-term trend is, you know, mid to high single digits. And so, you know, in long-term, we will continue to have to work hard to improve labor productivity, invest in technology, you know, IT, invest in infrastructure. And as Joey mentioned, continue to innovate, continue to improve our store operations so that we can maintain labor efficiency to offset that labor inflation. And so that's sort of like commodity price and labor inflation. Thank you. Thank you, Ann.
spk12: Ann, I'll just add one comment on that one. We do use every part of chicken except the chicken feathers. I would also like to point out that we have our team, both the pricing team and then the product innovation team, we have been able to introduce and use different proteins, beef, pork, fish, and duck. We are selling duck burger right now as we speak right now, chicken and duck burger. So we have a variety of protein in our product. that we can use and we can promote, depending also on the price. I mean, the thinking is rather simple. A good chef, they look at what is the best in terms of quality, not only price, quality and price, available in the market, and then you turn these fantastic ingredients into great food. Same for us, just at a much, much bigger scale, I guess. So we have both the flexibility and the scale, to deliver amazing food to our customer at very good price and very good value. Thank you Anne.
spk03: Your next question comes from Christine Ping with UBS. Please go ahead.
spk11: Thank you management for taking my question. So my question is on the product side. So I spotted a very interesting And a new product, which Joey mentioned, which is this beef burger. So I noticed that this product has been on the menu since May of 2021, which means that this is likely to be a longstanding product instead of an LTO. So if that is the case, Joey, can you share with us the thinking behind this product in terms of the rationale, the supply chain, management and also future plan for this product going forward. Because, you know, what I'm interested to understand is that, you know, will this beef burger, you know, potentially become a very important category for KFC going forward? And what's going to be the structural impact on KFC in terms of competitions, in terms of you know, margin trends, et cetera. So anything if you can share with us, that would be very much appreciated. Thank you.
spk12: Thank you, Christine. Well, it's already a very important product in KFC portfolio. The speed and the support from the customer exceed our expectation. To quantify the The sales of beef burger, I mean, we talk about it already. It already contributes meaningful sales mix to our business. It's about 3% to 4% of KFC sales mix. But that is a lot already. Because for original recipe, after all these years, is about six, seven percent. So it's half of our original recipe chicken cells already. So that's the number side. In terms of product side, for those who are in China, if you have a chance to try, I do strongly encourage you to try it. Then you can form the opinion yourself about the future of this product. I know it's rather unusual for companies selling chicken cell burger, beef burger, but Once you try it, you will understand why it works. We have a good range of product choices, from entry-price burgers, which taste amazing still, beef burgers, all the way to Wagyu beef burger and guest beef burger. As Andy mentioned, it's hard to imagine, but it tastes amazing, Wagyu beef. You can't go wrong with Wagyu beef burger. So, and the price is still very, you know, very good value. I won't say it's low price. I mean, it's, you know, the Wagyu beef burger, but it's fantastic value. So, the choice of product is fantastic. Third is the flavor, the taste. There are plenty of, you know, customer-made products video comparing our burger versus other competitors. One thing very distinct about our beef burger is the burger is very juicy. And this is our focus. Because while some traditional beef burger lover might love the barbecue flavor, for Chinese taste, they prefer the juicy burger. And that has been our focus. And we are uniquely positioned to do that because we have very high-quality ovens in our kitchen, each of our KFC kitchens, to produce that beef burger. So the beef burger, the patty, is cooked in oven, not on grill. So I hope that gives you some flavor of this amazing product that I love myself. Thank you.
spk01: Joey, let me add a little bit here because, you know, as I self-proclaimed number one fan of KFC, you know, I eat there very often and, you know, like, but still sometimes I do need variety besides chicken, right, and rice. So I think, you know, the beef burger is fantastic. You know, the beef burger, it's not only have one local beef burger, but now we have a range of, you know, burger that, beef burger that can, you know, appeal to different, you know, pricing points. I myself, you know, you know, increase my frequency going to the store, you know, because I have now, you know, like when I want to eat beef, you know, I have fantastic choice for the KFC beef burger. So from my customer standpoint, I think it's fantastic because it provides, you know, great variety. You mentioned different protein, different choices. And so I love it. So anyway, thank you. Thank you, Joey, and thank you, Christy, for your patience.
spk03: Your next question comes from Veronica Song with Credit Suisse. Please go ahead.
spk02: Thank you, management, for taking my question. And congratulations on a very strong set of results. I have a question regarding the coffee business. So as Joy mentioned, weíre going to win down the coffee and joy business and focus more on the K coffee and Lavazza. So could you share more color on the current situation or achievement of Lavazza, especially in terms of store expansion and a color on store economics? So how can we adopt the valuable experience we learned from both Kofi and joint KFC to drive Lavazza's success? Thank you.
spk00: Thank you, Veronica. Yeah, so, you know, I... Sorry, Joey, you want to say something?
spk12: Go on, go on.
spk01: Okay, okay. So, I think, you know, first of all, I think, you know, it wasn't repeated quickly, which is, you know, we start winding down the C&J business so that we can focus more our resources on the recovery resources on, you know, the master and give, you know, obviously the team a more focused, more laser focused you know, on the market. And as you mentioned, you know, currently our coffee sales, you have two, you know, two key brands. One is K-Coffee, which, you know, serves the value and convenience segment. And, you know, for La Vata, you know, we're focusing on, you know, offer authentic, you know, wonderful Italian coffee and experience. So obviously, C&J is a home-grown brand. Over the past few years, we've learned a lot. And this is one thing that we have to keep saying, we have healthy respect when we enter into a new business segment. Coffee business is very different, obviously, from fried chicken and from pizza business. So there's a lot of learning there, and how to give our product, coffee, water, milk, the whole process to make the coffee. Theme selection, obviously, is also very critical. And then, you know, obviously, for coffee, too, the star format, they come to figure out, you know, what a right format at different, you know, trade zones and economics and whatnot. And then also, you know, in terms of, you know, the Chinese customer, you know, it's coffee is still a relatively new market segment. A lot of Chinese consumers are still very new to the coffee, the taste of coffee. And what their preferences are also need time for us to develop and learn and apply to our product development. So a lot of this learning, I think, wonderful learning that we did with CNJ would help us to obviously apply to Labasto as it goes out and expand its business. And for Labaster, it's continued to recover obviously from a very challenging time, because a lot of in Shanghai early part of this year. And we see recently a business has rebounded. I think in terms of the product, the team, they continue to be on the right track. I don't think we can say we're there yet. But building a new brand, a new business is going to take time, but they have done a great job in terms of, you know, putting the right, you know, organizing the right team, putting, you know, the company to innovate in the product. You've seen a lot of new product innovations, right, whether buffalo milk, latte, and drinks. We also see, you know, the golden nut latte and all that have been, you know, wonderful success, you know, with the consumer. That sounds like, you know, offer that Italian experience, but also, you know, favorite that here to a Chinese consumer. And they will continue to do more, I think, you know, like in terms of training and food innovation. A salt farm is the same thing. You see that they continue to experiment and roll out. And overall, you know, you see the unit economics improve. But I think, you know, for them to reach, obviously, you know, their consumer awareness, the sales level, and also, you know, possibilities, you're going to take some time. I think people have to be a little bit more patient on that. They have opened quite a bit of stores this year, almost double. Right now we have 78 stores and continue to open more stores. And then they also continue to develop its capability. They continue to develop its digital and delivery capabilities. So if you look at South Mix now, you can see that uh you know the membership program and and and and also the delivery program continue to uh increase uh delivery now almost like you know 40 of the sales mix now so that's that's a great improvement and especially given the challenging uh environment with kovic uh and now in social development as you mentioned you know like you know threefold improvement increased from you know a year ago uh 278 store uh There will be more, and you know, like, but you should not, you know, it's not like COVID, obviously, you're going to have some impact. I think the last year we mentioned $1,000, and we're very much committed to that. But, you know, obviously the timing of that is going to be depending on, you know, some of my conditions, especially with COVID. As we mentioned, we have a very systematic and disciplined approach, even with, you know, the new coffee brand, like La Baza. But I think we're pretty confident, you know, as the stock economic improves, you will see more stores open.
spk00: So...
spk01: That's the update on Labasa.
spk00: Thank you. Thank you, .
spk03: There are no further questions at this time. I will now hand back to Ms. for closing remarks.
spk07: Thank you, Ashley. Thank you all for joining the call today. We look forward to speaking with you on the next earnings call. If you have further questions, please reach out. through the contact information in our earnings release and on our website. Have a great day.
spk03: That does conclude our conference for today. Thank you for participating. You may now disconnect.
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