Coronavirus Sets Up Yum China for a Challenging 2020
Despite the outbreak, we're not planning material changes to our fair value estimate and see several reasons why investors should remain optimistic.
Wide-moat Yum China's (YUMC) solid finish to 2019 (3% comps at KFC, flat comps at Pizza Hut, 90 basis points of restaurant margin expansion to 12.4%) was overshadowed by the impact of the coronavirus outbreak. While other consumer companies have provided cautionary statements about the impact of coronavirus, Yum China offered the most details to date, saying that had temporarily closed one third of its restaurants (more than 3,000) and that comps at those locations that remained open fell between 40%-50% during the Chinese New Year holiday (though it noted that delivery sales "have held up well"). Management also warned that the company could post an operating loss during the first quarter, and if sales trends continue, the full year. While the coronavirus situation remains fluid, we expect full-year comps to decline 15%-20% (including 30%-40% in the first quarter) with operating margins coming in just above breakeven.
While the impact of coronavirus appears to be more significant than previous illnesses in the region and Yum China has a long year ahead, we're not planning material changes to our $54 fair value estimate and see several reasons why investors should remain optimistic. First, delivery represented 21% of sales in 2019, and while this channel will not be sufficient to offset physical store traffic declines, near-term consumer adoption trends could lead to increased delivery order frequency as discretionary spending in the region recovers. Second, value-oriented players tend to outperform during times of uncertainty, positioning KFC (and Pizza Hut's recent price alignment efforts to a lesser extent) for transaction outperformance as the year progresses. Third, periods of uneven spending force consumer companies to become more efficient operators. This includes discussions with suppliers/landlords for more favorable pricing terms, something that could materialize as Yum China remains aggressive with restaurant openings (including 800-850 in 2020).
|Morningstar Premium Members gain exclusive access to our full analyst reports, including fair value estimates, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.|
R.J. Hottovy does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.