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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.

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Yum China Holdings Inc

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).

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About the Author

R.J. Hottovy

Sector Strategist
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R.J. Hottovy, CFA, is a consumer strategist for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. He is responsible for consumer discretionary and staples research. He has covered the consumer sector as an analyst and director of global consumer equity research for Morningstar since joining the company in 2008, and specializes in a broad range of consumer categories including restaurants, footwear and apparel retailers, consumer electronics retailers, fitness clubs, home improvement and furnishing retailers, and consumer product manufacturers.

Before joining Morningstar, Hottovy was a director and senior stock analyst for Next Generation Equity and an analyst for William Blair & Co., specializing in a wide range of retail and consumer product companies. He also spent two years at Deutsche Bank, covering waste management, water utilities, and equipment rental stocks.

Hottovy holds a bachelor’s degree in finance and a second degree in computer applications from the University of Notre Dame, where he graduated magna cum laude. He also holds the Chartered Financial Analyst® designation and is a member of the CFA Institute and the CFA Society of Chicago.

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