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Yum China (YUMC) Banks on Digital Efforts, Hurt by High Costs

Yum China's (YUMC) focus on high-grade delivery strategy bodes well. However, dismal traffic due to the pandemic is a concern.

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This story originally appeared on Zacks

Yum China Holdings, Inc. YUMC is likely to benefit from its digital initiatives, menu innovations and unit expansion. Also, focus on the loyalty program bodes well. Rise in expenses and the pandemic-induced dismal traffic are a concern.



Let us delve into the factors highlighting why investors should retain the stock for the time being.

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Catalysts

Yum China is capitalizing on the benefits of its technology. The company is increasingly shifting toward digital and content marketing to expand the customer base. It has adopted a high-grade delivery strategy that includes collaborations with aggregators to source traffic and fulfills orders by the company’s KFC riders. Also, the company tested rider sharing between KFC and Pizza Hut in Eastern China. With expansion on cards, the initiative is likely to help the company drive volume and leverage the extensive network to control quality. During second-quarter 2021, the company’s delivery contributed nearly 30% to KFC and Pizza Hut's company sales, up nearly one percentage point from the prior-year quarter’s levels. Digital orders during the second quarter accounted for 85% of KFC and Pizza Hut's company sales compared with 80% in the year-ago quarter.



Coming to loyalty membership, Yum China created a robust loyalty program that has more than 330 million loyalty members, cumulatively. During second-quarter 2021, the company sold 8 million privilege memberships at KFC and Pizza Hut. Member sales during the quarter contributed nearly 61% to system sales.



Another riveting growth potential of Yum China resides in its continual menu innovation to boost the top line. During second-quarter 2021, the company upgraded its hand tossed dough with more premium flour and low temperature fermentation to make pizza dough crispy outside and soft inside. Growing from a small base, the company is expanding its takeaway and ready-to-cook business through menu innovation. This will make the takeaway and ready-to-cook business more convenient for consumers.



Yum China is focused on relentless unit growth of restaurants to drive incremental sales. During the first half of 2021, the company had opened 719 gross new stores. It roughly possesses five restaurants per million people in China, which is expected to grow to 15 stores per million. Going Forward, the company plans to open approximately 1,300 new stores in 2021 compared with the prior estimate of 1,000 stores.

Concerns

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Shares of Yum China have gained 9.5% so far this year compared with the Industry’s 14.3% growth. The dismal performance was primarily caused by the coronavirus pandemic. Although the company stated sales recovery in April and May 2021, the trajectory was negated by the Delta variant outbreak in Guangdong Province (at the end of May). This along with dismal traffic at transportations and tourist locations negatively impacted the company.



Moreover, the company is bearing additional costs stemming from promotions, menu innovations and technological novelty. In order to curb labor costs, the company is focusing on delivery channels, which is again expected to curb margins in the near term. Also, costs related to transactions and franchises are expected to rise in the near future.

In second-quarter 2021, total costs and expenses rose 25% year over year to $2,218 million compared with $1,774 million in the year-ago quarter. The upsurge can primarily be attributed to a 23% rise in food and paper costs, a 41% increase in payroll and employee benefits as well as a 25% surge in occupancy and other operating expenses.

Zacks Rank & Key Picks

Yum China currently carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.



Some better-ranked stocks in the same space include McDonald's Corporation MCD, The Wendy's Company WEN and Jack in the Box Inc. JACK, each currently carrying a Zacks Rank #2 (Buy).



McDonald's 2021 earnings are expected to increase 48.6%.



Wendy's has a three-five-year earnings per share growth rate of 9%.



Jack in the Box has a trailing four-quarter earnings surprise of 26.4%, on average.



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