Yum China Holdings, Inc. Q4 FY2022 Earnings Call

Thank you all for standing by and welcome to the Yum China Fourth Quarter and Fiscal Year 2022 Earnings Conference Call. All participants are in a listen-only mode. There will be a presentation followed by a question-and-answer session. I'd now like to hand the conference over to your first speaker, Ms. Michelle Shen, IR Director. Please go ahead. Thank you, everyone. Thank you for joining Yum China's fourth quarter 2022 Earnings Conference Call. On today's call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung. 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 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 filings with the 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 talk about our journey in the past three years and discuss fourth quarter performance. Andy will then cover the financial performance and outlook in greater detail. Finally, we will open the call to questions. You can find the webcast of this call and a PowerPoint presentation, which contains operational and financial highlights on our IR website. Finally, we plan to host our 2023 Investor Day in Shanghai through September. We look forward to sharing more details about this event with you in due course. Now, I would like to turn the call over to Ms. Joey Wat, CEO of Yum China.

Thank you, Michelle. I want to wish everyone joining us today a happy and healthy Chinese New Year. Before looking at the fourth quarter and full year, I would like to reflect upon our journey these past three years with COVID, some of our key learnings and how we have grown. First, I am incredibly grateful to the entire Yum China team for their agility, creativity, and tenacity during this difficult time. Together, we became a more resilient, nimble business, better positioned for long-term growth. During the past three years, we quickly pivoted when buying traffic came under pressure. Delivery doubled from just 20% sales mix in 2019 to 39% in 2022. Our hybrid delivery model and dedicated riders enable us to capture the increase in demand. Combined with takeaway, off-premise sales reached almost two-thirds in the fourth quarter of 2022. Digital ordering also surged from 55% of sales in 2019 to now 89%. That's over $20 billion in digital sales in three years. We maintained our rapid growth. Our store portfolio expanded by nearly 40%, a total of 3,800 net new stores. KFC and Pizza Hut stores maintained a healthy payback of two to three years, respectively. The first year profitability of new stores also improved. Strong new store performance was driven by our flexible store model. We optimized store size and secured more favorable lease terms. For new stores opened in 2022, more than half were in smaller formats. Such flexibility allows us to continue to increase density in higher-tier cities, which is particularly useful and helpful for delivery and capturing white space in lower-tier cities. We enhanced the coverage and agility of our world-class supply chain to support business growth. We expanded from 29 to 33 logistics centers for better self-sufficiency in each province. During expanded lockdowns, we added rail and sea freight to move our inventory apart from our traditional trucks. Our store inventory visibility system allows real-time sales forecasting and smart inventory replenishment. These capabilities help mitigate severe disruption even during a lockdown and minimize wastage. We also supported product innovation by securing supply at scale. Apart from our classic offerings, we launched over 500 new or upgraded menu items last year from regional offers to national launches. We invest in digital and automation to improve operating transparency and efficiency. For example, we are rolling out a smart order system at KFC. The AI-powered system more accurately predicts demand and recommends food preparation plans to minimize stock outs and wastage, and also reduce waiting time for customers. It also enhances customer experience by reducing wait time and providing real-time order updates. Recently, we added robotic service at one-third of our Pizza Hut restaurants, freeing our crews to serve customers. We have remained profitable each and every quarter since the beginning of the pandemic in 2020. By rebasing our cost structure and implementing austerity measures, we cushioned shocks created by the volatile market situation. In the past three years, we generated US$1.9 billion in free cash flow and returned over US$1 billion to shareholders. Notably, I am proud to say we did this while also protecting the jobs of our employees. We have had no staff layoffs since the pandemic began. Looking back over this period, we see opportunities to improve our ability to operate in good times and bad times. Looking forward, our anti-fragile operations will enable us to shine and drive long-term growth in China. Now let me provide some highlights for the fourth quarter and full year. 2022 was filled with unprecedented challenges. In just 12 months, we managed sporadic COVID outbreaks, entire city lockdowns, nationwide infections, and the certain lifting of COVID-related restrictions. In October and November, COVID infections quickly evolved into major regional outbreaks, leading to tightened COVID-related measures. In December, as China entered a new phase of COVID response, we faced brand new challenges. With surging infection rates, a significant portion of our employees and riders became infected, resulting in a labor shortage. Thousands of our stores were temporarily closed or only provided limited services. Many residents also opted to stay home to avoid infection or recover from symptoms. Buying traffic fell sharply. During this time, as always, the health and safety of our employees and customers remained our top priority. We moved quickly and supported our employees with relief medicines and antigen test kits. We mandated daily testing for all crews and riders to minimize infections, and we organized informative health talks and a consultation hotline for our employees. At the same time, we took immediate steps to address the labor shortage. We simplified the menu, shortened operating hours, and optimized labor shifts. We reallocated crew resources among stores, prioritizing stores with stronger demand, and we adjusted delivery operations, encouraging customers to pick up orders and promoting packaged food products. I am thankful for our team's nimble actions and amazing execution. Even in this challenging quarter, we delivered substantial year-over-year restaurant margin expansion despite lower sales. This was achieved by our extensive scenario planning, operational efficiency improvements, cost rebasing initiatives, and temporary relief. We were also able to open a record 538 net new stores in the fourth quarter, or 1,159 net new stores in the full year. Let’s move on to the brand. By brand, KFC and Pizza Hut continue to introduce delicious food and exciting campaigns to delight our customers. At KFC, new categories grew with solid momentum. Juicy whole chicken and beef burgers doubled in sales in 2022. Combined, we generated around 5% of KFC's sales mix in the fourth quarter, nearly equal to our Original Recipe chicken. We continued to introduce more flavors in these categories, such as the Spicy Whole Chicken, launched during Chinese New Year. Following the success of Pokemon Psyduck in quarter two, our toys in the fourth quarter also generated huge social buzz. These include Fancy Chicken and Fluffy Chicken Popcorn, both were originally designed as pet toys but quickly became very popular with all customers and drove traffic. At Pizza Hut, pizza sales grew nicely for the year, reaching almost 40% of sales. We sold over 100 million pizzas in 2022, that's nearly seven pizzas per second. Apart from our signature pan-tossed and crispy pizzas, we have added stuffed-crust pizzas. Customers can choose fillings like double cheese and sausage. These new launches encourage trade-ups and lift effective prices. We continue to offer stunning value for money. Our signature value campaign at KFC, Crazy Thursday, attracts excellent traffic, generating over 50% more sales on Thursdays compared with other weekdays. Sunday, Buy More Save More continues to spur weekend sales. New retail packaged foods provide us flexibility during lockdown and when we were short of staff. In 2022, packaged food sales grew 90% and reached nearly CNY 900 million. We continue to broaden our offerings, adding some of the classics such as our egg tart and Popcorn Chicken. Now moving on to our emerging brands. We have solid management teams and strategies in place. While it will take time to fine-tune and test the business model, we are making solid progress. Lavazza continues to execute its four-pillar strategy, which includes brand building, menu innovation, digital and delivery, and store development. Throughout the year, we introduced new coffee flavors such as orange buffalo latte with buffalo milk. We also introduced sweet and savory food that pairs well with coffee. Loyalty members more than doubled to 1 million in 2022, contributing to over 40% of sales. We enhanced operational efficiency and optimized new store designs, lowering upfront investment. Although COVID disruptions have delayed store openings, Lavazza reached 85 stores by the end of quarter four. Taco Bell doubled its store count in 2022 to 91 stores. We continue to localize the menu for Chinese customers. For example, a crispy one-time taco uses duck and a one-time wrapper in place of a tortilla. We also continue to improve the value proposition, customer experience, and unit economics. Little Sheep and Huang Ji Huang were expectedly impacted by COVID due to their dine-in focus. We used 2022 to refine their business models and strengthen fundamentals from menu, marketing, store models, supply chain to digital initiatives. Huang Ji Huang also continued to generate operating profit. To wrap up, with a new chapter opening in 2023, we are excited to see positive momentum in the Chinese New Year season. We took decisive action to ensure operational efficiency and capture sales. At KFC, we broadened our signature Golden Bucket, which is a holiday favorite. At Pizza Hut, we introduced a holiday-themed pizza with wagyu beef and seafood, which is inspired by a popular game. It is gratifying to see how our delicious food plays an important part in our customers' celebrations during the holiday. Yet COVID remains a reality, and many challenges still lay ahead, including cautious consumer spending through the holiday. While we anticipate the road to recovery will be gradual and uneven, I'm optimistic that brighter days are ahead. We will continue to execute our proven RGM strategy, which stands for resiliency, growth, and strategic mode, to capture the growth opportunity and deliver shareholder value. With that, I will turn the call over to Andy.

Thank you, Joey and belated Happy Chinese New Year to everyone. Let me share with you our fourth quarter performance. As Joey mentioned, we faced an extremely fluid and challenging fourth quarter due to substantial changes in COVID conditions and related policies. In late November, due to rising infections and strict COVID-related health measures, the number of stores that were either temporarily closed or offered only takeaway and delivery services reached a peak of over 4,300 stores. In December, we faced a different situation where most of the COVID measures were lifted. Due to labor shortage, we had to temporarily close or provide limited services at over 1,300 stores on average. In such a volatile environment, we took swift action to capture off-premise demand. Furthermore, we controlled costs, limited wastage, and enhanced product despite lower sales. Our team did a wonderful job improving restaurant margins by almost three percentage points despite very difficult circumstances. Let us now go through the financials. Unless noted otherwise, all percentage changes are before the effect of foreign exchange. Foreign exchange had a negative impact of approximately 11% in the quarter. Fourth quarter total revenue declined 9% year-over-year in reported currency to $2.1 billion. In constant currency, total revenues grew 2%. The contribution of new units and the consolidation of Hangzhou KFC were partially offset by same-store sales decline and temporary store closures. System sales and same-store sales both declined 4% year-over-year. By brand, KFC same-store sales were 97% of the prior year's level, with same-store traffic at 84%. Ticket average grew 16% due to the rise in delivery mix, which has a higher ticket average than dine-in. Pizza Hut same-store sales were 92% of prior year level. Same-store traffic was at 98%. Ticket average was at 95%, driven by lower ticket average of delivery orders and smaller party sizes due to the pandemic. Restaurant margin was 10.4%, 290 basis points higher than the prior year. The year-over-year increase was mainly driven by labor productivity, operational efficiency, and temporary relief. These were partially offset by the sales leveraging impact, which includes temporary store closures, as well as higher rider costs due to high delivery volume. We also faced inflationary headwinds in commodity and labor costs. Our team worked hard to protect margins during the fourth quarter, which is seasonally slow in terms of sales and profits. Let me go through the key items and highlight the actions we took. Cost of sales was 31.9%, 60 basis points lower than the prior year. We kept commodity inflation relatively modest by strategically locking in prices and innovating the menu. We also carefully planned promotional activities and reduced wastage. Cost of labor was 28.8%, 90 basis points higher than the prior year. This was mainly due to increased rider costs from a higher delivery sales mix, low single-digit wage inflation, and sales leveraging. This was partially offset by better labor productivity and temporary relief of $14 million. Occupancy and other was 28.9%, 220 basis points lower than the prior year despite sales deleveraging. This was mainly due to lower rental expenses and other cost-saving initiatives. Rental expense, as a percentage of sales, benefited from rental relief of $12 million, strong portfolio optimization, and more favorable lease terms. G&A expenses increased 2% year-over-year, mainly due to increased compensation and benefit expenses, as well as the consolidation of Hangzhou KFC. The increase was partially offset by cost control initiatives. Operating profit was $41 million compared to $633 million in the year prior. In the fourth quarter of 2021, we recorded a non-cash gain of $618 million from the remeasurement of our previously held equity interest in Hangzhou KFC. By excluding the remeasurement gain, adjusted operating profit increased 189% year-over-year from $60 million to $40 million. The net contribution from Hangzhou KFC’s consolidation was 12% of operating profits in the quarter. We included the last quarter of amortization of intangible assets acquired, which was roughly $15 million. The effective tax rate was 29.9%, 480 basis points higher than the prior year, due to lower pre-tax income and the Hangzhou KFC consolidation. Prior to consolidations, the equity income from JVs was not subject to tax, resulting in a lower tax rate. Net income was $53 million. Adjusted net income was $52 million. Excluding the $4 million mark-to-market net gain on our equity investment in Meituan in the quarter and the $9 million net loss in the prior year period, adjusted net income grew 154%. Due to the diluted EPS and adjusted EPS, they were at $0.13, the mark-to-market gain in Meituan increased value EPS by $0.01. In December, we acquired an additional 20% stake in Suzhou KFC JV for approximately $115 million. This increased our total ownership in the JV from 72% to 92%. For the full year 2022, we generated free cash flow of $734 million. We returned roughly $668 million to shareholders in cash dividends and share repurchases. Cash, cash and short-term investments were $3.2 billion, down from $4 billion in the third quarter. The reduction in cash and short-term investments was mainly due to the reclassification of around $600 million from short-term investments to long-term time deposits. We invested in long-term bank deposits to benefit from better interest rates. Let's now turn to our outlook for 2023. In January, most of the temporarily closed stores resumed normal services. Our same-store sales from the comparable Chinese New Year holiday season were up mid-single-digits year-over-year but remained below the comparable level. Same-store sales benefited from pent-up demand as the relaxation of COVID policy coincided with the Chinese New Year holiday. However, the real test will be the sales trajectory after the holiday, as we face more cautious customer spending and macroeconomic uncertainties. Looking ahead, we are encouraged by the new COVID policy. The future indeed looks bright. But we must keep a level head and recognize that uncertainties and challenges still lie ahead. Our country has shown that further outbreaks and the emergence of new COVID variants will pass after COVID restrictions are lifted. We also face macroeconomic headwinds such as elevated commodity and wage inflation, as well as softening global economic conditions. These factors may impact our operations and consumer spending in China. Now at the risk of sounding like a broken record, we continue to expect recovery to take time and be non-linear and uneven. For 2023, our top priority is to drive sales. At the same time, we will remain agile. One of the lessons we learned in recent years is the importance of planning and preparing for a wide range of scenarios, both to capitalize on growth opportunities and mitigate risks when needed. On store development, we are targeting to open 1,100 to 1,300 new stores. We expect capital expenditure of $700 million to $900 million to support organic growth, remodeling, digital, supply chain, and other infrastructure development. As always, the quality of growth is what matters to us the most, not just the quantity. So we will continue our systematic and disciplined approach to investment and growth. Finally, we remain committed to returning capital to shareholders. The Board has approved raising the cash dividend from $0.12 per share to $0.13 per share. This is supported by our healthy balance sheet and strong cash flow. With that, I will pass you back to Michelle to start the Q&A.

Thanks, 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. Please start the Q&A.

Thank you. Your first question comes from Brian Bittner from Oppenheimer & Company. Please go ahead.

Thank you. Good morning to you. My question is on the new stores that you've built since COVID began. You've built a significant number of new stores over the last three years, over 3,700 of these new stores. And I know the payback on these stores is still very strong despite operating in a pandemic, which is incredibly impressive. But Andy, can you talk about where the sales productivity and the margins on this class of stores that have been built since COVID currently stand relative to the rest of the asset base? So we can kind of understand how to think about the model moving forward?

Thank you, Brian. If we look at our store opening for the past three years, as Joey has mentioned, we have increased our store count by almost 40%. But nevertheless, if you look at the new store performance, the payback period is very consistent and very good. For KFC, it’s about two years, and for Pizza Hut, it’s about two to three years. The reason why Pizza Hut is two to three years is that if you go with a satellite model, which is the new model that we have, the performance is on par with KFC, which is about two years. Then obviously, for the more standard models, their payback period is a little bit longer. Overall, for this year and last year, the new stores we opened have unit economics that continue to perform very well. If we look at the stores that opened recently, most of them breakeven within three months, even in this very challenging environment. If you look at our new store portfolio, the difference with the existing store is that over the past couple of years, we did increase penetration in lower-tier cities where there is white space, and we also increased density in the urban area, especially with smaller models—satellite models or smaller KFC models. We need to cater to consumers' demand for convenience and delivery and takeaway services. The new stores opened are smaller, so the sales throughput generally is less than their existing portfolio, roughly about two-thirds of the sales competitive portfolio average. The profitability of those new stores is better. We mentioned we have lower step-up investments for the small stores. If you look at it properly, we probably spent about $2.5 million on our new store openings, and now we are spending on average about RMB 2 million, and for the small model, it's close to RMB 1.5 million. We improved efficiencies throughout this pandemic. In 2022, despite the tough market environment, we managed to improve restaurant margins, especially at KFC. So I think we're pretty confident that we have the right format and resources to grow our store network at a healthy pace and maintain a robust payback for our investment.

Brian, I'll just add some color to your question. The theme here of the aggressive new store openings is resiliency because while we emphasize how many stores we have opened in the last three years, which is 3,700 net new stores, we also had to retire some stores. By opening more productive new stores, we simultaneously retired less productive assets. Thus, the quality of our assets for Yum China has improved in the last three years. Just to highlight here, for the new stores we are opening now, we have 90% of them with flexible rents, which makes us more resilient. We talk about lower CapEx as well, if you think about our CapEx, which is roughly split 40-60. 40% for equipment, which we can move around, and 60% in some cost. The reduction of CapEx in terms of some costs is even more than just the total reduction of CapEx. The size is smaller, and as a result, the productivity of the new stores is better. The location of the stores matters too because they're both in higher-tier and lower-tier cities, with about a 40-60 spread. For lower-tier cities, 60% of our new stores are very effective in entering new cities. For KFC in 2022, we actually entered 200 new cities. These are white space, and you can imagine it’s a pretty good market to grow. For higher-tier cities, our focus is on filling the gap or the distance between the stores to increase the density of our stores in high-tier cities, which is incredibly important for our delivery business. So I hope that gives you some insight into the new stores in terms of quality and resilience for that business. Thank you.

Thank you so much.

Thank you. Your next question comes from Chen Luo from Bank of America. Please go ahead.

Thank you, Joey and Andy. Happy Chinese New Year. So before I raise my question, I'd like to highlight three points, if I may. First, out of the 12 quarters during the pandemic period, for five quarters, we reported restaurant margins better than the pre-pandemic level. And despite the fact that for four quarters, we have seen mid- to high single-digit same-store sales decline versus 2019, where for Q3 last year, we saw more than 10% same-store sales decline over the same period in 2019. Apart from the one-time cost relief, we have significantly rebased our cost structure and developed innovative store formats, as Joey and Andy just elaborated on. Meanwhile, we also consolidated Hangzhou KFC and Suzhou KFC in the past three years. Supposedly, this portion of the business carries higher margins than the group average. The market, in general, would expect pretty meaningful margin expansion going forward when sales start to recover. Point number two, I also noted that our priority this year is to drive sales. Yet the market believes the company is very good at balancing top line and margins. Point number three, we will be planning for multiple scenarios in a very fluid situation. So after highlighting these three points, my question is: Assuming that for 2023, our macro environment is somewhat stable so that the momentum could be similar to that of the second half of 2020 and the first half of 2021, can we expect to bring our restaurant margin to a level largely similar to 2019 or even a bit higher?

Hi, Chen Luo. Thank you for the summary and also for your question about restaurant margin potential. As we have always stated, when there's same-store sales decline, that generally puts pressure on restaurant margins. However, when there is a recovery in sales, we also expect some leverage. We are quite encouraged by the relaxation of the COVID policy, which we believe will provide us with a little bit more certainty regarding the business environment and our operations during the Chinese New Year trading period. So we are cautiously optimistic. The reason we mentioned this is due to market conditions and the reality of COVID still being present is that we need to keep a level head. The operational improvements, labor productivity, and margin improvements we expect most of them or some of them would continue. We've done a lot of work to rebalance our cost structure over the past few years. Regarding labor structure, restaurant management versus crew, and custom processes, as we have previously mentioned, we received about $26 million of rental relief in the fourth quarter alone and $86 million for the full year, which are likely to go away if things normalize. We also consider commodity prices and labor inflation. Looking ahead, we expect low single-digit price inflation and mid to high single-digit labor inflation to gradually return to a more normal level. That's how we view the margins and cost environment as we move into 2023.

Let me add some context here. The management views regarding core costs and margins is as follows: If we look at our historical numbers, cost of sales and labor costs are something we strive to keep relatively stable, without becoming too low, as that would mean a lack of value for customers, which is dangerous. Our goal is to keep it at a reasonable level. In 2022, it was around 38%, and historically, it has varied from 29% to 30%. Notably, Pizza Hut’s cost of sales was 31.5% now, compared to just 26% previously. This shows that while we aim to improve our margins, we also prioritize value for customers. We have improved occupancy and operating expenses as well, reducing 5.6% over the years. However, when savings occur, we do not simply allow it to flow through to the margins; we consistently pass on some savings back to the customer, focusing on long-term business growth. I hope this helps clarify our management focus on margins and key cost items.

Yes, thank you. That's very helpful. By the way, your toy is really cute, and I'm very amazed by the newly launched products. So I'm looking forward to having a thought on that.

You must try them.

Thank you. Your next question comes from Wei Xiaopo from Citi. Please go ahead.

Good morning. Hi, Joey, Andy. Happy New Year. I appreciate the great rundown of Joey's opening remarks, showing us the journey over the past three years and how you built your identity and also maintained long-term growth. So my question is, during these past three years, your agility has been very visible, which has protected your margin and allowed you to capture digital growth and delivery. But when China reopens, the market will be more dynamic. I want to get a sense of whether Joey and the team will be more aggressive in terms of demand activation because you have stayed ahead of competition to reserve costs and protect margin during difficult times. Will you be a little bit more offensive in looking for market share gains post-reopening?

Thank you, Xiaopo. I would like to address the narrative regarding whether we have been offensive or defensive these past three years. I believe we have been very offensive in the past three years, given our expansion of the footprint by 40%. Our view is that we shall take advantage of the crisis and adversity, and I think we have done that. Moving forward from 2023, I believe we will continue our aggressive pace. The focus will be on driving sales, delicious food, new products, valuable pricing, and exciting campaigns while maintaining a disciplined approach to capture growth. Over the last three years, our biggest constraint was sales due to COVID disruptions. Therefore, going forward, we will focus even more on driving sales, including accelerating store growth. Andy mentioned targeting 1,100 to 1,300 net new stores in 2023, and we will optimize store formats. There's still much to be done and expected support for smaller brands to grow, and we will invest to strengthen our strategic moat involving supply chain and digital initiatives. I hope that sheds light on our focus. Our priority is still on resiliency, growth, and strategic moves supported by our anti-fragile operations, which have improved over the past three years while maintaining a strong sales focus. Thank you.

Let me add another point. When looking at our store network expansion, we have been very disciplined since the spin-off. Within that consistent approach, we've built a mechanism to accelerate growth when the unit economics perform well, and slow down when they do not. For instance, when times are good and the format is performing well, our market managers themselves propose more store openings, which will be approved under our model. This is evident with Pizza Hut's rejuvenation program prior to the pandemic, where new store unit economics were constrained, resulting in limited net new store growth. However, with the success of the satellite store model, we are now seeing significant expansion in this area. Our approach is disciplined and systematic, reflecting both the economic conditions and our unit economics, allowing for acceleration or deceleration based on performance. Thank you, Xiaopo.

Great. Thanks. Looking forward to meeting both of you very soon physically. Thank you.

Absolutely.

Yes.

Thank you. Your next question comes from Michelle Cheng from Goldman Sachs. Please go ahead.

Hi, Joey, Andy. Thanks for taking my question. My question is about the promotion activities and the competitive landscape. We know in the past few years, the smaller players have been squeezed out significantly, which has benefited our business. Moving forward, in this new reopening world, how should we think about the competitive landscape changes? On the other hand, we know that consumption power has been challenging lately. What is your strategy to drive traffic back leveraging those promotional activities?

Sure. Hi, Michelle. For the competitive landscape, I am happy to report that we’ve been doing quite well. Between 2019 and 2022, the overall market in our business has dropped by mid-single-digits, but Yum China has held steady. This means our market share has likely increased a bit, so I think we have done something right. Regarding promotions and sales momentum, we examine promotion, product, and operation in a holistic view. The focus of driving sales prioritizes both traffic and ticket average. How do we achieve this? We will pursue a series of initiatives that form our promotional strategy. It starts with having fantastic products; it's insufficient to focus solely on promotions without offering great food. Therefore, even during the pandemic, we launched about 500 new products each year, with or without traditional marketing, leveraging our 430 million members. New products are marketed effectively to them. Our promotion campaigns have become more effective over time; however, fewer but more impactful promotional events are crucial to drive sales while protecting margins. Addressing potential price increases is also within our plans, but we implement it thoughtfully. We aim to have a range of prices, offering lower entry points alongside premium products to cater to all customers. So with this combination of initiatives, we hope to drive traffic, maintain margins, and produce sales for our shareholders. Thank you.

Yes, thank you, Joey, for your comments on pricing.

Thank you. Your next question comes from Anne Ling from Jefferies. Please go ahead.

Thank you. Hi, Joey. Hi, Andy. A couple of questions here. First, regarding the company's exposure to the 5% same-store sales growth during the Chinese New Year, would you share with us how it compares for both KFC and Pizza Hut? How does it differ in terms of the pace of recovery? What should we expect?

Hi, Anne. For the Chinese New Year same-store sales number, KFC performed slightly better than Pizza Hut, with transportation hub stores doing particularly well. This was even better than government statistics, which helped. In terms of region, all regions performed well across the board, especially in lower-tier cities. However, we need to be cautious with the numbers, as this year's Chinese New Year was very early, which makes comparisons complex. We should look at the Chinese New Year number, including January and February for a more complete picture. Delivery business also increased significantly from 20% to 39% between 2019 and 2022 for Yum China. However, we also examine off-premise business holistically because delivery still outperforms dine-in. We consider the ceiling of delivery growth and the importance of our off-premise business, which currently makes up two-thirds of total sales. This is a core aspect of our analysis and strategy as it provides business resiliency, and even when specific stores are temporarily closed, off-premise business helps achieve breakeven sales. Therefore, that 20% increase from 2019 to 2022 is a significant achievement for us.

Interesting. Thank you.

Thank you. Your next question comes from Lillian Lou from Morgan Stanley. Please go ahead.

Thank you, Joey and Andy, for your explanation of the situation. Just a very quick follow-on question because that's exactly what Joey mentioned, that KFC versus Pizza Hut recovery pace. Given this current still volatile situation, and meanwhile, we are seeing an improvement in off-premise traffic. So like for Jan and Feb and even for 2023, are we seeing that KFC's momentum in terms of the pickup trend will be stronger than Pizza Hut? How might this delivery portion normalize compared to last year, and how does that impact our forecast for same-store sales growth? I believe traffic will offset some downward pressure on ticket size for KFC, but it could be more challenging for Pizza Hut. How do we view these dynamics in the next couple of months and also for 2023?

For KFC and Pizza Hut, they're very different businesses. KFC has clear results, while Pizza Hut has a significant dine-in portion, particularly in casual dining. They will recover at different paces. Over the past year, Pizza Hut opened a record number of stores, over 300. Our focus for the brand is to increase scale for better resiliency, with emphasis on new formats like the satellite store. The satellite store model is performing very well; currently, around 20% of our portfolio, and there’s a strong demand, particularly around new store openings since this has the best payback period for Pizza Hut. While there may be challenges, robust plans for store openings and a focus on our casual dining strategy will hopefully lead to improving momentum in both KFC and Pizza Hut. Thank you.

Thank you, Joey.

Thank you. Your next question comes from Lin Sijie from CICC. Please go ahead.

Thank you, Joey and Andy, and congrats for another resilient quarter. So I have one question concerning the recovery of Chinese consumption. We find that the recent recovery, even after the Chinese New Year, of shopping traffic and restaurant sales is strong in cities like Chengdu, Chongqing, and Changsha, but I'm not sure if it's common across the nation. Given our extensive layout in most regions and city tiers, what do you think about the potential differences in recovery among regions and tiers in the future?

Sijie, thank you. As I mentioned earlier, the Chinese New Year recovery is encouraging, and we are happy to see good momentum across regions. Tier 2 cities like Changzhou, Jinan, and Jinhua have particularly benefited from travel during the Chinese New Year. However, caution is necessary regarding post-Chinese New Year trading; while we are thrilled to see traffic returning, we want to be mindful of consumer spending behaviors. Our focus is on valuable promotions to draw customers in, especially as we monitor post-holiday sales closely, understanding broader macroeconomic trends. Thank you, Sijie.

Yes, Sijie. We are encouraged by the successful Chinese New Year trading period. However, we do not take sales growth for granted. We expect uncertainty and change ahead, so we are committed to working hard to drive that growth while maintaining discipline in our store expansion strategy. Our sentiment is to plan for the best while preparing for the worst. This has been our strategy over the last couple of years, to remain adaptable to different scenarios.

Thank you, Joey and Andy.

Thank you. Your next question comes from Ethan Wang from CLSA. Please go ahead.

Thank you. Good morning, Joey and Andy. My question is about the supply chain, which is crucial to our business, both during and after COVID, but often overlooked. We have seen strong inventory due to carbon footprint impacts and potential changes in our supply chain dynamics. Would this imply changes in supply choice or investments with our suppliers to achieve our sustainability goals, and how will that affect our business long-term?

Hi, Ethan, thank you for your question. In terms of supply chain, it continues to be a major advantage and is vital for our sustainable growth. We will, as stated in our previous Investor Day, step up our investments in supply chain and infrastructure. This includes increasing our supply chain footprint and incorporating automation while also focusing on reducing our carbon footprint. It is essential for us to work closely with our supplier base to meet climate change initiatives; we have developed a plan for those initiatives including a commitment to net-zero emissions by 2050. Achieving this will necessitate working in tandem with suppliers and customers to create sustainable practices for everyone involved.

I would like to add two key points. First, regarding investments addressing ESG without harming margins, our approach is to ensure that investments have a desired payback. It is not merely about social responsibility; it is about achieving sustainable operations. For instance, we look for efficiency in energy usage without excessive costs; our teams innovate with our suppliers to balance affordability and sustainable practices. Secondly, I am optimistic about innovations in the supply chain driven by challenges faced during the last few years. We have learned to be adaptable; for example, during the Shanghai lockdown, we quickly utilized railway and sea freight for logistics. This kind of flexibility has been pivotal and will empower us in the future.

Great. Very useful.

Thank you. Your next question comes from Red Sue from CMBI.

Hi. Can you hear me?

Yes.

Hi. Joey and Andy, thank you so much for the detailed sharing and resiliency last year. My question is about your new store target. Do you think your new target is a bit too conservative? You've done well in opening more than 1,100 stores last year during COVID. Without COVID, could you raise the numbers higher this year?

Hi, Rob. Thank you for your question regarding our new store opening target. As we mentioned, we opened over 1,800 stores, achieving a net increase of more than 1,100 stores last year. We have been aggressive in store openings even during the pandemic. However, our target for this year at 1,100 to 1,300 new stores reflects our focus on quality over quantity. We generally do not set a numerical goal like 'this year will open x number of stores'; instead, how many stores open ultimately depends on market conditions and unit economics.

Rob, I want to stress that operationally, above all, our focus is on good store managers. Training good store managers takes time, so we prioritize quality growth. For the 1,100 to 1,300 target, we believe it aligns with our prudent approach to growth and ensures both capital efficiency and operational excellence.

In terms of openings by brand, KFC remains the largest brand for small openings. We expect robust growth for Pizza Hut following last year's record openings and we are continuing to see strong expansion for Lavazza. Taco Bell is also on track to increase its presence as we work closely with our franchisees.

Thank you.

Thank you.

Thanks, Andy. We'll now conclude the call for questions. In order to provide everyone with a fair chance to engage, please limit your questions to one at a time. Sari, please close the Q&A.

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.