Yum! Brands, Inc.
Q3 2018 Earnings Call Transcript

Published: 31 Oct 2018

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the Yum! Brands Third Quarter 2018 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. I will now turn the conference over to Mr. Keith Siegner, Vice President of Investor Relations, Corporate Strategy and Treasurer. Please go ahead, sir.

[Keith R. Siegner:]

Thanks, Krystal. Good morning, everyone, and thank you for joining us. On our call today are

[Greg Creed:]

Thank you, Keith, and good morning, everyone. System sales growth for the third quarter was 5% with 2% same-store sales growth and 4% net new unit growth. This achievement was largely attributable to the tremendous performance at Taco Bell as well as a solid quarter at KFC, delivering 5% and 3% same-store sales growth respectively. As well as strong net new unit growth at each brand. As a result of timing factors, we've outlined all year and consistent with our expectations for the quarter, core operating profit growth was 2%. Now, I'd like to discuss our guidance for full year 2018. Consistent with our communications after our second quarter earnings, we anticipate net new unit growth to be at the high end of the 3% to 4% range and same-store sales growth to be at the low end of the 2% to 3% range included in our original 2018 guidance. We are also reiterating our full year core operating profit growth guidance of approximately flat. However, we have a few items to note in the pieces that comprise core operating profit. We now anticipate our underlying base operating profit growth to be at or slightly below the low end of the previously communicated high single-digit range, owing to the reduced contribution from Pizza Hut, particularly in the international business. Offsetting this, we now anticipate the headwinds relating to the timing mismatch between refranchising and associated G&A savings to be slightly below the low end of the previously communicated six-point to seven-point range. Our estimate of a two percentage point to three percentage point headwind related to the recognition accounting standard is unchanged. Before I begin with our key growth drivers, I want to thank and celebrate Roger Eaton for his many years of service. Roger's imprint on Yum! and the KFC brand over the last 20 years is vast. He joined KFC in 1990 and held roles in operations, development and finance across Australia, New Zealand, and the U.S. before finally taking over leadership of the global KFC brand in 2014. Everyone who has met Roger knows that he always brings passion and energy enabling world-class operations to his roles, encouraging markets to adopt and share the best ideas. Roger's focus on ensuring excellence in operations, value and food innovation will leave a lasting impact for which we'll be eternally grateful. With Roger's retirement comes a new opportunity for Tony Lowings who is being promoted to CEO of KFC Global. Tony has a long history of creating value for all of Yum!'s stakeholders having helped build one of our strongest markets, KFC Australia as well as LA&C, another KFC powerhouse. From there, he served as Managing Director, KFC Asia-Pacific, enhancing and expanding this emerging market. And finally, Tony joined KFC Global earlier this year as President and Chief Operating Officer and has provided wise counsel across Yum! through our global leadership team. We're excited for Tony and wish Roger all the very best in his retirement. We are now two years into our three-year transformation and are continuing to execute on the key items designed to accelerate growth. The foundation of this is our four key growth drivers, which David and I will talk to you about today. I'll provide an update on two of these drivers

[David W. Gibbs:]

Thank you, Greg, and good morning, everyone. Today, I'll discuss our third quarter results, progress towards our transformation initiatives and two of our four growth drivers, bold restaurant development and unmatched franchise operating capability. Let's start with our third quarter results. As expected, Q3 was better than the first half. Our consolidated same-store and system sales growth rates improved reaching 2% and 5% respectively. In fact, I'd like to note that system sales growth ex-FX was 8% at Taco Bell and 7% at KFC, both impressive accomplishments. As a reminder, the following two items weighed on our third quarter core operating profit results

[Operator:]

Our first question comes from the line of John Ivankoe with JPMorgan.

[Keith R. Siegner:]

John, are you there? You might be on mute.

[John William Ivankoe:]

Yes. Sorry about that guys. The question was on Pizza Hut. Obviously, looking at the U.S. and the Transformation Agreement that's been put into place there, it does seem like you're identifying that many of your bigger international markets are having the similar type of issues that the U.S. was having a year or so ago in terms of what products are promoted at what price and basically serving the dining store versus the Delco store. So, are we now beginning a position or are you alluding to that maybe some of the international markets need some of the capital and operating costs and attention that the U.S. was really talked about about a year or so ago?

[Greg Creed:]

Yeah, John, I think one important difference between the U.S. and international is our international dine-in stores are actually in fairly good shape. These are good assets in good locations and in many countries we actually have a very strong dine-in business that we have confidence in for the future. That's quite a contrast to the U.S. where we have a lot of Red Roof restaurants that are in the wrong part of the trade area, haven't been remodeled and clearly need to go away. So there's a lot of capital required to get out of the Red Roof restaurants in the U.S. It's not a similar situation internationally. So no, we don't anticipate any kind of capital investment needs from Yum! going into international dine-in business.

[John William Ivankoe:]

And is there – I mean, I guess, a similar type of conversion opportunity over time, even if the assets are in good shape that makes them actually easier to convert, to integrate some of the Delco or fast casual type developments within the existing Red Roof type or a full-service type of estate that exists internationally. I mean, are we at the point where not just 90% of new units are Delcos but you need to begin to convert many of those legacy assets over to something that is more flexible for the overall business model?

[Greg Creed:]

Yeah, that's exactly right. I think I shared 80% of the stores are – that are being replaced, so when we have a dine-in unit that does need to be replaced it is being replaced with one of the fast casual or Delco assets. We think this transition will occur, it won't happen overnight but it is planned to occur over time. And with half of our sales coming – roughly half of our sales coming from dine-in today, we think that number will be closer to a quarter of our sales within three to four years, just from the natural shift of, for example, closing on the Telepizza deal, adding all of those delivery sales, building all these net new unit Delcos that are in the pipeline and then all the work that's being done to replace dine-in stores with delivery stores. So we want to give everybody the clear signal that we do have a plan to migrate out of those dine-in stores, but we thought it was important to highlight frankly that the delivery carryout business at Pizza Hut International is actually fairly healthy. That business is doing well, but the results we report don't show the success that we're having in that part of the business.

[Keith R. Siegner:]

Thank you. Next question, please.

[Operator:]

Our next question comes from the line of Matt McGinley with Evercore ISI.

[Matthew Robert McGinley:]

Thank you. My question is on the core operating profit guide. I know the guidance update today was just based on 2018. As I look at the refranchising and the G&A savings benefit that's more of a timing mismatch that would have worked itself out anyway. Are you concerned that the underlying issues of Pizza Hut International would impair the core operating profit growth over the longer term? Or do you think that those issues are more just isolated to this year?

[David W. Gibbs:]

Yeah, I think the beauty of Yum! obviously is that we do have a diverse portfolio of brands and countries. And yes, the Pizza Hut business is underperforming our expectations when we started this transformation journey. But obviously, we're also seeing great strength at the much bigger parts of our business at Taco Bell and KFC and we did reiterate our guidance for 2019 today. So I think you never get there the way you planned when you start the journey and we'll talk more about this when we get to December Analyst Day. But we feel good about the state of the business. Obviously, the results this quarter and the fact that we are very demonstrably ramping up net new-unit development certainly helps this earnings model of ours. Just as another fact on that front, year-to-date now we have 892 net new units opened for the year compared to 2017. At the same point, we had 677, so we're 215 units ahead of the pace we had last year. Remember last year we were well ahead of the pace from the prior year, so that's all quite positive and typically the fourth quarter of the year is the biggest year on development by far. So a good story on the development front that helps the earnings model.

[Operator:]

Our next question comes from the line of Sara Senatore with Bernstein.

[Sara Harkavy Senatore:]

Thank you. I'll ask my follow-up first and then I'll ask my question. The follow-up is on Pizza Hut U.S., I know you said the turnarounds are slow build, but I think this is the second quarter where you said maybe the messaging wasn't as effective even though you did pivot to value. So, could you talk about what can be done here? Because as you noted this isn't a dine-in issue since that's such a small piece of the business in the U.S. at this point. So, I guess, what is the strategy from here if really the only issue is messaging? And then I have a second question.

[Greg Creed:]

Yeah, sure. Look if I answer it in its totality, we're now the NFL partner. It's with us and not a competitor. Is that a good thing? Yes it is. We know what the right price points are to be successful in the marketplace. Do we have all of our franchisees on those price points right yet? No, we don't. But are the stores that are on the right price points doing better? Yes, they are. And as we said, I personally feel that we just got to do a better job of communicating this compelling value. We've got a new agency, they're onboard, the team is all over it and I think you will see us going forward with what I'll call sharper and more distinctive advertising and communication around this compelling value that we offer.

[David W. Gibbs:]

Yeah, and just one thing to add on that although the dine-in sales in the Pizza Hut U.S. business are only 10% of the business or so, remember about half the assets are dine-in assets. Those assets are very often in the wrong part of the trade area to deliver, they're not set up in the back of house to deliver. So, although the sales mix is now down to a much more manageable level, we still have work to do that should give you confidence over time. Once we move those assets we'll be in a much better shape.

[Keith R. Siegner:]

Thanks David.

[Operator:]

Our next question comes from the line of John Glass with Morgan Stanley.

[John Glass:]

Thanks, good morning. David just going back to the 2019 comments, do you believe 2019 is a year you can still deliver on the high single-digit operating profit growth? Are you signaling that there are different pieces you get to the EPS number, but maybe not the operating profit number you'd once envisioned? And related to that I think your G&A on a percentage of system sales is at your target rate of 1.7% this quarter, so is this the right sort of baseline to think about G&A and then it grows in line with system sales from here, are there additional opportunities you've identified as you've gone through this year?

[David W. Gibbs:]

Look I think, we'll talk a lot more about 2019 guidance when we get to the December analyst event. But we weren't trying to imply that there was any change to our high single-digit core operating profit growth model in future years with any of the comments today. The business and the models all generally remain intact, but we'll provide a lot more color on that when we get to the December event.

[Operator:]

Our next question comes from the line of David Palmer with RBC Capital Markets.

[David Palmer:]

Thanks. Just a follow-up on Pizza Hut, since KFC and Taco Bell seem to be cranking along here. The U.S. business, you've invested a lot this year and obviously to this point you're going to have the big fall push here with the NFL. But to this point, the momentum has not been as strong. You mention creative, but next year you're going to be lapping some of those investments. Do you feel like that this is in a fragile position where you really got to get brand momentum going here in the near-term to start to lap some of those investments? I mean, how should we think about the state of Pizza Hut U.S. heading into the 2019 in particular?

[Greg Creed:]

Dave, the way I think about it is that the foundations of Pizza Hut U.S. are in a much better place. I think our delivery times, the quality of the food we're delivering, the price points, all of those are fundamentally in a better place. So our foundations are definitely in a better place. Have we made it easier for our customers to access? Yes, we have through both digital, through both our apps, through the pricing. The point I was making and I think it's one that the team is very aware of is that we have to bring that sort of sharpness of what we're now delivering and doing so we attract new customers. I think our current customer base is very happy with the foundational improvements they're seeing in the brand. The opportunity for us is to bring in new customers by communicating and messaging better this compelling new proposition that Pizza Hut U.S. has to offer, which is an operating improvement, an ease improvement, a value improvement. We just got to do a better job of communicating that and I'm confident that once we do do that and when customers have a new Pizza Hut experience they'll be very happy with the experience that they have. And on that basis, I feel good about the momentum that the (37

[David W. Gibbs:]

On the question of lapping, all of the transformation initiatives were really designed to help the business for the long-term. There really isn't a lapping issue. We invested in media. You'd think that could be a lapping issue, but that was done so that then the franchisees ongoing contribution in media would jump up. So we will have that additional media in future years, so there's – it's not like that creates a lap issue and then the other investments in things like pouches, and different standards for the brands, launching the loyalty program, we should continue to reap the benefit of those investments over time.

[Operator:]

Our next question comes from the line of Dennis Geiger with UBS.

[Dennis Geiger:]

Good morning and thanks for the question. David just wondering, if you could talk a bit more about the accelerated unit growth potential for the business going forward. Maybe following another strong quarter at KFC, maybe specifically about your confidence in the accelerated growth there, generally which reasons you see that coming from. And just how you're thinking about the U.S. getting back to positive based on the strong returns that the franchisees are seeing? Thanks.

[David W. Gibbs:]

Yeah, look again, we'll go into a lot of the future guidance and we'll actually have the leaders from each of the brands talk about their development plans when we get to the December analyst event. I think I want to celebrate the fact that we've made meaningful progress to-date during this transformation as we've been doing all these things like cutting G&A and getting the business more focused. We're starting to see the benefit from development. It's showing up in the numbers, which is why I'm trying to highlight that every quarter. Do we think – and are we pushing to take the numbers higher from here? Yes. Do we think there are opportunities in almost every market whether they be the mature markets in the U.S. or the international markets? Yes. KFC U.S. is very focused on getting to be a positive net new unit grower. And just as a preview, I think we can get them there next year. So, yeah, that is something that's really quite additive to the model, when you think about how many units they've been closing over time. But yes, we're excited about unit growth. We'll never stop pushing for more, because when the returns are healthy, you should be capitalizing that and building more and the franchisees love it. It's a way for them to grow their business. But we'll give you even more color on that when we get to December.

[Operator:]

Our next question comes from the line of Jeffrey Bernstein with Barclays.

[Jeffrey A. Bernstein:]

Great. Thank you very much. Just a question broadly on the franchisee health and profitability, I'm not sure whether you can slice it U.S. versus international, but however you look at it. I mean in the past you used to use restaurant margin as a proxy for the franchisees' health and profit, but obviously that margin is no longer representative as the base is so small. So, just wondering if you can offer any directional thoughts on the franchisee health at each brand, maybe how you're suggesting they best manage through the labor cost headwinds they're presumably all facing, and whether or not any of them have concerns about access to capital with rising interest rates? Thank you.

[David W. Gibbs:]

Yeah, that's true Jeff that now we – you really can't judge the margins that we report and use that as a proxy for the franchise unit economics since we're down to some small numbers with a lot of noise in them. I guess, a general comment on franchisee health is when you operate in as many different combinations of brands and countries as we do there are always pockets of issues. We got 2,000 franchisees. There is always going to be some that are having challenges that we're working with, but the vast majority of our franchise system around the world is quite healthy. The areas where we would have more issues that you would expect would be in businesses where we're trying to transform the business a little bit like Pizza Hut U.S. We're trying to make sure we have the healthiest system of franchisees that we can. Some of the stuff we did in the Transformation Agreement was designed to give us some strength to manage out our underperforming franchisees. And you may see some change in the franchise system there. But in general, I think our franchise health around the world is quite good, and the unit returns that we're reporting are strong. You heard Yum! China yesterday on their earnings call talk about two-year cash paybacks on brand new KFC, so that kind of thing at least to help new franchisees.

[Operator:]

Our next question comes from the line of David Tarantino with Baird.

[David E. Tarantino:]

Hi, good morning. My question is on Taco Bell, which did have impressive performance in Q3. And I just wanted to see if you would elaborate on the drivers of that and whether the reintroduction of Nacho Fries had a big impact on that or whether you think there's something more structural or sustainable that you have that's driving that trend? Thanks.

[Greg Creed:]

Yeah, I think Taco Bell is just doing everything really well. Obviously to report 5% system sales growth, the calendar was incredibly strong. The team adjusted the calendar, which I was really proud of. The fact that they weren't happy with how they got out of the gate, so they adjusted the calendar. I think the product innovation continues to be world class. I still believe that there's no better product innovation that comes out – that doesn't come out from Taco Bell. The restaurants are being incredibly well-run. The value price points are spot on. The communication is distinctive and cut through. And to the delivered system sales growth of 8%, that is really at the top end, definitely the top end of what happened in the Mexican category and I would argue at the top end of what's happened in QSR. And then, I guess, to top it all off, the prestigious Harris Poll to make Taco Bell the number one Mexican brand in the country was I think just the icing on the cake. So I think this brand is set up for continued success.

[David E. Tarantino:]

Great. Thank you very much.

[Operator:]

Our next question comes from the line of Chris O'Cull with Stifel.

[Chris O'Cull:]

Thanks. Good morning, guys. I had a follow-up to a prior question and then a second. David just going back to your Pizza Hut comment, is there a compelling financial argument that could be made for the company to increase its support to accelerate the Pizza Hut conversions?

[David W. Gibbs:]

I think we've done a lot to support the franchisees as we move out of the dine-in asset base into the delivery base. By compelling arguments, there are some incentives that we've done to do that, that we haven't talked about a lot on these calls. So I think we've looked at those things and we've worked with the franchise community to help support them in that regard. Remember that, building a new delivery carryout unit is a very good economic proposition in general. It's a low-cost investment and it generates a three, four year cash payback in general. So the economics are there to make it happen, but when you're dealing with over 3,000 dine-in restaurants it's just going to take some time.

[Keith R. Siegner:]

Thanks, operator. We'll take one more question, please.

[Operator:]

Our final question comes from the line of Brian Bittner with Oppenheimer & Co.

[Brian Bittner:]

Thanks. Good morning. Just two questions, one on KFC and one on Pizza Hut. On KFC same-store sales accelerated there particularly on a two-year basis, so super strong performance there. I know we had Yum! China's comps last night, but what's driving the improvement elsewhere at KFC? Is the momentum of delivery growth in some of these markets really gaining momentum? Or anything else you can point out there. And just on Pizza Hut, the $5 lineup you announced, is this a sustainable value offering, are franchisees able to operate at this price point? Thanks.

[Greg Creed:]

Well, yeah, I think as I said the KFC performance and the acceleration is down to a number of things

[Greg Creed:]

Okay. So first of all, I just want to thank everyone for being on the call today. We remain confident that we are going to deliver on our transformation to be more focused, more franchised and more efficient, all of which will deliver more growth. Q3 was a strong quarter. We obviously have work to do on the top line at Pizza Hut International, but I am happy with their new-unit development. However, it is great that two of our brands which represent over 80% of our operating profits are delivering on all four of our key growth drivers. The high single-digit system sales growth at both Taco Bell and KFC was impressive I think by any standard. And we look forward to discussing this more in December and thank you for being on the call with us today.

[Operator:]

This concludes today's conference call. You may now disconnect and have a wonderful day.