With more than 29,000
restaurants, 800,000 employees and a new
location opening every 3.5 hours. Kfc is one of the
world's largest fast food chains. But while much of
the brand's early success came from the US today, the
majority of that growth is in China. In the city of
Hangzhou, about an hour outside of Shanghai, KFC
China recently celebrated the opening of its 10,000th
store. By comparison, the US has a
little over 4300 kfcs. The last four years is the
highest speed of KFC development in our 36 year
history. Because the the sheer scale
of the economy provides us the opportunities to build
more stores. Over 40% of our stores have
been built in the last four years alone. China is a very important
market, you know, for yum. It is the largest KFC
market and Yum's second largest pizza market. Remarkably successful in a
market, you know, full of restaurants. It's not like
there aren't a lot of restaurants in China. They're everywhere. Known for more than just
chicken. A typical menu in China can include items
like rice congee, steamed dumplings and egg tart. Digital ordering and
delivery are also a major component. And here. I can choose the the nearest
restaurant and this one is a restaurant I'm right now. Kfc China claims it has over
4300 million members. It identifies members as
someone using a member coupon, QR code or ordering
through its app. A million of those
customers visited at least 100 times in 2023, but the
business has faced headwinds, including food
safety scandals, lockdowns due to Covid, concerns
about the health of the Chinese consumer, as well
as questions about plans for future growth. Definitely has more US
brands enter. Kfc might see itself facing
more direct competition from the faces its used to
seeing only in the US. Yum China, the operator of
KFC China, generated revenue of $7.2 billion from its
KFC segment in 2022. Over the coming three
years, the company plans to return $3 billion to
shareholders. So how did KFC overtake
other fast food chains in China like McDonald's,
Starbucks and Taco Bell? And can the business
continue to grow? Cnbc traveled to Hangzhou,
China to find out. The first KFC franchise
opened in Salt Lake City in 1952, but the chain didn't
get its start in China until 1987. A leg up on the
competition and an infusion of Chinese characteristics
into the menu were key to its early success. So 36 years ago, we only
serve eight products in a restaurant, including
original recipe chicken. Um, right now our menu is
bigger, uh, 40 items on the menu. However, every year,
including 2022, we introduce 180 different products to
our customers in China. They more than any other
Western food concept in China. Early on understood
the need and necessity of not only introducing, uh,
you know, flavors and menu items that would resonate
with the Chinese palate, but adjusting their menu. At that time, it was still
owned by PepsiCo. And so PepsiCo was more
concerned with beating Coke and less concerned with
what its restaurant brands were doing. So they kind of
went full throttle in China. Pepsico spun off its fast
food business, including KFC, Pizza Hut and Taco
Bell in 1997. The business was later
renamed yum! Brands. By 2000, China
accounted for 12% of the sales in the international
restaurants category at yum! Brands. Other fast food
chains were capitalizing on China's economic
transformation, too. Mcdonald's launched there
in 1990. The reason that yum is
larger, the reason that KFC is larger in China versus
McDonald's is really twofold. The first is that
yum owned the distribution business in China, so it
just allowed them to access smaller cities first and
get that first mover advantage. And the second
piece is that chicken as a part of KFC is just
naturally more appealing in China, where chicken is a
larger protein than beef. They look at Colonel Sanders
and there is a Chinese expression for them. For Colonel Sanders, they
call him like old grandpa. And so he's kind of an
iconic figure, just like Ronald McDonald, you know,
a representation as an American cultural icon. But the brand was hit with a
series of food safety scandals in 2012 and 2014
that weighed on its growth. Yum! Brands China division
saw same store sales decline 5% in 2014, and an
additional 4% the following year. It the brand was a bit tired
at that time. Uh, the stores were a bit
tired. Uh, the same store sales,
uh, was on negative double digit. Uh, we start to ask
the question, Will the Chinese people still like
fried chicken? End of 2015? Yum. China was having some
challenges that the same store sales recovery was
non-linear and was underwhelming. Investor
expectations. At the time. There was activist pressure
at the time to separate the two businesses that the
company adhered to. Yum brands spun off its
China business in 2016 to create Yum China, an
independent company incorporated in Delaware
and listed on the New York and Hong Kong Stock
Exchange. Joey Wat took over the role of CEO in 2018. Today, the company has over
14,000 restaurants in 1900 cities and is one of
China's largest restaurant companies with exclusive
rights to operate KFC, Pizza Hut and Taco Bell brands
there. Unlike its US counterpart
yum! Brands, with 98% of its
stores franchised. Yum China owns and operates
the vast majority of its restaurants. In Yum China. Over 90% of our stores are
still owned by our company. They are not franchisees. I mean, the investment
payback of our store is incredible. In China. That ownership model has
helped to boost the company's store count. Yum
China had revenue of $9.5 billion in 2022, compared
with yum! Brands that had revenue of
$6.8 billion that year. Yum brands has over 55,000
restaurants in 155 countries and territories. When we run our equity store
in China, we can open our store very, very fast. We don't have to negotiate
with franchisees. How many do we open the
store in one province or the other one? We can execute
in a very, very high speed. I think. Usually when you
see this kind of behavior, it's usually indication
that they they prefer to keep most of the profits to
themselves rather than sharing those profits with
individual owners. And so therefore, it's kind
of an indication that on a unit level basis, the China
stores are not only well operated, but they're
profitable. It also benefits yum brands. Yum China pays a license
fee to yum! Brands of 3% of net sales
in the third quarter of 2023. China made up 25% of
yum! Brands KFC system sales. For comparison, the US, its
home market, only accounts for 15% of its system sales
every quarter. Investments in automation
and AI have also helped reshape the business. The first one is, uh,
delivery to home, and the second one is dining or
takeaway. And the third one is order
a coffee. So we'll choose this one
right now. In 2023, the company said it
would invest an additional 3.5 to $5 billion over the
next three years to improve its digital capabilities,
boost its store count and bolster its supply chain. Instead of having my staff
to order how many buns or how many burgers or how
many chicken to the store, this is done by AI already. Our staff don't have to
touch it going forward. How could I help our staff? The the next step from AI
to AGC is the the new technology allow the the
language to be spoken as a human. For example, our
staff, our manager will already have a watch. The watch will tell them,
oh, it's time to marinate another 50 chicken to
prepare for the next batch of customer. It is also allowed it to
trim staff. Yum China cut its workforce
by 10,000 people over the past seven years, while at
the same time almost doubling its store count
from 7500 restaurants to over 14,000. Digital orders, including
delivery, mobile orders and kiosk orders, accounted for
89% of Yum China's KFC sales in the third quarter of
2023. Yum! China's digital orders
exceeded $8 billion in 2022. Chinese consumers are
digital first in their behavior across the board. You cannot be retail
anything in China without being on top of digital
much more than in the US. So, you know, the fact that
most of these companies Walmart, Alibaba, all of
them, Zara, they're they're digital teams in China
often end up being the innovation center for the
rest of their operation. Globally. A trade war with the US and
rising unemployment have caused strains not only for
the Chinese economy but also for KFC. Economic growth in China is
expected to slow, from 5.2% in 2023 to 4.2% in 2025. Yum China recently warned on
its third quarter call that there's been a little bit
of slowdown, and it's hard to tell if this is
something that's seasonal, it might improve or if
there's just a general pessimism in the Chinese
economy. If you look at their
profitability, it's starting to taper. And then we have
to figure out, you know, to what extent is this related
to the overall sort of slowdown in the Chinese
economy, or is it or is it more related to the concept
itself? There's also some concern
that there might be a little bit of backlash or apathy
towards Western brands in particular, which might not
hit KFC to the same extent as, say, Starbucks. But it's still something to
consider. The pandemic also impacted
sales the number of Yum China stores temporarily
closed, or that offered only takeout or delivery
options, reached over 4300. In November 2022, total
revenue at Yum China declined 3% in 2022 from a
year earlier. Kfc's China's same store
sales declined 7% during that same period. Covid pandemic really did
put a hit on KFC. The only thing that kept
them alive was the delivery business. Kfc China established its
own delivery platform in 2010. By 2022, about 90% of
KFC's in China offer delivery, contributing to
39% of sales. But can KFC continue to
expand? Franchising might be one
option for future growth. In 2019, Yum China
announced its first KFC franchise at gas stations
with China Petrochemical and China National Petroleum. Combined, the two companies
operate more than 50,000 gas stations. Going forward, we're going
to open up more to franchisee business because
we have enough, um, our alumni, our employees who
are, you know, going moving on to the next thing you
know, you know, we might give them opportunity x Yum
China employee to be our franchisee. And if they do foresee the
opportunity franchise that actually potentially makes
their stock more interesting because within those 10,000
locations, they could sell those locations off to
individual families and recover a lot of capital,
which would really boost their stock. Coffee is another market KFC
is hoping to capture. Starbucks launched in China
in 1999. Today, there are over 6500
stores. K coffee, KFC's in-house
coffee brand, has about 300 locations, including inside
trucks, kiosks and small formats. Nationwide, KFC
China said it expects to sell 180 million cups of
coffee in 2023. We're seeing a proliferation
of of coffee concepts in China, given the fact that
it's high ROI, with low barriers to entry, and the
added benefit of the gross margin on coffee is far
better than really any other product or restaurant can
sell. Per capita consumption of
coffee in China is about five cups a year versus the
US, where it's closer to 400 cups annually. Total revenue for Yum China
in the third quarter of 2023 increased 9% from a year
earlier to $2.9 billion. But moving forward, KFC
China's biggest challenge might come from closer to
home as other Western fast food brands continue to
expand there. Now, a lot of them are
really leaning in, especially as the economy
has opened up since Covid. So we've seen, for example,
McDonald's is really doubling down on China. Starbucks has said multiple
times, no matter what happens to their stores in
China, that they are all in on China. Popeyes,
obviously a close competitor of KFC in the US. So that sets up an
interesting competition there in the future. Popeyes plans to open 1700
restaurants in China over the next decade, where
they. Only serving one third of
Chinese population. What happened to the other
two thirds? One reason we are not
solving the other two thirds is we just don't have
enough stores yet to serve them. We are not even close
to where do they live?