Yum (YUMC) China Plunges Following President Xi’s Reelection, Putting Lockdown Fears In Spotlight
3:43 pm Monday, October 24th, 2022
Chinese stocks are taking a big hit today and Yum China (YUMC), which operates over 12,000 KFC and Pizza Hut restaurants in China, is one of the weakest names among the group. The sell-off is primarily being spurred by the reelection of President Xi to a third term and the associated concerns about his strict zero COVID policy. Some mixed economic data from China, including a weaker-than-expected Retail Sales reading for September, may also be contributing to the weakness. However, given that YUMC has been so severely impacted by COVID-related lockdowns, we believe the reelection news is by far the more significant issue.
While addressing the Communist Party Congress over the weekend, Xi staunchly defended the zero COVID program, stating that the safety of the country’s citizens must come first. This policy, though, which is only implemented in China, has had a crippling effect on the country’s economy. Although China’s Q3 GDP of 3.9% did edge past the 3.5% expectation, the economy there is on pace to grow by the slowest rate in decades (not including the 2020 COVID year) in 2022.
Adding to investors’ angst, Li Qiang, the current Communist Party Chief of Shanghai, is in line to become China’s next premier in March. As Premier, Li will have considerable control over economic policy. That’s concerning because Li has been a very vocal advocate for Xi’s zero COVID approach, signaling that any softening of business restrictions is unlikely to materialize any time soon.
For YUMC, the reelection and the affiliated government appointments will likely prolong, and potentially exacerbate, its struggles.
In 2Q22, same store sales decreased by 16% yr/yr, with declines of 16% at KFC and 15% at Pizza Hut. During April and May, over 2,500 of YUMC’s stores were either temporarily closed or only provided takeaway and delivery services. The Shanghai market took the brunt of the zero COVID policy as only 30% of YUMC’s restaurants were open and able to offer limited services.
As a result of the sales deleveraging and commodity/wage inflation, restaurant margin contracted by 370 bps yr/yr to 12.1%. Combined with a 13% yr/yr revenue decrease, the margin deterioration caused EPS to plunge by 52% to $0.20.
The main takeaway is that the reelection of President Xi in China, and his appointments who have a similar hardline approach with COVID and lockdowns, means that YUMC will likely be contending with strict business restrictions for the foreseeable future.
