Pizza Hut focused on value promotions, smaller footprint

Yum! Brands painted a familiar picture during its third quarter 2012 earnings call today, with operating profits up 22 percent in China. As has been the case throughout the past several years, the big story for Yum! Brands is its growth and success in the China market.

Yum!'s other markets also turned in a solid quarter, with operating profits up 14 percent at Yum! Restaurants International (YRI) and 13 percent in the U.S.

Global system sales grew 6 percent, prior to foreign currency translation, including 22 percent in China, 4 percent at YRI and 1 percent in the U.S.

Same-store sales were up 6 percent in China, 2 percent at YRI and 6 percent in the U.S.

In development news, 394 new restaurants opened during Q3, including 192 units in China and 181 in YRI markets. Of these new units, 86 percent are located in emerging markets.

"About 60 percent of our profit is generated in emerging markets which is where the real economic growth in the world is occurring today. This growth, combined with the facts that we have powerful global brands and only two restaurants per million people in emerging markets compared with 58 restaurants per million people in the U.S. gives us tremendous confidence in our ability to continue our aggressive expansion," said CEO/chairman David C. Novak.

Strengthening brands in the U.S.

The company's objective with the U.S. is to improve the brand positioning for Taco Bell, Pizza Hut and KFC. Yum!'s Q3 was buoyed again by Taco Bell's latest product innovations in the Doritos Locos Taco and Cantina Bell menu. President Rick Carucci said he expects these initiatives to continue delivering strong results into 2013 with the introduction of new flavor varieties and line extensions to complement the current menu.

Novak said the Doritos Locos Tacos extensions have been pushed into 2013 because the testing's success led to a taco shell supply shortage.

Carucci added that the Doritos Locos Taco line is causing some customers to trade up from regular tacos. Similar results also seem to be coming from the Cantina Bell menu.

"Regarding the Cantina Bell products ... we are seeing more people at lunch time and that the people who buy Cantina products have higher ticket, which is obviously expected given the price point of the product," Novak said. "The other thing is our team loves it. Our (Cantina) products are skewed a little bit more towards lunch and female customers."

Novak added that Taco Bell learned a lesson from the fast casual segment that customers want higher quality food, even if they're going to have to spend more money. Those same customers want that food fast and convenient, and with Taco Bell's distribution around the country, the brand is well positioned to fit that demand.

Pizza Hut and KFC also contributed significantly to Yum!'s U.S. performance. Pizza Hut got a lift from its $10 any pizza and salad promotion, as well as its box promotions. The chain is also building momentum from a new, smaller footprint.

"This system has also successfully reversed its trend of declining units by introducing a smaller, less expensive delivery concept we call Delco Lite. After 10 years of unit declines, Pizza Hut added 53 net units in 2011 and expects to add over 130 net new units this year. Our franchisees are very excited about these initiatives and the returns that are generating," Novak added.

KFC's business is stabilizing and the main focus has been on operations. The company is making investments in technology and equipment to provide a consistent customer experience. This year's same-store sales have improved with the launch of its Bites menu item, as well as from a larger advertising presence.

China

In China, same-store sales grew 6 percent, with transactions down 1 percent. This is over last year's 19 percent same-stores sales growth with transaction growth of 27 percent. The company is driving record new unit development in the market and is expected to open more than 750 new units by year's end.

"We're acquiring the premier sites in the most vibrant trade zones and we're using our assets throughout the day with breakfast, delivery and 24 hour operations. Our new fast food business model balances great tasting food with high quality service and speed. We offer a balanced menu across multiple proteins and day parts and promote healthy lifestyles as well as focus on being rooted in China with continuous innovation," Novak said about KFC.

Pizza Casual Dining includes more than 700 units in 120 cities, with more than 150 new restaurants expected to open this year across cities of all sizes. The brand's menu is switched up twice a year. Pizza Hut Home Service – an emerging brand for Yum! – now has 140 units in 14 cities.

There have been growing concerns about China's slowing economy. However, Novak pointed out that it is still growing, with GDP up 7 percent in the second quarter; and expected to be up another 8 percent next year. Additionally, the middle class is expected to double in the next decade, and the infrastructure continues to expand, with new cities and clusters coming into play for possible penetration.

With 750 new units to open in China this year (an 18 percent rate), the company addressed concerns about moving too fast. Pat Grismer, chief financial officer, said: "We approach China development extreme rigor, taking care not too let our cash get out in front of our people capability. This development discipline has four key pillars." Those pillars include:

  • Allocating resources to China development with a 1,000-member team on the ground;
  • Selecting sites based on an intermittent understanding of retail development in China, fully informed by a proprietary database that grows in size each year;
  • Evolving the new store portfolio to optimize returns. For example, shifting development from Tier one cities where store margins are under some pressure to lower tier cities where returns are higher; and
  • Building a large pipeline of fully qualified restaurant general managers to ensure new stores deliver on their brand promise.

India, International

Yum! India division includes 495 restaurants with 100 new restaurants expected to open this year. The company is working on having leading brands in every category through KFC, Pizza Casual Dining, Pizza Hut Home Service and Taco Bell.

For the rest of YRI, Carucci said the company is en route to building 900 new units in 2012. The big focus has been on France, Germany, Russia and the African continent.

"In (France, Germany and Russia) McDonald's has about 2,900 units and makes well over a $1 billion in profits. Last year in these countries, YRI had 383 restaurants that made less than $30 million in profits. So we know we have a tremendous runway for growth," Carucci said.

Yum has taken a page from McDonald's France model and is now using a business rental program.

"I think McDonald's has shown us that the business rental models are where you can expand with good returns over the long-term and I think we've gone to school on that model and we think it can work for us," Novak added. "And the good news for us is we're just on the ground floor on this."

In South Africa, YRI has 650 KFCs. The company expects to have a presence in 17 countries outside of South Africa by the end of 2012, including Nigeria, Kenya and Ghana.

"Our primary objective is to build people capability, infrastructure and scaling these countries. We do not expect them to add significantly to our profit results in the next several years. However, we are pleased that we have started the journey in this part of Africa. With over 1 billion people, Africa can be a very significant business for Yum," Carucci said.

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