Yum China - Earnings Call - Q2 2025

Executive Summary

• Q2 2025 delivered record profitability: operating profit rose 14% YoY to $304M and OP margin expanded 100 bps to 10.9%, with restaurant margin up 60 bps to 16.1%.
• Revenue grew 4% YoY to $2.787B, while diluted EPS increased 5% YoY to $0.58; EPS was roughly in line with consensus and EBITDA modestly beat, but revenue was slightly below Street.
• Guidance: net new stores maintained at 1,600–1,800 for 2025 and CapEx revised down to $600–$700M (from $700–$800M), reflecting lower CapEx per store; management reiterated mid-single-digit system sales growth and expects company restaurant and core OP margins to moderately improve for FY 2025.
• Strategic and demand drivers: delivery sales grew 22% YoY to ~45% of total sales, digital sales reached $2.4B with 94% digital ordering, and membership expanded to ~560M; management emphasized balanced use of delivery platforms to drive top-line while protecting margin integrity.

What Went Well and What Went Wrong

What Went Well

• Record margins and profits: “We delivered double-digit growth in operating profit and substantially expanded our margins… OP margin… record high for the second quarter”.
• Same‑store sales and transactions: SSS turned positive at +1% with 10th consecutive quarter of same‑store transaction growth; system sales growth improved sequentially to +4%.
• Brand execution: KFC resilient (system sales +5%, OP +11% to $292M, OP margin 14.0%) and Pizza Hut sustained momentum (SSS +2%, OP +16% to $46M) with successful product innovations (Crazy Spicy Zinger; upgraded thin‑crust pizza).

What Went Wrong

• Delivery mix cost headwind: rider costs as a % of sales increased due to higher delivery mix; cost of labor rose 90 bps YoY to 27.2% despite operational efficiencies.
• Ticket average pressure: strong growth in small orders lowered average check; KFC ticket average is expected to decline slightly YoY in 2H despite mix effects.
• Interest/investment impacts: net income growth was muted (+1% YoY to $215M) due to lower interest income and negative mark‑to‑market equity investment impact (~$14M vs +$6M last year).

Transcript

Speaker 0

Good day and thank you for standing by. Welcome to Yum China second quarter 2025 earnings conference call. At this time, all participants are in the listen only mode. After the speaker's presentation, there will be question and answer session. To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your first speaker today, Ms. Florence Lip, Senior Director, Investor Relations of Yum China. Please go ahead. Thank you, operator. Hello everyone. Thank you for joining Yum China's second quarter 2025 earnings conference call. On today's call are our CEO Ms. Joey Wat and our CFO, Mr. Adrian Ding.

I'd like to remind everyone that our earnings call and investment materials contain forward looking statements which are subject to future events and uncertainty. Actual results may differ materially from these forward looking 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 which is available to the public through our investor relations website located at ir.yumchina.com. You can also find a webcast of this call and a PowerPoint presentation on our IR website. Please note that during today's call, all year over year growth results exclude the impact of foreign currency unless otherwise noted.

Now I would like to turn the call over to Joey Wat, CEO of Yum China. Joey, hello everyone and thank you for joining us. I'm excited to share that we delivered solid results once again in quarter two. Thanks to the dedication of the entire Yum China team, we achieved second quarter record highs in revenue, operating profit and OP margin. Our dual focus strategies have played a crucial role. First, our emphasis on both same-store sales and system sales growth is bearing fruit. Quarter two, same-store sales growth turned positive at 1%. Same-store transactions grew for the tenth consecutive quarter. We achieved this while opening 336 net new stores in a quarter. System sales growth reached 4%, showing a sequential improvement of 2 percentage points. This aligns with the mid-single-digit range we targeted for the full year. At the same time, our margins and profit increased significantly.

Despite our large scale, restaurant margin improved by 60 basis points and operating margin by 100 basis points. Year over year, operating profit grew 14% to $304 million. By brand, KFC remained resilient, achieving 5% system sales growth and a very healthy restaurant margin in quarter two. The brand now operates over 12,000 stores in more than 2,400 cities, having entered around 300 new cities during the past year. We are rolling out innovative modules such as K Coffee Cafe, leveraging KFC store space, various in-store resources, and membership to drive incremental sales and profit both online and offline. Pizza Hut sustained its momentum, achieving 2% same-store sales growth in quarter two. Our new menu resonated with consumers, contributing to a 17% increase in same-store transactions. The brand now comprises over 3,800 stores and 900 cities, having entered around 150 new cities during the past year.

Pizza Hut's margins also improved in the first half through our efforts to streamline and automate operations and enhance supply chain efficiency. These results were driven by our due focus on innovation and operational efficiency. I'm excited about how well positioned KFC and Pizza Hut are to capture the growth potential in China. Our sales initiatives were instrumental in driving our results by offering innovative and good food at great value. We achieved over 1 billion total transactions in the first half, setting a new record. At KFC, we add creative twists to our well-loved classic products like Zinger Xianna Qi Tui Bao. In quarter two, for a limited time, we launched a new flavor, Crazy Spicy Zinger. The extra spicy chicken and eye-catching red tint drove excitement. Total Zinger sales soared by over 30% during the promotion period.

In spicy-loving provinces such as Jiangxi and Sichuan, Crazy Spicy Zinger sales were especially high. At Pizza Hut, we took our thin crust pizza to a new level and showcased our expertise. This new thin crust pizza, handcrafted with lighter dough, features a 10-inch size that allows for more cheese and toppings. This pizza is perfectly crispy and satisfying. Customers love it. Pizza Hut also brought back a popular all-you-can-eat campaign. For limited periods each year, we offer our customers an indulgent meal at an excellent value. This time the menu featured juicy Tama hot stick, some on Liu Pai, flavor-packed seafood, exotic durian pizza, and more. The campaign generated genuine excitement and drew in a wave of new and young customers eager to savor the diverse and abundant choices. Emotional value is equally important to our customers.

On Children's Day, we achieved the highest daily sales yet in 2025 by partnering with beloved classics like Hello Kitty and Pokémon. We sold over 4 million new sets with delightful toys during the promotion. These collaborations sparked social buzz and attracted a wide audience, both children and adults. The star of the show was a Hello Kitty shaped camera toy, which became an instant hit in quarter two. Delivery sales were around 45% of the total sales mix, up from 38% in quarter two last year. The growth was driven mainly by deals on our own channels and increased promotions on delivery platforms. We are open to working with all platforms but at our own pace. Our goal is to serve customers where they are. By June, all our brands were listed on major third-party delivery platforms, leveraging platform traffic.

We increased exposure for our emerging businesses such as K Coffee Cafe and attracted new customers to our core brands. We used a balanced approach, driving top line while protecting margins. In addition to capturing sales opportunities in a disciplined manner, we carefully manage price perception and pursue other long-term benefits. As a reminder, sales outside the delivery aggregators account for around 70% of our total sales. Our own channels, including super app and mini programs, offer exciting exclusive deals and membership privileges, continuing to enhance member stickiness. Let me now turn the call over to Adrian Ding to discuss our results in detail. Afterward, I will share additional color on our technology initiatives.

Speaker 1

Adrian, thank you, Joey. Let me start with KFC. In quarter two, KFC system sales increased 5% year over year. Same-store sales grew 1%. Our same-store transaction index remained even with last year, the ticket average increased by 1% to 38 yuan. Strong growth in smaller orders caused a downward trend in the ticket averages for both delivery and dine-in. This was offset by the higher delivery mix, which carries a higher ticket average, resulting in a slight increase in overall ticket average. KFC expanded its restaurant margin by 70 basis points through favorable commodity prices driven by supply chain efficiency gains and through streamlined operations. Operating profit grew 10% year over year to $292 million. We added 295 net new stores in quarter two, bringing our total to 12,238 stores. New store payback remained healthy at two years.

New stores bring us closer to our customers and our side-by-side module. K Coffee Cafe increases the number of occasions we can serve them. This quarter, we opened 300 K Coffee Cafes, bringing our total to 1,300 locations nationwide. Average cups sold at K Coffee Cafes continue to increase in the quarter, bolstered by our menu innovations and growth in delivery. This summer, our Eye Sparkling Americano became increasingly popular, representing over half of beverage sales. In June, we offered a wide range of sparkling flavors from our signature apple flavor to our new Lychee Brandy flavor. K Coffee Cafes have been effective in driving incremental traffic, sales, and profit. Given the progress we have achieved in the first half of the year, we're raising our 2025 target from the previous 1,500 to 1,700 locations. Let's now turn to Pizza Hut.

Pizza Hut has sustained its growth trajectory since reaching an inflection point in 2024. Same-store sales growth turned positive to 2%. Same-store transactions grew significantly by 17%. The ticket average was 76 yuan, 13% lower year over year. These results align with our strategic focus on map market positioning and are supported by healthy margin expansion. System sales in quarter two grew by 3%. Pizza Hut's moderate system sales growth relative to its same-store sales growth was due primarily to the strategic optimization of the brand store portfolio. We closed some larger underperforming stores and opened new smaller stores. The total store operating weeks were also affected by the timing of the closures and openings. Store closures came earlier while store openings were later. We expect both factors to normalize in the second half of the year.

Quarter two marks the fifth consecutive quarter of year over year margin expansion for Pizza Hut. Our enhanced operational efficiency offset the impact of our all you can eat campaign. Restaurant margin expanded slightly to 13.3% and operating profit grew by 15% year over year. Pizza Hut reached 3,864 stores with the addition of 95 net new openings in the second quarter. New store payback remained healthy at two to three years. We remain confident in achieving double-digit % net new store growth for Pizza Hut in 2025. Pizza Hut WOW stores are making progress. We saw a meaningful improvement in profitability for the converted WOW stores. We also opened new WOW stores in over 10 new cities where Pizza Hut had no existing presence. The latest CapEx per store ranged from ¥650,000 to ¥850,000, with streamlined operations and lower entry price points.

Our WOW model broadens Pizza Hut's addressable market, enabling it to enter low-tier cities more effectively. Let me now go through our quarter two P&L. System sales grew 4% year over year within the range of a full year target. Same-store sales grew 1%, turning positive. Our restaurant margin was 16.1%, 60 basis points higher year over year. Savings in cost of sales and occupancy, other costs offset increases in cost of labor. Cost of sales was 31.0%, 50 basis points lower year over year. Ongoing benefits from Project Red Eye along with favorable commodity prices contributed to the improvement. We passed some of the savings onto customers, offering great value for money. Cost of labor was 27.2%, 90 basis points higher year over year due to higher rider costs as a percentage of sales.

While we continue to lower rider costs per delivery order, the higher delivery mix led to higher rider costs overall. Non-rider costs as a percent of sales remained stable year over year and our efforts to optimize operations offset low single-digit wage inflation. Occupancy and other was 25.7%, 100 basis points lower year over year as a result of cost optimizations in a number of areas, notably utilities and streamlined operations. G&A expenses were 4.7% of revenue and 30 basis points lower compared to 5.0% in the prior year. Project Fresh Eye generated incremental benefits year over year. Our OP margin was 10.9%, 100 basis points higher year over year, driven by improved restaurant margin and G&A. Operating profit was $304 million, growing 14% year over year. Core op also grew 14% year over year.

Effective tax rate was 25.8%, 60 basis points higher year over year, primarily due to the increased tax repatriation resulting in higher withholding.

Speaker 0

Tax.

Speaker 1

Net income was $215 million, growing 1% year over year. As a reminder, we recognized $6 million less in interest income in quarter two this year due to a lower cash balance resulting from the cash we return to shareholders. Our mark to market equity investment also had a negative impact of $14 million in quarter two compared to a positive impact of $6 million in quarter two last year. Diluted EPS was $0.58, growing 5% year over year or 15% excluding mark to market equity investment impact. Let's now move on to capital returns to shareholders. In the first half of the year, we returned a total of $536 million to shareholders, including $356 million in share repurchases and $180 million in dividends. For the second half of 2025, we announced our share repurchase agreement totaling $510 million, a 43% increase from our share repurchases in the first half.

Assuming a quarterly dividend of $0.24 per share, we expect to return at least $1.2 billion in 2025. We remain committed to returning $3 billion to shareholders from 2025 through 2026, on top of the $1.5 billion in cash we returned in 2024. The average annual capital return is around 8 to 9% of our market cap. We maintain flexibility regarding the split of the capital returns to shareholders between the two years, taking into account factors such as stock price, market conditions, and our cash needs. Our cash positions remain healthy with $2.8 billion in net cash as of the end of the quarter. Finally, turning to our 2025 outlook, despite the complex and fluid market conditions, we are reiterating our full year targets for the net new store openings and system sales growth.

We are revising our full year outlook on restaurant margin and core opening margin to reflect our first half performance and our latest expectations for the second half. Let me provide additional color in terms of store openings. Overall, we anticipate the ramp up in net new store openings in the second half of the year with more gross openings and fewer store closures. We have a solid pipeline and remain confident in achieving our target of 1,600 to 1,800 net new stores in 2025. We expect the franchise store mix of the net new openings for the full year 2025 to be similar to the first half, which was 41% for KFC and 26% for Pizza Hut. That means we'll meet our guidance of 40 to 50% for KFC and 20 to 30% for Pizza Hut ahead of schedule.

We anticipate the franchise mix of our net new stores to further moderately increase within these ranges over the next few years. With our store expansion plans unchanged, our target of mid-single-digit system sales growth for the full year 2025 remains in place. This range is also applicable to the second half. Predicting same-store sales growth is more difficult as consumer spending remains rational for quarter three. We're working hard to achieve 11 consecutive quarters of same-store transaction growth. The ticket averages for both delivery and dine-in continue to show a downward trend due to an increase in smaller orders. We aim to achieve steady same-store sales levels year over year in the second half. Regarding delivery, we maintain a disciplined approach to capturing sales. We leverage delivery platforms to enhance visibility and increase traffic, especially for our emerging businesses.

While sales from smaller ticket beverage orders grew nicely, the overall impact on our business is more limited. Additionally, higher delivery mix results in higher rider costs and our balanced and nimble approach enables us to drive sales while preserving price integrity and protecting margins. Let me now go through our margin expectations for the second half. All comparisons are stated on a year-over-year basis. While we continue to enhance operational efficiency, we face tougher comparisons as more meaningful benefits from Project Fresh Eye and Red Eye were already in larger space in the second half. Additionally, rider costs driven by a higher delivery mix continue to be a headwind for KFC. Our aim is to maintain relatively stable restaurant margins.

For Pizza Hut, we expect restaurant margin to slightly improve year over year considering the impact of streamlined operations partially offset by higher delivery costs and a higher base versus the first half. With G&A percentage improving a bit, we expect Yum China core OP margin to also slightly improve as quarter four is traditionally our low season. With smaller sales and profits, margins may be a bit more volatile with our outperformance in the first half. For the full year 2025, we expect the restaurant margin for KFC and Pizza Hut as well as the company's core OP margin to moderately improve. On the CapEx side, we are revising our full year CapEx guidance down from around $700 million to $800 million to $600 million to $700 million mainly due to lower CapEx per store. With that, let me pass it back to Joey for her closing remarks.

Speaker 0

Thank you, Adrian. Our end-to-end digitization initiatives are central to our efforts to drive growth and efficiency. We've been working on this for over a decade. AI, both analytical and generative, is simply our latest iteration. In June, we held our first ever AI Day, which featured our very first Yum China employee hackathon. The enthusiasm for AI Day was extraordinary. Participating teams from across the country represented diverse backgrounds in operations, supply chain, finance, and more. I was impressed by how they proactively identified frontline needs and tackle problems with innovative solutions to support promising projects. We set up a ¥100 million Yum China Frontline Innovation Fund and committed to making AI Day an annual event. Our employees are embracing new technologies like Gen AI, and by doing so, they help us further deepen our strategic moat. Our end-to-end digitization is just that.

It starts at our customers, extends to our RGMs, and all the way back to our suppliers, and touches everything in between: customer service, our membership programs, store operations, store management, shared service functions, logistics centers, and upstream suppliers. We look forward to sharing more details during our upcoming Investor Day in November. Before we turn to Q&A, let me recap the three key takeaways from today. First, we achieved solid results in quarter two despite navigating a dynamic environment. Same-store sales growth turned positive. System sales growth sequentially improved. Restaurant margin expanded year over year. Second, we remain confident in achieving our full-year targets for 2025, including new store openings, system sales growth, and margin expansion. Lastly, our new initiatives are shaping up well, expanding our addressable market for years to come. For example, K Coffee Cafe leverages KFC's resources to scale up.

Pizza Hut's WOW model is making meaningful progress in improving its profitability and helping us penetrate into lower-tier cities. Our business remains resilient in a rapidly changing landscape. Our dual focus on operational efficiency and innovation continues to generate strong results. Looking ahead, we are confident in our ability to grow our brands, enhance our competitive edge, and unlock more opportunities in China. With that, I will pass it back to Florence. Thanks, Joey. Now we will 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. Operator, please start the Q and A. Thank you. We will now begin the question and answer session. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced.

To withdraw your question, please press star 11 again. Please stand by while we compile the Q and A roster. We will now take our first question from the line of Michelle Cheng from Goldman Sachs. Please go ahead. Michelle. Hi Joey, Adrian, Florence, thanks for taking my questions and congrats again for the very strong results. My question is about the delivery. We see our delivery business already grow very strong in second quarter and these also lead to a very solid same-store sales growth in second quarter. Given the elevated delivery platforms promotion activities into third quarter, can you share with us any thoughts about the upside in the business and same-store sales growth into third quarter? Also, aside from the revenue, I think you touched base a little bit regarding the margin and also higher rider cost.

Can you elaborate a little bit more on these impact on UE, especially we also heard that the platform also wants brands to participate in some of the promotion campaign? This is my question. Thank you. Thank you, Michelle. Let me give some context and Adrian can fill in more details. The biggest dynamic for Q2 indeed is the intense delivery platform competition, particularly in the small orders or related to drinks in our industry. What I want to provide as context is such a dynamic or disruption is not new to us. We've been through it. The last time the platform competition was so intense actually was back to 2017. We might have learned a thing or two for the quarter two. One thing we really go back and focus on is really focused on building our core competency.

Anything from food innovation, supply chain, digital solid execution and providing compelling value to a customer is still the most important thing instead of buying sales. As I mentioned in my earlier prepared remarks, 70% of our sales outside the third-party delivery aggregator are still within our control. For Yum China's approach for quarter two, we have adopted a balanced approach. You know, balanced approach in the short term to drive the top line, protect the margin, and preserve the price integrity of our brands, which is incredibly important actually. In the long term, we also, you know, look at how to build the long term benefit to ensure sustainable growth throughout the last few months. Interesting dynamics. With that, I'll pass to Adrian to provide more details.

Speaker 1

Sure. Thank you Joey and thank you Michelle. I think Joey summarized pretty well on the delivery dynamics and our philosophy and I'll briefly comment on the SSG outlook for the second half related to our question. Michelle and then now and later I'll go through the UE outlook as well. As I mentioned in the prepared remark, predicting SSG is more difficult given the dynamic market and macro consumers stay rational and delivery platform dynamics are evolving as Joey mentioned. As a reminder, we faced tough comparison from the aggressive promotions and higher same-store sales index back in the second half of last year. With this said, we are working hard to achieve a steady same-store sales levels year over year as I mentioned in the prepared remark and 11 concept quarters of same-store transaction growth.

Then coming to UE, we believe the main impact from delivery aggregators, you know, subsidy war is on our COL or rider cost. For COL, we face continual headwind from a higher rider cost with higher delivery mix. Even with a lower cost per delivery order, the rider cost as percent of sale are expected to increase. We aim to maintain non-rider cost stable, offsetting the low single-digit wage inflation through more streamlined operations. Now I'll also briefly comment upon COS and O&O given this is related to UE as well. For COS, we expect it to improve year over year for the full year with the ratio to be between 31% and 32% for Yum's fee and for KFC as well.

For Pizza Hut, as I mentioned in one of the previous Q&As in the earnings call, we expect the full year COS to be 32% to 33% in the second half. We're lapping a more meaningful benefit from Project Red Eye last year. Tailwind from favorable commodity prices, as you can imagine, will gradually decrease or gradually reduce. We'll also dynamically adjust our promotional intensity depending on market condition on competitive dynamics obviously. Lastly, in terms of O&O, occupancy and other cost as a percentage of sales is likely to slightly improve year over year for the second half as well. We continue to explore optimization opportunities to offset cost increases.

Overall, from margin perspective, as I mentioned in the prepared remark for KFC, we expect that to be stable, relatively stable year over year for the second half and we expect Pizza's restaurant margin to slightly improve for the second half. As a result, for Yum China as a whole, the restaurant margin will slightly improve in the second half as well. Hopefully that address your question, Michelle. Thank you.

Speaker 0

Yeah, very clear. Thank you, Joey. Thank you, Adrian. Congrats again. Thank you. We will now take our next question from the line of Lillian Lu from Morgan Stanley. Please ask your question. Hey. Thank you. Hey Joey, Adrian, and Florence. I have a question about the new floor Maxing Zhou Yi mentioned. This is very important for driving long-term growth, in particular for Pizza Hut WOW. Do we have store opening targets right now for this year and next year? Given that it seems we have more confidence about the Pizza Hut WOW performance, and also Joey mentioned there has been meaningful improvement, can you share a little bit of detail about the operation? That is, what kind of margin level right now we're achieving or any targets we have on the profitability and also the growth pace. Thank you. Thank you, Lillian.

Mildcon is very exciting and we started our first store, I think, last May, May last year. By now we have over 200 stores. You know, all the fundamentals, the menu, the operation, the margin, we like what we see. The exciting part, the most exciting part, is among the over 200 stores, 10 stores are new and they opened in cities that are new model in new city. We like what we see about the sales, the margin level, and the OP level. That is incredibly important for the brand because for the first half of the year, KFC opened stores in 300 new cities and Pizza Hut opened in 150 cities. This is a much higher number of new cities compared to previous years.

The Pizza Hut WOW model will be good to help Pizza Hut penetrate into lower tier cities because we talk about, we know that, and we have very clear understanding internally that between the KFC and Pizza Hut, the delta is 1,500 new cities. Historically, the traditional pizza model is just not sharp enough to enter the lower tier city, and now we have one. That is incredibly exciting on top of many other things in addition to bar. That's why we suggest that 2024 is the inflection point and thus more opportunity. I'll pause here. Adrian, you have a bit more.

Speaker 1

Sure, sure. In terms of the guidance on net new open for WOW Store, Lillian, we are not giving guidance for net new open for this particular model. Given it's a new model and especially given its potential significance within the Pizza Hut brand, we do take time to develop and further iterate and evolve the model, and that's why we don't give open guidance. You are right that we did meaningfully improve the profitability of the WOW model. Actually, sequentially improved in all the line items, as a result of the project Red Eye initiative, as a result of a more efficient and streamlined operation, labor scheduling and all that O and O, you know, in terms of smallware, utilities and a little bit amp as well. We do see a meaningful improvement in the profit.

With this said, the profitability of a WOW model for the converted store is still slightly less than, you know, the Pizza Hut as a brand overall, still less than the main model. What is exciting is for the new stores, as Joey mentioned, we opened around 15 new stores for WOW. The capital expenditure is somewhere between RMB 650,000 to RMB 850,000 and the sales performance initially was quite encouraging. Obviously, there might be some honeymoon effect there. With the current sales level, the margin is actually pretty, pretty satisfactory. We will continue observing the performance after the honeymoon period. Once we get more concrete performance of all the new model or the new WOW Store as well as the converted store, we'll provide more guidance on the financials as well as net new open for this particular model.

In a nutshell, we are quite encouraged by the WOW model development. It's one of the major breakthroughs over the past few years for Pizza Hut and we continue to develop the model. Thank you, Lillian.

Speaker 0

Thanks a lot. Dohee and Adrian. Thanks. Thank you. Our next question comes from the line of Ann Ling from Jefferies. Please ask your question. Hey, thank you. Thank you, high management team. Also, questions on Pizza Hut. I just wonder what will be the potential ultimate goal in terms of restaurant margin as well as operating margin. If I let you know, take a look at, like, you know, all the way back, you know, back in the year 2013, it can be as high as KFC, right? You know, with 19% restaurant margin and 15% operating margin. Of course, you know, it is a very different business model as well and a different price point, you know, more, more high end.

My question is, you know, based on the current model, what would it take to further improve the operating margin as well as the restaurant margin or it is not realistic for me to aim at that kind of target over time. Thank you. Hi.

Speaker 1

Hi Ann, thank you for the question.

Speaker 0

Hi.

Speaker 1

I would like to leverage this opportunity to do a little bit of advertising for our Investor Day this November in Shenzhen. You know, obviously at that time we'll provide some more longer term guidance, you know, potentially including the Pizza Hut restaurant margin. Just to briefly address your question, right, speaking of Pizza Hut margin, this year, as I mentioned in the prepared remark for second half, we expect the restaurant margin to slightly increase year over year for the second half. With a pretty significant outperformance in the first half by 110 basis points in restaurant margin expansion for the full year, the Pizza Hut's restaurant margin is actually improving pretty moderately and pretty nicely. Speaking of mid to long run Pizza Hut margin, we do see opportunities for improvement in all the three key line items for Pizza Hut's margin.

That's why in the previous earnings we did mention that in the mid to long run, hopefully Pizza Hut's restaurant margin will improve to somewhere between where it is today and KFC. Speaking of COS, right, last year the pizza COS was roughly 32.7%. This year we guided a, you know, year over year improvement in COS. For the longer term, you know, our optimal COS range is always 31% plus or minus 1%. There's a, you know, good room for potential improvement there for COL. Currently it's slightly north of 28% for PCOL. In the mid to long run, given the efficiency improvement, given the streamlined operations, given the automation and centralization of the processes, etc. we do see a little bit of COL improvement potential there as well. For O&O for AMP, right?

As I mentioned in previous earnings, although we don't disclose the exact AMP split by the two brands, Pizza Hut AMP is a bit higher than KFC. We do see potential there and depreciation, you know, our previous capital expenditure per store, that's $1.2 million RMB per store. This quarter, as you notice in our presentation, it's lower to $1.1 to $1.2 million per store already. It's like, you know, 5% to 10% down already. If you think about the WOW store development, right, the capital expenditure for WOW store is RMB 650,000 to RMB 850,000 per store. With all that you can expect the depreciation for Pizza Hut to also improve, you know, over the years to come. All in all, you know, I would say there is good room for improvement for mid to long run for restaurant margin.

We have not yet given any guidance on a quantitative or figure level, but we might do so in November. Let me advertise for Investor Day again and thank you for your question.

Speaker 0

Okay, thank you, thank you, thank you. We will now take our next question from the line of Chen Luo from Bank of America. Please go ahead.

Speaker 1

Hi Joey and Adrian. Congrats again on the results. My question is again related to the online platform's delivery subsidy war starting from Q3. Is it fair to say that the majority of the subsidies are bound by the platforms and we only share a very limited portion of the subsidies? That's all my question. Thank you. Thank you, Luochen. In terms of the subsidy and whether the merchant contributes to the subsidy, it's actually rather dynamic. In general, as you can imagine, the bigger merchants or bigger brands like ourselves do enjoy more favorable subsidies and do enjoy a more favorable subsidy split. Sometimes the subsidy comes to the entirety of the platform's expense. Sometimes we do share a split. Given it's very commercially sensitive, we are not able to give exact guidance on the split.

You can imagine for the larger merchants like ourselves, we are doing more favorable subsidy arrangement and subsidy split. Hopefully that addresses your question. Luochen, just a follow-up question if I may. Is it fair to say that the online platform subsidies won't have any major impact on our margins in Q3? Luochen, we don't give quarterly guidance on margin, but for the second half, as I mentioned for KFC, we do expect the restaurant margin to be relatively stable for the second half. Year over year, we do expect Pizza Hut margin to slightly increase for the second half. This guidance actually took into account the subsidy by the aggregators and the current delivery dynamics. For Q3 and Q4 split, we are not giving the guidance. I do want to give a reminder that Q4 is typically our smaller quarter with smaller sales and smaller profitability.

It's a bit more volatile there.

Speaker 0

Thank you.

Speaker 1

Okay, got it. That's very helpful, thanks and congrats again.

Speaker 0

Thank you. Our next question comes from the line of Brian Bittner from Oppenheimer and Company. Please go ahead.

Speaker 1

Hi. Thank you. Yeah, congrats on same-store sales turning positive in 2Q. A big piece of this at KFC was the average check change. Average check went from 4% drag in the first quarter to a 1% tailwind in this quarter. Can you just talk more specifically on what drove that trend change from 1Q to 2Q? Do you anticipate average check at KFC to remain positive in 3Q and 4Q and into 2026? Excellent. Thank you. Brian. Indeed, KFC's ticket average was 38 yuan for quarter two, which is enjoying 1% tailwind. The strong growth in smaller orders caused a downward trend in TA for both delivery and dine as I mentioned in the prepared remark. This was offset by a higher delivery mix, which carries a higher ticket average for delivery. The mix impact actually offset the drop in TA in both the channels for the second half.

We actually expect the downward trend in TA for both the delivery and dine to continue, and we aim to contain the year-over-year decline to low single digit overall for KFC in the second half and maintain a relatively stable restaurant margin. In other words, the impact of the decrease in TA for both the dine and delivery channel in the second half more than offsets the increase in delivery mix, and thereby the TA for KFC will have a slight decrease year over year. What I would like to caution is this decrease in TA is not necessarily caused by the promotion intensity with discounts. It is more caused by the mix and incremental small orders we're getting for both the dine and delivery channels. For instance, if you think about KCOFFEE, the average TA is only mid-teens RMB, right.

That's incremental and that helps our incremental sales and profit. That's definitely rational for us to do as much business like that as possible, and similarly for breakfast, right. No TA day part, but we do have the opportunity of lots of incremental orders, so we do a bit of that. The mix actually is the major factor that drives the lower TA. We do expect the margin to be stable year over year in the second half for KFC.

Speaker 0

Thank you, Adrian. Let me add just two comments for this question, Brian. In the longer term, we are expanding our addressable bond market, so as Adrian mentioned, the drinks, the smaller order, but also lower tier cities. As we enter even more aggressively into lower tier city, the ticket average there is indeed lower, but the profit margin stays, that's key. Secondly, in our business, the ultimate focus among all is to drive the same store transaction growth, which we are delivering. Because of our pretty robust management of margin, with the movement of the TA, even with the headwind, we managed to protect the margin, and I think that capability is demonstrated even more in Pizza Hut than in KFC. Net net, we do have a very balanced approach of TA profitability. Big order, smaller order, but the ultimate focus is same store transaction growth. Thank you, Brian.

Right, thank you. We will now take our next question from the line of Christine Peng from UBS. Please go ahead. Thank you, management, for addressing my question. My question is about the CapEx. The earlier presentation Adrian mentioned, the CapEx guidance has been lowered from now the $600-700 million. Adrian, can you share with us more details in terms of the underlying reason for the CapEx cut and any colors for 2026 or even beyond?

Speaker 1

Sure Christine, thanks for the question. If you look at our guidance for CapEx, the previous guidance of $700 million to $800 million is assuming a same assumption of manual open of 1,600 stores to 1,800 menu stores and that target has not changed. The key delta there is really the CapEx per store. As you may have noticed from our presentation uploaded earlier today, the CapEx per store of KFC has lowered from RMB 1.5 million per store to around RMB 1.4 million per store. I'm talking about RMB Yuan, and then the CapEx per store for Pizza Hut has lowered from RMB 1.2 million per store to RMB 1.1 million per store. With that 5% to 10% improvement CapEx per store, we're lowering our guidance from $700 million to $800 million to $600 million to $700 million.

Another perspective is if you think about first half actual this year versus last year, there is a decrease in capital expenditure for the first half actual and that, in addition to the lower CapEx per store, indeed the lower equity net new open for the first half is also partially contributing to that. As we mentioned, we do expect the second half of net new open to pick up in pace and we are quite confident in our ability to achieve our guidance of the manual open 1,600-1,800 range. Hopefully that addresses your question Christine.

Speaker 0

Yeah, thank you. Can I just follow up, any indication in terms of the trend beyond 2020, in 2026 and beyond, will this trend be continuing? Meaning that in the future should we expect $600–700 million of CapEx per year, or is there any further room to cut the CapEx? Thank you, Adrian.

Speaker 1

Yeah, sure, sure. I mean I was originally planned to give this guidance in November, but you know I think qualitatively you are right that going forward our capital expenditure per year will be similar to our guidance for this year, and then we are keeping our equity menu open relatively stable year over year, and then obviously franchising is incremental. On top of that, obviously franchising is not taking any capital expenditure. Hopefully with that in mind, with improvement, profitability, operating cash flow, with a relatively stable capital expenditure, our free cash flow will increase at a nice pace. Thank you, Christie.

Speaker 0

Thank you, Adrian. Thank you. Our next question comes from the line of Sijie Lin from CICC. Please ask your question. Thank you, Jerry and Adrian. I have one question on the franchise mix because we are seeing the franchise mix of door opening quickly achieves our previous guidance. When we decide whether to open one franchise store, will we decide to open one franchise store instead of one company-owned store because of macro uncertainty, or do we decide to open one franchise store only because this location is only suitable for a franchise store in the foreseeable future? I'm asking this because after all, the profit contribution of one franchise store is less than one owned store, right? Trying to understand how to achieve the optimal balance and maximize profit.

Speaker 1

Thank you.

Speaker 0

Thank you, Sidhya. The context of accelerating franchisee store is based on one alignment within our company, which is the franchise store are incremental because our equity store actually are fairly profitable. It would make sense to our business if we open incremental franchise. There are two types of franchise stores we are talking about, and internally we are quite clear about the focus and strategy. One is the lower tier cities store that are probably more effective to be managed by franchisees, and sort of our management efficiency in those locations are not as good as franchisee, and those are one type of incremental franchise store, so lower tier city. Second is strategic channels such as certain store in sort of high traffic, sort of the high speed rail location or tourist location, certain sites that we could not obtain but the franchisee had.

Those are what we call strategic channel franchisee store. These are the two focus. Thank you, Joey. Thank you, Suju. Thank you. In the interest of time, we will take our last question from Ethan Wang from CLSA. Please go ahead.

Speaker 1

Thank you. Good evening. My question is competition because it seems many other restaurants or drinks company are being pretty active in this round of delivery subsidy battle. For us, since we're just doing things our own way and Joey mentioned the company has learned a lesson back in 2017, I'm just wondering when everyone else is doing a lot of promotions in some way may sacrifice the margin trying to take market share. What's our take on that? At the same time, do we think the competition environment actually worsens in the second quarter? That's my question. Thank you.

Speaker 0

Thank you, Ethan. China market is always very competitive. It's just in different forms and shape. Quarter two happened unexpected. Thank God that we have learned few lessons. One lesson, as I mentioned earlier, one lesson we learned is we don't buy sales. Back to 2017, KFC business was very robust and we have a nice balance of the incremental sales we can get versus the margin and Pizza Hut. Actually, that was before I managed the Pizza Hut. Business was going a bit quite aggressive to get the subsidies to get the incremental sales. By 2018, obviously when the subsidy was pooled, then the business sales suffered quite a bit. We have seen how things play out. By the time quarter two, this platform competition happened. We know that we have to have a good balance and the bottom line is we don't buy sales.

We took our time to learn in a small scale about how the sort of the numbers work. We realized that the focus for the hyper competition was on the smaller order, mainly the drinks. We also work out the certain threshold of the ticket average. We need to protect the price integrity, need to protect, otherwise it just does not work, the numbers don't work. We took our time to test the dynamic between different moving pieces and then we figure out what to do. I think so far we have maintained a good balance between the incremental sales in delivery and also the price equity, the price perception. At the same time set it up the business in a way that we also see how to grow the delivery business in the long term, particularly via our super app, our own delivery, our own takeaway business, etc. etc.

I think overall we see the balance as a result. We see the balanced growth of the sales and protect the margin and nice OP growth. Adrian, any further comments?

Speaker 1

I think that's pretty much all of it.

Speaker 0

Thank you, Ethan.

Speaker 1

Thank you, Ethan.

Speaker 0

Thank you, Joey, and also Adrian. This concludes our Q and A session. Before we end the call, we are delighted to announce that our Investor Day will be hosted on November 17th in Shenzhen this year. If you're interested in joining, please contact the IR team. Thank you for joining the call today. Thank you all. Thank you for your participation in today's conference. This does conclude the program. You may now disconnect your lines.