Yum China Holdings Inc

NYSE:YUMC

Earnings Call Transcript 2023-Q2

[Operator]

Thank you for standing by, and welcome to the Yum China Second Quarter 2023 Earnings Conference Call. All participants are in a listen-only mode. There will be a presentation followed by question-and-answer session. [Operator Instructions]

I would now like to hand the conference over to Ms. Michelle Shen, IR Director. Please go ahead.

[Michelle Shen, Director of Investor Relations]

Thank you, Ashley. Hello, everyone. Thank you for joining Yum China's Second Quarter 2023 Earnings Conference Call. On today's call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung.

Before we get started, I'd like to remind you that our earnings call and investor materials contain forward-looking statements, which are subject to future events and uncertainties. Our 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 the GAAP measures is included in our earnings release.

You can find the webcast of this call and a PowerPoint presentation on our IR website.

Now I would like to turn the call over to Joey Wat, CEO of Yum China. Joey?

[Joey Wat, Chief Executive Officer]

Hello, everyone, and thank you for joining us today. I'm delighted to report outstanding performance in the second quarter, both topline and bottom line. Our results are the testament to our resilient in anti-fragile business, which allow us to capture upside in good times and protect downside in bad times. From the back office to the front lines, our teams are doing a great job. During the quarter, we reached new heights on multiple fronts.

First, sales performance. Total revenue of $2.65 billion set the new record for second quarter, especially given the exchange rate. System sales grew 32% and same-store sales grew 15% year-over-year. We observed strong demand around holidays. Trading for the May 1st Labor Day holiday was vibrant. However, demand actually softened afterwards with a dip in customer traffic. We adjust nimbly with attractive campaigns and regain sales momentum in June.

On June 1st Children's Day, we hit the record 8.5 million transactions that equivalent to a transaction every minute in every location across our 13,000 plus store portfolio in a single day. Thanks to our amazing operation team, robust end-to-end digitalization and agile supply chain. We flexibly handle the spike in demand during campaigns without compromising quality and customer service. The result demonstrate our brand equity and ability to connect with customers with delicious, innovative food and compelling value for money.

Second, store expansion. In the first six months this year, we opened 655 net new stores, setting a new record. We continue to see vast opportunities across all regions and city tiers in China. KFC continued its aggressive expansion, hitting 9,500 stores in over 1,900 cities. Notably, Shanghai became our first city to reach 500 KFC stores. Our 500 store is in the Shanghai Library, Shanghai [indiscernible]. As part of our Book Kingdom Program for kids, it features a dedicated reading area to promote the love of reading to children. It's also one of our 36 Angel Restaurants of KFC China. The restaurant offers a warm inclusive space for employees and customers with special needs. It showcases our commitments to positive social impact in the communities we serve.

Pizza Hut opened a record 169 net new stores in the first half of the year, supported by strengthened fundamentals through the revitalization program. Healthy new store payback give us confidence for accelerated growth. In addition, Pizza Hut reached 3,000 stores in China, a milestone that few casual dining restaurant chains can claim. Our 3,000 store is in Qinhuangdao, a popular holiday destination in Northern China. This resort [indiscernible] both a beautiful patio with stunning seaview. In addition, it was built with eco-friendly materials and an intelligent energy management system.

Third is profitability. Our operating profit for the first half of 2023 has already exceeded the entire year of 2022. This achievement reflects our ability to capture sales and rebase our cost structure. Our [indiscernible] first half was below 9%. This is the best ratio in the past decade.

Now let's talk about KFC. Our value platform generated amazing sales results. First, Crazy Thursday, the famous Crazy Thursday [Foreign Language] continue to be a tremendous draw driving 50% more sales than other weekdays. Second, Sunday Buy More Save More [Foreign Language] energized Sunday sales. We captured a home consumption with our Juicy Whole Chicken [Foreign Language]. We sold 22 million of this product in the first half and more than doubled itself year-over-year.

Third, our weekday value combos, OK San Jian Tao are gaining popularity. We added a new sizzling roasted chicken fried burger [Foreign Language] to enrich our entry price point offerings for just US$3. Customers love the new weekday value combos. Delicious and innovative food continues to delight our customer in KFC. In the second quarter, we introduced K-zza, a creative twist on pizza that utilized our existing ingredients. We used the wrap from our Dragon Twister [Foreign Language] to make the thin-crust and popcorn chicken [Foreign Language] as the topping. This fun, innovative, limited time offer generated strong sales. We see great potential for more K-zza variations in the future.

K-Coffee sales grew 50% with 47 million cups sold in the second quarter. Our Iced Sparkling Americano with Zesty Lemon [Foreign Language] is the perfect drink to beat the summer heat. We use our soda fountain machines to make this sparkling drink without additional investment in the store. It has become K-Coffee's best ever limited time offering.

Now let's talk about our marketing campaign. Connecting with families and children is an important part of strengthening our brand affinity. Around Children's Day, we partnered with Sanrio and sold nearly 3 million meal sets with adorable toys such as Hello Kitty. This campaign contributes to our overwhelming success on Children's Day. Of course, this popular toys also work very well for adults as well.

Pizza Hut. Let's move to Pizza Hut. We continuously innovate to offer better products at great value. Our new launch in May has been a big success and strong sales drivers. Over half of the menu items are either new or upgrade from a year-ago. Pizza is our biggest category, accounting for over one third of sales. We continue to fortify our pizza expert image by upgrading existing products and introducing new toppings. Apart from our Signature Super Supreme [Foreign Language] and Durian Pizza, we introduced a new pizza like Bolognese pizza with beef [Foreign Language] pizza is a familiar taste, because of spaghetti and it has become a customer favorite, especially among children. Of course, we use quite a bit existing ingredients to simplify the store operation and to keep the ingredient fresh as well.

In addition, many customers are trading up to stuffed crust pizza, which accounts for nearly 40% pizza sales. Most recently, we launched pineapple and cream stuffed crust [Foreign Language] to compliment our other stuffed crust choices of cheese and sausage. Pizza Hut has been sharpening its value proposition and customer engagement. Our value platform Scream Wednesday successfully drove sales and traffic growth. Every Wednesday, we offer different meal choices from pizza, steak, rice and pasta to appetizer at attractive price of US$3 to US$5.

There are choices for one person meals and for social gathering. We continue our collaboration with Genshin Impact, Iansan for the second year. This campaign significantly boost sales and attract many young customers. We saw more than 2 million meal sets with steamed accessories, tripling last year's numbers. This value popular campaign help us recruit over 1 million new members.

Lavazza. Let's switch gears to Lavazza. Lavazza continues to make good strides forward. In July, we crossed the 100 store milestone. In addition to the coffee shop business, we sell Lavazza coffee beans and capsules to premium hotels, restaurants, and other channels. Recently, Lavazza also start supplying coffee beans to Pizza Hut to upgrade the coffee at Pizza Hut. I'm happy with the progress we have made and excited about the growth opportunity.

Digital. On to Digital. Our digital ecosystem plays a crucial role in recruiting and engaging members, driving their activities and unlocking sales performance and potential for us. Our loyalty programs now exceed 445 million members. Member sales increased to 66%, setting a new record. Our Super-Apps had a major update earlier this year, offering our customers a better digital experience. We introduced interesting member exclusive perks to tickle our customers such as app, exclusive new product pre-sales and lucky draws utilizing member points.

In addition, we have been working with third-party online platform to expand our reach. For example, prepaid discount vouchers [Foreign Language] have been gaining popularity on short video platforms. By offering geographically specific deals, we effectively attract new members and increase spending of existing customers. Our end-to-end digitization unleash great potential of our Restaurant General Manager, RGM. Our store management team sharing initiative is progressing well at KFC and Pizza Hut. Select RGM for the first time in our history can now manage multiple stores.

Our AI-enabled systems have streamlined administrative work to help relieve our RGMs of repetitive tasks. By further integrating our store management system, we enhance the visibility of store operation and cross store data analytics. This digital tools empower our RGM to manage multiple stores more effectively while upholding operating center. This will be a driver for future store costs, management, and also address our bottleneck of new store opening. So we are looking for more progress going forward.

Summer peak season, as we speak, we have entered our summer peak trading season. We are ready to capture summer holiday traffic with eye catching menu items back up by rock solid operations. At KFC, we have brought back our crowd pleasing fried chicken tacos with a new ingredient [indiscernible]. It does not translate well, but trust us it is a better KFC for our customer in China.

At Pizza Hut, we have extended our popular Durian Pizza with a new product, Durian Coconut Lava Pizza, [Foreign Language]. To handle increased demand in the summer peak season, we are ramping up crew resources, securing surprise, and staying vigilant with multiple scenario planning.

With that, I'll turn the call over to Andy.

[Andy Yeung, Chief Financial Officer]

Thank you, Joey, and hello, everyone. Let me now share with you our second quarter performance. I'm delighted to report our robust performance in the second quarter. We achieved record revenues of $2.65 billion, representing 25% year-over-year growth. Operating profit of $257 million also reached a record level, more than tripling that of the prior year. We accelerated new store openings. We opened 542 new stores, resulting in net new store growth of 422, setting a new second quarter record.

Even though same-store sales remain below 2019 levels, we saw 25% growth in revenues and 26% growth in operating profit in the second quarter compared to the pre-pandemic levels in 2019. We accomplished all this while operating in a challenging and volatile environment, an uptick of COVID infections started in late April. Consumer continue to be value conscious. Sales materially weakened after the May 1st holiday. But leveraging our multiple scenario planning, we swiftly responded by launching attractive offers to drive sales. Our sales subsequently improved in June. To provide more context, in the second quarter last year, multiple cities were under lockdown. We are lapping last year austerity measure and temporary relief.

Now with that, let's go through the financials. Foreign exchange had a negative impact of approximately 6% in the quarter. Second quarter total revenue were $2.65 billion in reported currency, a 25% year-over-year increase. In constant currency, total revenue grew 32%. System sales increased 32% year-over-year in constant currency. The strong growth was mainly from same-store sales growth of 15%. The remaining growth can be roughly split equally between new unit contribution and the lapping of last year's temporary closures. Dine-in sales rebounded significantly year-over-year while delivery continued to grow.

By brand, KFC same-store sales grew 15% year-over-year. Same-store traffic grew 21% and ticket average decreased 5%. It was driven by successful traffic driving promotions, the lapping of large community purchasing orders and the decrease in delivery mix. Delivery has higher ticket average than dine-in. Pizza Hut same-store sales grew 13% year-over-year, same-store traffic grew 27% and ticket average decreased 11%. It was driven by successful promotional activities and the lapping of community purchasing orders. Lower mix of delivery, which has a lower ticket average than dine-in at Pizza Hut partially, offset the ticket average decrease.

Restaurant margin was 16.1%, 400 basis points higher than the prior year. Occupancy and other improved significantly year-over-year. This was primarily due to offering leverage derived from higher sales and ongoing benefit of cost structure rebasing efforts. This was partially offset by lapping last year's austerity measures, increased promotional activities and wage inflation.

Let me now go through the key items. Cost of sales was 30.7%, 20 basis point lower than the prior year. We kept our cost of sales low despite increased promotional activities to drive traffic. Our supply chain team's hard work and innovative use of affordable ingredients contributed to the favorable commodity pricing. Cost of labor was 26.4%, 70 basis points lower than the prior year. This was driven by operating leverage from sales growth, lower rider cost due to low delivery sales mix and benefit from small management sharing initiatives. This more than offset wage inflation, the lapping of austerity measures and temporary relief last year.

Occupancy and other was 26.8%, 310 basis points lower than the prior year. Rental expense and depreciation improved year-over-year. Operating leverage from higher sales, store portfolio optimization and more favorable new store rental terms all contributed to the improvement. This was offset by lapping austerity measures and higher rental relief last year.

G&A expenses increased 15% year-over-year in constant currency, mainly from higher performance base incentive accruals and merit increases. Operating profit was $257 million more than tripled year-over-year. Our effective tax rate was 24.7%. We continue to expect our full-year effective tax rate to be around 30%.

Net income was $197 million, increasing 138% in reported currency. Diluted EPS was $0.47, increasing 135% in reported currency. We generated $417 million in operating cash flow and $264 million in free cash flow. We returned $160 million to shareholders in cash dividends and share repurchases. At the end of the second quarter, we had around $3 billion in cash and short-term investments and another $1.2 billion in long-term bank deposits and notes to benefit from better interest rates.

Now let's turn to our outlook for the third quarter. Driving sales remain our top priority. As Joey mentioned earlier, we are stepping up promotional activities and have planned attractive offers with great food at compelling values. We are also lining up exciting marketing campaigns and resources to support those initiatives to capture peak summer holiday sales.

In terms of store opening, with healthy store economics and a robust store pipeline, we are confident to achieve 1,100 to 1,300 net new stores in the full-year. Our team has put tremendous effort into developing multiple store formats, lowering CapEx and securing more favorable lease terms. We opened 655 net new stores in the first half of 2023. Our new store have maintained a healthy payback of two years for KFC and three years for Pizza Hut. This gives us confidence to expand across different city tiers and regions.

Regarding margin, our store network expansion and our cost structure rebasing efforts, over the past few years, positioned us well to capture both sales and drive operational leverage since the reopening. With 40% of our current store opened after 2019, we are opening an average of one new store every five hours. Our store portfolio is well suited to operating efficiently in the evolving market condition. We expect our efforts on efficiency improvement and cost structure rebasing to continue to benefit profitability in the long-term. And we look at last year's record third quarter restaurant margins set a relatively high benchmark due to our austerity measure and $30 million of temporary relief in the prior year. We also expect some more hiring to normalize and measure inflation of low-to-mid single-digit in the second half.

Now, despite macro uncertainty and volatilities in the near-term, our multiple scenario planning capabilities and agility positioned us well to capture opportunities in good times and manage the downside in bad times. We continue to focus on driving sales, improving operational efficiency, and investing in digital and supply chain for long-term growth.

Before I conclude, I would like to highlight our upcoming Yum China Investor Day to be held in September in Xi'an, China. Joey, myself, along with our leadership team, including KFC and Pizza Hut brand manager, we will share updates on our strategic priorities. We have also planned food tasting during visit to our restaurant, logistics center and digital center. Now, through this event, investor and analysts can gain firsthand insights into the market and our business, so we look forward to hosting you in Xi'an.

With that, I'll pass you back to Michelle. Michelle?

[Michelle Shen, Director of Investor Relations]

Thank you, Andy. If you are interested in attending our Investor Day in person, please reach out to the Investor Relations team. Now we will open the call for questions. In order to give more people the chance to ask questions, please limit your question to one at a time. Ashley, please start the Q&A.

[Operator]

Thank you. [Operator Instructions] Your first question comes from Michelle Cheng with Goldman Sachs. Please go ahead.

[Michelle Cheng, Goldman Sachs Group, Inc.]

Hi, Joey, Andy. Congrats, again for the very strong results. My question is about the promotion and the competition. So as you mentioned, the market is still very promotional and also we hear some smaller players are actually coming back. So on one side, can you discuss or share with us your observation on the competition side. And more specifically on the margin, we still see the food cost margin manage pretty well and particularly can you talk about Pizza Hut? Since, we have been working on this value position for many years, but it looks like in this quarter the food cost control is pretty decent. So can you also share with us how should we think about this pricing strategy and also further savings on the food cost? Thank you.

[Joey Wat, Chief Executive Officer]

Michelle, thank you. I'll talk about the promotion competition. Andy will handle the margin question. Customers are very value cautious for sure, but at the same time, it's not enough if we just focus on promotion. It has to be promotion – fun, promotion and good food. And our focus is to focus on few very effective promotion platform. So what are the famous ones? Crazy Thursday is very, very fun, its user generated content these days and of course, the food there is good. So we have some new food like spring roll, not only normal spring roll, but skinny spring roll. When the spring roll is smaller, they actually taste better. You can try it with our KFC spring roll on Crazy Thursday.

And then Pizza Hut is focusing on Screaming Wednesday. Again, very powerful message, very simple message, but with great food and great order from steak to pizza. And Taco Bell, focus on taco to steak. So not only just random promotion, but very focused promotion and we keep doing it again and again and again. It takes time to build to have the effect because a little do people remember Crazy Thursday start from back to 2018. So by know-how, it's a very familiar mechanism and that worked beautifully. And of course, we continue to build new promotional platform KFC, the new one will be Buy More Save More on Sunday. And that has a clear product focus called the whole chicken, during normal times the chicken sell for 39, but on Sunday weekend it sell for 29. So it's not only promotion, but grapefruit.

And I think, what people – some also necessarily correlate, how we differentiate from our competitors in driving this promotion. We have the unique advantage of having our own very effective, powerful, agile and nimble supply chain. Because without the supply chain capability to source, to innovate and to deliver all these very affordable ingredients is almost impossible to support this kind of promotion on a sustainable basis.

Last but not least, operation team. June 1st Children's Day, we achieved 8.5 million transactions a day. That's huge number of transactions and the fact that our operation team can handle that is amazing. Well, for people who are running the restaurant in operation, we would be able to appreciate how difficult it is to be able to handle that peak and the spike, and the IT system, it did not go down. And we can continue to push our system in terms of the stability and efficiency so that all come together. It's not just marketing promotion, it's supply chain, it's the digital, it's the operation. And while many competitors can probably replicate the marketing campaign, but the operation, the supply chain, digital, these are the real top core capability, very difficult to replicate.

So I'll pause here and move on to margin question.

[Andy Yeung, Chief Financial Officer]

Okay. Thanks, Joey. So in the second quarter improvement in terms of margins, I think obviously the number one driver is the operational leverage from higher sales. And also, if you look at the overall margin improvement, it continue to benefit from our portfolio optimizations over the past few years. As I mentioned earlier, if you look at our portfolio, currently 40% of our store are open after 2019, and they're very much geared to our – working efficiently in our current operating environment. Also, we continue to benefit from the cost structure rebasing that we initiated over the past couple years. And so those are key driver for margin improvement. And I think it position us well for the long-term to operate efficiently.

Certainly, if you look at particularly on cost of sales, I think, overall with lower commodity pricing in the second quarter was slightly favorable with overall commodity inflations being favorable, but the chicken price in the second quarter actually we continue to experience an upward trend. And given the stock price and also our contract, we expect that to probably extend into the third quarter. So I think for both brands, they manage their sale as very well, over the past few years, generally balancing to expand the pricing range so that we can continue to expand our addressable customer base and balancing commodity price and also the value proposition to consumer. And we generally try to return some of the savings to our consumer.

So if you look at cost of labor, it also improves 70 basis point in the quarter. And again, like it's driven by the cost structure rebasing that we have. And then also as Joey mentioned, we have the store management sharing initiative that continue to help us run our store efficiently. And that more than offset the low single-digit labor inflation in the second quarter we experienced. And then, if you look at O&O, as we mentioned, biggest improvement over the past few years, we continue to structurally change our rental contract.

Not only, we have more variable components of that rental term, but also overall lease, our rent as a current revenue at decade levels right, best in the decade. And so I think those structurally change will continue to benefit and also in terms of depreciations and also as we work down our capital investment per store, that's also very sustainable, I think. And then, look at – our initiative in energy savings and also we benefit from our investment in technology so that our A&P also is seeing some leverage. And so all that contribute to O&O improvement. So I think that's how we look at it.

In terms of like outlook, I think, as we mentioned, commoditized generally a favorable with exception perhaps with chicken price in the next quarter. In term of labor cost inflation, I think we're looking at low to mid single-digit in the second half this year. Again, like – but one thing I wanted to again emphasize a little bit is that last year it was a special situation. Obviously we received about $30 million of one-time relief due to COVID situation last year. And then we also have some alternate program. So that's it. Thanks.

[Operator]

Thank you. Your next question comes from Brian Bittner with Oppenheimer & Company. Please go ahead.

[Brian Bittner, Oppenheimer & Co.]

Thank you. I just want to ask about the sales trends. Andy, you mentioned that May saw a step back in demand trends, but then you regain momentum in June. Can you just add some context here? Could you perhaps talk about where your underlying trends are verse 2019? Or anything else regarding, perhaps the consumer environment in China that you're witnessing right now, just to help us all get on the same page with modeling sales moving forward?

[Andy Yeung, Chief Financial Officer]

Okay. Brian, thanks for the questions. I think, as you mentioned, we are pretty early still in the reopening. This is the second quarter since the reopening. So we are going to – probably going to come and see some volatilities and whatnot. Obviously the decline in – or like the softening in demand in May had to do with couple of things, but when we've seen an uptick in COVID, at the end of April, starting at the end of April. And then the other one is obviously you have seen some of the economic data and indicated that the macroeconomic situation is still markedly challenging.

So consumer obviously have experienced three-year COVID and would likely going to take some time to regain some of the confidence. And so that's what we are seeing right now. But as we mentioned, we have multiple scenario planning as always. So we take quick actions as we see the change in consumer behavior. We have very strong product offering and successful campaign, and that as we mentioned revitalize the sales momentum in June. And I think, again, like, I think in the near-term, it's going to be some volatility uncertainty, but I think we are well positioned to capture the opportunity when we emerge and then able to respond quickly, should the situation become a little bit more challenging.

[Joey Wat, Chief Executive Officer]

Brian, thank you. Let me give overall picture of the business that might help understand the sales trend right now as well. Overall, I would strongly suggest our investor and analyst to really look at the business with a fresh pair of eyes because the business is a rather different business now compared to pre-pandemic. We might not be obvious enough, but 40% of our current store did not exist before pandemic. So the same-store sales really only apply to a bit more than half of our business now because 40% of the stores are new. And even for the portfolio that exists before 2019, the business is very different too because the management team has taken the opportunity in the last few years pandemic to prune the portfolio, particularly those stores with less desirable economics.

So overall, the portfolio is better, but even for the store that has survived the pruning process, you bet the economics are much better with lower rent, et cetera, et cetera. And the big historical problem that we have, we used the pandemic time to sort them out as much as possible. On top of that, we have replaced the cost structure. We have completed the end-to-end digitalization and also digitalization of the entire supply chain process. So the business is more resilient, more nimble, and with better cost structure for the entire company, but also for the store economic for each store. So it's very different. Therefore, the system sales growth is quite good and same as the profitability, and that's what we wanted.

Going forward, in terms of outlook, Andy talked about Q2, Q3. Obviously we're going to focus ourselves. We are going to focus on growth. We are going to focus on opening more stores and then continue to focus on delicious and innovative foods that really work for customers. But in the longer term, the macro in the short-term, it's hard to predict from month-to-month basis, but China GDP has slowed down to growing probably at twice as fast as other developed countries. It's not too bad. Isn't it? And then it's amazing big market, and we still serve 2 billion customers a year and certain regional growth like in the middle of China, it's very nice. The growth is very good. And therefore, we are able to open stores very fast, particularly in these, what we call new basket.

So what does that mean to KFC, Pizza Hut? KFC, you can see from our speed of store opening in the last few years, we are opening a lot of store and we are reaching 9,500 stores in China alone for KFC. And Shanghai alone is 503. And we are not only just opening store in lower tier cities, we are actually opening store in all tier cities. We are utilizing franchising, we are utilizing different channels such as – some channels are newly found opportunities such as university and hospital and high speed rail service station, and it works.

And then Pizza Hut, it's really ready to accelerate the growth after a few years of turnaround. The margin is good and it surpassed 3,000 store mark for casual dining, which is quite difficult to get to in terms of scale, in terms of casual dining. So the smaller brands are also developing. Lavazza just reached 100 store milestone and also start to sell coffee beans in retail. So going forward, we are committed, we are optimistic, and therefore, you can see our net new store opening this year is still at the rate that is record for our business in the last 36 years. Thank you, Brian.

[Operator]

Thank you. Your next question comes from Chen Luo with Bank of America. Please go ahead.

[Chen Luo, Bank of America Merrill Lynch]

Thank you, Joey and Andy. My question is on margin as well. So if we combine first half this year with second half last year, and actually it would imply a four quarter, a full margin of a close to 17% at the restaurant level. So I remember many years ago, we talk about the long-term normalized restaurant margin of 70%. I know we no longer talk about long-term target. The market usually will still look at 17% as a reference. But now we are almost there. How much upside are we going to see from here? In particular, as Andy mentioned previously starting from Q3, we are going to see pretty high lapping for margins. Is it fair to say that from now on, the low hanging fruit from cost rebasing is no longer industrial and the majority of the margin expansion will come from the same-store sales or sales leveraging in the future? Thank you.

[Andy Yeung, Chief Financial Officer]

Thank you, Chen, and thank you for your questions. It's a one-off question and then it's also wonderful question as you mentioned the issue to deal with, right. Because after the reopening, after all those restructuring cost structure rebasing that we have performed over the past few years after, as Joey mentioned, our portfolio change entirely different – almost entirely different stock portfolio. We are now at obviously at multi-year, right? I think at least five years if not all time high internal margins. So we're offering very efficiently at this point. And as mentioned, even, despite the near-term volatility and challenges in the market, we are offering very efficiently.

And so I think, a couple things that I want to mention. If you look at the cost structure rebasing, as we mentioned, those are very fundamental change in terms of how we operate our restaurant and also the cost structure itself. Now in terms of 17% margins, I'm glad that, when you mentioned over the past four quarter, you average hour is more there. We don't give guidance on margins, but we just do it sometimes, right? And so we did mention it over the past year or two, but I think we continue to focus on doing that. We are pretty confident in terms of our cost structure rebasing with that. We are pretty confident that our new store performance, our new store economics at multi-year, I guess the offering and investing in multi-year level. And so that give us confidence in how our portfolio moving forward as we open more stores. So we look forward to that improvement continuing.

However, as we always mentioned, we generally look at cost of sales, we try to maintain that capability there. The reason why we do that is because we obviously have a very innovative team that can help us to mitigate some of the volatilities in commodity prices. We also use efficiently our product that we have over the years. So fully utilizing the resources like food, chicken, beef and then also our supply chain’s tremendous ability to actually lock in long-term contract, for example, coffee bean over last couple years – were able to long-term about three-year contracts. However, we always been very cautious about pricing and price increase and because reason is that we want to make sure that our consumer continue to benefit from cost saving and also enjoy quick value from our food. So we generally try to keep stable.

I think we have initiative continue to improve labor productivity improvement. As we mentioned, we have the store management sharing initiative and continue to invest in technologies and enable our team member to work more efficiently in the restaurant. But we have got to also look at the ongoing, so labor inflation is a fight in our industry, right? We always have to deal with labor cost inflation over time. So we generally also try to keep that obviously stable.

Now, as mentioned, O&O have improved over the years and not only in the last couple years, but even over the past five years, 10 years. And so as we mentioned, we are at, pretty, pretty efficient level. But we see continued room for improvement. So that's generally how we look at the overall margin. Obviously the next quarter or so, we will be there with something anomaly on a year-over-year basis because of last year temporary relief and austerity program. But overall, I think our trajectory is right trajectory. Thanks, Chen Luo.

[Operator]

Thank you. Your next question comes from Anne Ling with Jefferies. Please go ahead.

[Anne Ling, Jefferies]

Hi. Thank you very much for taking my call. I have – first of all the question also on the restaurant margins, Pizza Hut improving and success in the restructuring. What would be the normalized restaurant margin would be over time? Can it be like without naming like – can it be as high as like KFCs like 18% plus, and if that's the case what are the drivers? Is it more on the scale of the whole network or is it more on like driving the sales per store for further normalization? And Joey, last time mentioned that in the previous call that, you would love to see further increase in the delivery business for the Pizza Hut side. Any strategy that we can facilitate this? Thank you.

[Andy Yeung, Chief Financial Officer]

Yes. Hi, Anne. Yes. Thank you for the questions. Regarding, Pizza Hut, we are very happy to see that the revitalization program have achieved very strong result over the last two quarter already. We continue to see very strong traffic growth, continue to see strong sales growth. And as Joey mentioned, that’s fantastic product that coming out from Pizza Hut and also, Pizza Hut over the past few years as we have kept pricing stable, have continued to improve its value proposition to consumer. The value is great. And then you look at the brand, we sit resonating really well with consumer as well, and especially with some of the campaign, Genshin and other that really connect with our new customers.

So I think it's wonderful that they make this transformation because I think expand the pricing range improves the value proposition. It continues to drive that addressable market, right? So now we are at 3,000 store level. Obviously, we have great opportunity to grow in more stores. And in fact, if you look at their store opening right now, it's at record level. And if you look at in the quarter alone, it probably opened more restaurant than like last couple of years combined. And so I think that's tremendous progress. And I think we continue to hope to see KFC more network expansions, especially driven by satellite store and smaller store format, and then continue to build that value positions. And then also, as they have done in the last couple of quarters – to improve their margins over time. So when you say normalize, I think, normalize, I think right now margins is even higher until 2019. I don't know, when you continue being not normalized, but I think you have the right trajectory for sure.

[Joey Wat, Chief Executive Officer]

And the ultimate question for Pizza Hut is not necessarily only about margins. Our goal for Pizza Hut going forward after turning around is to continue to work on its resiliency and growth. Because after turning around, that's what we want the growth. But growth without resiliency is not too comfortable. Isn't it? So growth – resiliency and growth. And then of course, next step is the most strategic mode, right? We are very consistent with our thinking RGM. So the question is how to get there. What's the key to unlock to get the resiliency, to get more sales, to manage the investment and to get profit in the short-term and long-term? Well, our view of the key, which we have been working on, is the satellite store model. Overall, we look at the result of the new store payback.

Pizza Hut move from four years to three years in which satellite store really deliver, these are the smaller store focus on take away and delivery, which is your second question. The satellite stores do the trick and satellite store require less investment. It requires a different menu because they may need delivery and take away-driven, and the profit is very good. And the payback is two years. So when we put the satellite store and the other store together, the overall payback is three years. So we have found the key, which is satellite store. We just need the time to build more and more and more and more from top tier city all the way to lower tier city.

And the growth story of Pizza Hut is not difficult to understand. KFC only in 1,900 cities in China with 9,500 stores. And Pizza Hut, we only have 3,000 stores in 700, 800 cities in China. So that's more than a 1,000 cities in China that has Pizza Hut does not have – that has KFC, does not have Pizza Hut. So you can see why we are quite confident about the growth potential of pizza in terms of self-profit resiliency. Thank you, Anne.

[Operator]

Thank you. Your next question comes from Lin Sijie with CICC. Please go ahead.

[Sijie Lin, CICC]

Thank you, Joey and Andy. I have a follow-up question on promotion and competition. So we've seen that our insistence on value for money leads to very resilient sales recovery. But we've also seen increasing promotion and more value combos like OK San Jian Tao. So do we think this is only because people are value cautious under this economic environment or this also has relationship with more intense competition from McDonald's, from [indiscernible] and all other competitors and how this impact our ticket average and sales per store? Thank you.

[Joey Wat, Chief Executive Officer]

Thank you. So OK San Jian Tao is new. Right now is delivering about low single-digit in terms of sales mix. The key thing here is, well, of course, customers are very cautious. It doesn't hurt to open up the price range. What does that mean? In the past, we did not have that price at 19 yen as a combo. When we introduced it, the most critical thing that we are looking for is incremental sales. In particular, incremental same-store sales, what not to like, it's fantastic. It's new business for us.

And then in terms of its performance across city tier, well, people might think that it worked very well in low tier cities. Actually, not really. It works better in top tier city because this is more for what we call balance the functional consumption for the lunch. So it works better for the top tier city. But for lower tier cities actually give us insight. We still can open more stores, we can open more store in low tier city to capture that functional consumption. So we are happy with that. And again, the key to unlock this, OK San Jian Tao is ability in supply chain, whether we can solve such affordable ingredient to deliver that price point and still a reasonable profit. And our team did it. Thank you.

[Operator]

Your next question comes from Lillian Lou with Morgan Stanley. Please go ahead.

[Lillian Lou, Morgan Stanley]

Thanks. Thanks, Joey and Andy for all the answers. I have a follow-up questions on same-store sales growth. So because Joey just mentioned that our store network right now is very different from pre-COVID. So when we look at the same-store sales growth compared to Pre-COVID, i.e. 2019th level, second quarter was still 10% below. But if we look at more on the holistic basis because we're adding more and more smaller stores, does that mean that actually our same-store sales growth will be below 2019th level for a longer period of time, even though our underlying operation is already kind of close to back to normal? That's more like mathematics problem question. And also in the operation perspective, what has been dragging our same-store sales growth below normal level in particular, is it still the traffic – stores or in certain area or in certain tier of cities or store format? Thanks a lot.

[Andy Yeung, Chief Financial Officer]

Lillian, so let me try to clarify this. Our system sales of 25% year-over-year, our same -store growth was 15% year-over-year. And then, if you adjust for the impact of temporary store closure last year, our system same-store sales growth lost time people use that in the industry would be about 24%. And then – sorry, our systems growth is 32%. So if you look at that in our adjusted like same-store sales growth would be close to 24% year-over-year. So I think even we mentioned some of the slowing down in the May period, in fact, our same-store sales growth were very robust and very strong.

And obviously the driver for the different tiers are slightly different, as Joey mentioned. The loyalty series genuinely grow faster. And then you mentioned about the TMT space. TMT space will only very important for us, and we continue to see very robust recovery over there. And if you look at the tourist locations, I think, it's doing quite well, probably quite well. Even at the major transportation hub for domestic travel for high-tech level and for domestic flight, they are continuing to improve. I think that trajectory is [indiscernible] obviously international travel, flight travel is little softer and would probably take longer time until flight schedule got sought out. And so I think in terms of our same-store sales growth is pretty robust. So I don't know if Joey have anything to mention.

[Joey Wat, Chief Executive Officer]

For the existing store that opened before 2019 as Andy mentioned, the transportation hub actually coming back during the May and particularly during the holidays. And by the way, that's sort of another consumer behavior right now. There's consumption during the holiday and festival is amazingly well, it's just in between, it's a bit more depressed, but we have program to manage that. But for tourist location, actually have recovered really, really well, and particularly in the tier two cities like Xi’an and whatever. So these sort of tourist destination tier two cities that are doing really well back to pre-2019 level already.

But to answer your other question about the holistic same-store sales. Well, the ultimate question is how to continue to grow our same-store sales, particularly when our stores are getting smaller and smaller and smaller, particularly the newly open one, because the smaller stores require less CapEx and the payback is good. Well, it's not silly, but why not growing the same-store sales outside the store? Therefore, it's rather important to continue to drive the delivery take-away. And that goes for both KFC and Pizza Hut. And therefore, I've been emphasizing on how important it is to grow the off-premise sales and the new retail.

New retail is still low single-digit compared to the entire Yum China sales. But the absolute number is not small. It provides very nice resilient sales driver, particularly during the tough time. And let me be a bit more specific about KFC. How do we do it outside the store? If you come to China have opportunity, particularly during our Investor Day, you will see more and more and more KFC store will have a window opened up so that you don't even need to – customers don't even need to go inside the store to get your coffee or ice cream or whatever snack or meal. And that improved convenience help. And you bet we are doing it at scale at whenever we could.

And then you will see more coffee trucks or standalone coffee. Well, the system sales growth this nicely, but if we look at our KFC coffee compared to last year, it only increased by 50%, which is not too bad. Isn't it? And the coffee truck investment is low. It's lovely. It's so cute. In any tourist location or anywhere without a fixed location, it's okay. So we only have about 200 right now, but you bet we're going to have more.

And then during the holiday and festival, they're popup stores. Well, actually, it's not something new, we just don't talk enough about it. We do a lot of the popup stores during Chinese New Year, and right now it work for holiday and festival too. So it doesn't matter, well, to a certainly matter, but we don't want the size of the store to limit our same-store growth because we can go outside. You will see more and more and more breakfast kiosks around that go these days, it works both for KFC and Pizza Hut. Even though it is already very convenient to pick up breakfast from our store, we further improve the convenience by bringing the breakfast to the subway station, et cetera, et cetera. So I hope that give you a sense about how we drive the holistic things despite our stores are getting smaller. Thank you.

[Operator]

Your next question comes from Christine Peng with UBS. Please go ahead.

[Christine Peng, UBS]

Thank you, management for the presentation as well as answering most of the questions I think investors care about. So I have a very quick question regarding the capital allocation. If you look at the first half of 2023 cash – free cash flow et cetera, so basically all the images suggest that the cash accumulation for the company has been very strong. But as we look at the cash dividends and share repurchases, it was not really suggesting a big pick up compared with the pandemic period. So I was just trying to understand what's the logic behind this and what's the future in terms of distributing more cash towards investors? Thank you.

[Andy Yeung, Chief Financial Officer]

Thank you, Christine. I think, couple things, and one is that our capital allocations as always is focusing on driving organic growth. And so it is on store opening, is on store remodeling that generally capture more than 6% of our CapEx spend. And then we also look into investing obviously new brand and also digital and supply chain to make sure that we continue to run our operations effectively, efficiently and also accurately, so that we can deal with different uncertainty.

The other one is for capital allocations, obviously, we want to have a strong balance sheet to make sure that we can deal with any contingency that may come up. Occasionally, opportunistically, we look at investment, especially investment that will boost our capabilities both in the technologies, in our install operations and our supply chain.

We are very committed to return capital to shareholder. If you look that in the quarter, we have returned more than $110 million to shareholder. The pace of share repurchase obviously would vary depending on the number of factors. But I think we hold very strong commitment to return excessive cash to shareholder. Dividends, as we have done so in the first quarter this year, we have raised dividends at the early part of this year by almost 8%, 9%. And so when we revisit obvious dividend policy with our board every quarter and every year. And so – but again, we are very glad in our strong operating performance generated good operating cash flow and good free cash flow in the second quarter and in the first half this year. And so we'll continue to return that excessive cash to shareholder for sure. Thanks, Christine.

[Operator]

Thank you. That is all the time we have for questions today. I'll now hand back to Ms. Michelle Shen for closing remarks.

[Michelle Shen, Director of Investor Relations]

Thank you for joining the call today. If you have further questions, please reach out through the contact information in our earnings release and on our website. Thank you.

[Operator]

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.