Yum China Holdings Inc

NYSE:YUMC

Earnings Call Analysis

Yum China Reports Strong Q3 Growth and Increased Capital Returns

Yum China announced solid Q3 results, with system sales rising 4% year-over-year and same-store sales reaching 97% of pre-pandemic levels. Core operating profit surged 18%, with diluted EPS increasing by 32%. KFC and Pizza Hut both contributed to this growth, driven by innovative pricing strategies and operational efficiencies. The company opened 1,200 new stores year-to-date and aims for 1,500 to 1,700 by year's end. Importantly, Yum China plans to enhance capital returns by 50%, targeting $4.5 billion from 2024 to 2026, including $1.5 billion this year, showcasing confidence in long-term growth potential.

Strong Q3 Performance Signals Resilience

In Q3 2024, Yum China demonstrated strong operational resilience, reporting a 4% year-over-year increase in system sales and a same-store sales index that reached 97% of the previous year's levels. The company's core operating profit surged by 18%, reaching $371 million, while diluted earnings per share (EPS) elevated by 32% to $0.77. These numbers indicate that Yum China is effectively navigating the challenges of a competitive market and economic uncertainties. The company's focus on operational efficiency and innovation is reflected in the improved restaurant margins, which expanded by 60 basis points year-over-year.

KFC and Pizza Hut Show Differentiated Growth

Breaking down the performance by brand, KFC exhibited remarkable growth with a 6% increase in system sales. Same-store sales were reported at 98% of prior levels, indicating a continued recovery trend. Notably, KFC's strategy to offer a wider price range succeeded, particularly through combo deals that drove incremental traffic and double-digit delivery sales growth. In contrast, Pizza Hut's system sales grew only 2%, impacted by a 9% decrease in ticket averages. However, Pizza Hut focused on appealing to value-conscious segments, which is a crucial shift in its long-term strategy.

Pizza Hut's Transformation and Efforts to Improve Margins

The ongoing transformation at Pizza Hut aims to enhance its mass-market appeal by lowering ticket averages and introducing value-oriented menu items. The restaurant's core operating profit margin notably improved by 140 basis points, showing signs of recovery and operational efficiency. Innovative store formats such as the Pizza Hut WOW model, which has been rolled out in response to changing customer demographics, are beginning to show positive sales trends despite being newly introduced.

Shifts in Franchise Strategy Promise Future Growth

Yum China is shifting its franchise strategy, with an aim to expand the franchisee mix to 40-50% for KFC and 20-30% for Pizza Hut over the next few years. This marks an increase from earlier guidance of 15-20%. This strategy reflects the company's readiness and operational capacities to support a broader franchise network, allowing for quicker store openings and lower capital expenditures. Furthermore, encouraging franchisee performance data shows that 80% of new stores opened in the past two years reached profitability within three months.

Capital Returns and Future Outlook

In alignment with its robust cash generation capabilities, Yum China plans to return $4.5 billion to shareholders through dividends and share repurchases from 2024 to 2026, a significant increase from $3 billion previously projected. This includes a commitment of $1.5 billion for 2024. The company maintains a healthy cash position of $3.1 billion, which provides a substantial buffer for investment and returns. Looking ahead, the company is cautiously optimistic about fourth-quarter performance, expecting continued improvements in same-store sales transactions, albeit with a cautious consumer spending atmosphere.

Navigating Market Conditions and Consumer Behavior

Yum China's management acknowledges ongoing macroeconomic challenges and competitive pressures but remains confident in its dual strategy focusing on system sales growth and same-store sales growth. Although quarter-to-date insights do not highlight significant changes in consumer sentiment post-holidays, the organization's structured approach aims to capture incremental traffic through innovative offers while protecting margins. Initiatives like Project Fresh and Project Red Eye focus on enhancing operational efficiency, positioning the company favorably amidst market fluctuations.

Earnings Call Transcript 2024-Q3

[Operator]

Thank you for standing by, and welcome to the Yum China Third Quarter 2024 Earnings Conference Call. [Operator Instructions]

I would now like to hand the conference over to Florence Lip, Senior IR Director. Please go ahead.

[Florence Lip, executive]

Thank you, operator. Hello, everyone. Thank you for joining Yum China's Third Quarter 2024 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 uncertainties. 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 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?

[Joey Wat, executive]

Hello, everyone, and thank you for joining us. I'm proud to share that we achieved strong results again in Q3 2024. We delivered robust sales growth as well as accelerated profit growth compared to Q2. System sales grew 4% year-over-year. Same-store sales index improved sequentially and reached 97% of prior year's level. Delivery sales achieved double-digit growth as it has for 10 consecutive years.

On a comparable basis, both restaurant margins and OP margin expanded year-over-year. Core operating profit grew 18% and diluted EPS increased by 32%. As we execute our RGM 2.0 strategy, we have a new focus on operational efficiency and innovation. Savings generated from improved efficiency allow us to reinvest in food innovation and our value for money offer.

This broadens our expressible market. It also helped us capture more traffic, drive sales growth and expand profit margins. Meanwhile, our innovative business models KCOFFEE Cafe and Pizza Hut WOW are gaining momentum and successfully capture new customer demand.

In the first 9 months, we set several new records USD 8.7 billion in revenue, over $1 billion in operating profit, 1,200 net new stores and over $1.2 billion returned to shareholders. We outperformed the industry in a challenging and fluid environment.

Today, I will provide an update on our operations and store opening strategy. Adrian will then go through the financial performance and our latest capital return plan. I will start with operational efficiency.

We are making great progress with Project Fresh and Project Red Eye. We introduced these projects in quarter 4 of last year and quarter 1 of this year, respectively. These projects are to enhance operational efficiency through innovation across all aspects of our operations. Project Fresh Eye has reshaped our operations.

We are evaluating processes through the Fresh Eyes of our restaurant managers, redesigning to support them more effectively by simplifying, centralizing and automating key processes. We are easing the burden of restaurant managers so that they can focus on better serving customers. We are also using innovative technology and automation in our operations.

This makes us more efficient. For example, intelligent energy management reduces utility costs. Project Red Eye has created a fresh mindset to innovate and deliver results by spending better and buying better. Our procurement teams are serving our marketing teams better and faster. Generator savings are passed on to our customers and fund innovation.

We are also hearing our product design to optimize ingredient use and improve operational efficiency. These initiatives have enabled us on product innovation and value for money while expanding margins.

On a comparable basis, Q3 restaurant margin improved 50 basis points year-over-year and core OP margin expanded 140 basis points. Importantly, these are sustainable improvements that strengthen our business capabilities. while driving high levels of customer satisfaction.

Turning to sales. It's true that consumers are becoming more rational and sophisticated in their choices. But we know that the demand is great, the consumers seek value for money, good quality and emotional value, which is a project.

That's exactly what we are offering them and it's working. We regard both system sales and same-store sales growth is equally important. On one hand, we see ample opportunities across China to enter underserved markets and enhance customer assets.

On the other hand, we look to balance our unit growth with same-store sales growth, 7 consecutive quarters of same-store traffic growth and sequential improvement in same-store sales index for both KFC and Pizza Hut show the strength of our strategy.

Our delivery sales grew 18% continuing the double-digit annual growth Yum China has maintained over the past decade. In quarter 3, delivery sales reached around 40% of our sales mix. We have strategically adjusted delivery fees and introduce more entry price offerings to capture incremental consumer demand.

We have enhanced our presence on aggregated platforms and expand delivery coverage. Through these initiatives and more, we have captured incremental orders, especially from solo diners and value-cautious customer. As a result, both KFC and Pizza Hut have increased their market share on aggregator platforms.

Even as we expand on aggregator platforms, we continue to maintain strong control over our business. Sales outside the delivery aggregators account for over 70% of our total sales, including dining, takeaway and delivery. Let me share a few highlights on KFC. We continue to bridge fresh energy into our flagship products. Take the new original recipe chicken burger as we introduced in quarter 2, they've been exciting innovation, so not so obvious.

Taking our queue from the classic way kids in China enjoy KFC's original recipe chicken with mass potato. We combine them into a new burger product. It is being very successful. Building on the set, we introduced an original recipe chicken with curry gravy in August, This time, we add curry gravy to the original recipe chicken and mashed potatoes. Customers are loving it.

As a bonus, it doesn't require new ingredients in the stores. We maximize the use of existing ones while delivering exceptional value and taste to our loyal customers. In the first 9 months, KFC sold nearly 200 million cost of KCOFFEE, surpassing all cups sold in 2023. During the period, both sales and costs sold increased by about 30%. As our membership data indicates that a significant majority of our members have yet to try KCOFFEE. We see huge potential for growth.

We have just opened 500 side-by-side KCOFFEE cafe this morning, China Time. With the prime location in Shanghai,. We are also tapping into strategic locations like college campuses and transportation hubs. By the end of the year, we expect to exceed 600 cafes.

Our distinctive menu of coffee, drinks and food, stunning value proposition and cafe amnions are resonating well with their customers. Our disruptive limited tomo of Original Recipe chicken Lattice, generated first disbelief curiosity reality and finally, trial. Perhaps surprisingly, it's become one of our best sellers. KCOFFEE cafe also effectively cross-sell to KFC's loyal customers, driving incremental sales and profit. KCOFFEE cafe potential is exciting.

Turning to Pizza Hut. The brand is making solid progress. Pizza Hut opened nearly 300 net new stores in the first 9 months, exceeding 3,600 stores. Since 2017, Pizza Hut has been strategically lowering its ticket average to drive traffic and enhance its mass market appeal. We have launched more entry price products designed for value cautious customers and solo diners, capturing more smaller ticket orders.

Pizza Hut has also improved its profitability. Core OP increased 20% year-over-year in quarter 3. Core OP margin was up by 140 basis points. We boost operational efficiency with simplified ingredients and redesigned kitchen processes. This also allowed us to further improve our high food quality and service level.

We continue to fortify our reputation as pizza expert. We recently upgraded the hand-tossed for better taste consistency and easier preparation. In addition, we continue to build on our signature product,, durian Pizza, now our #1 best-selling pizza. One in every 4 pizzas sold in Pizza Hut China is now a Durian pizza. We sold nearly 30 million durian pizza year-to-date.

We have expanded our success with durian to burgers, launching the Pizza burger with durian and pineapple it sounds a new, but it's perfect for our durian lovers and sold out quickly. Our breakthrough Pizza Hut is looking like a promising vehicle for expanding our addressable market. It's been only 5 months since we converted our first store.

Initial results are encouraging. For dine, we have seen significant same-store sales growth, driven by incremental transactions despite lower ticket averages. So far, we have converted around 150 stores expanding from Guangdong to over 10 provinces, covering Tier 1 cities to lower tier. We will continue to refine the model across different locations for both dining and delivery.

With our new focus on system sales and same-store sales growth in mind, let's talk about our door expansion plan. In Q3, we opened 438 net new stores with over 1,200 net new stores year-to-date. We are on track to meet our target of 1,500 to 1,700 net new stores this year.

This growth is underpinned by strong new store performance. At KFC, the paper period held steady at 2 years and at Pizza Hut, paper improved to 2 to 3 years. Around 80% of new stores opened in the past 2 years, turned profitable within 3 months of opening.

Alongside our successful equity sale, we are accelerating franchise development to unlock additional opportunities. Our franchise strategy focuses on assessing strategic and remote locations as well as the lower tier cities that were previously beyond our reach. We have built the infrastructure to support our franchisees from food safety to store management.

We have also elevated new store models suitable for franchisees such as KFC time, so we are now prepared to pick up the speed. Currently, franchisees represent 12% of KFC's store portfolio. The franchisee mix for net new stores increased from 15% in 2023 to 27% year-to-date, exceeding the guidance we gave at last year's Investor Day of 15% to 20%.

We now expect this ratio will gradually increase to 40% to 50% over the next few years. Pizza Hut will be on a similar path, but will take more time to get there. For Pizza Hut's net new stores, the franchise mix was 7% year-to-date. We anticipate this ratio will gradually increase to 20% to 30% over the next few years.

With that, I will hand the call over to Adrian Ding, our acting CFO. By way of background, Adrian has been with Yum China in 2019, leveraging his investment banking background, Adrian has led multiple successful strategic investments and capital market projects in his role as our Chief Investment Officer. He was also instrumental in establishing our Lavazza joint venture and building the business in China as our General Manager of Lavazza GE. Adrian's combination of financial background with operational experience, making world suited for this position. I'm thrilled to welcome Adrian to his new role. Adrian?

[Adrian Ding, executive]

Thank you, Joey, and great to be with everyone today for my first earnings call. In the third quarter, we achieved strong results with major KPIs trending positively. System sales grew 4%, and same-store sales index sequentially improved to 97% of prior year level. Restaurant margin expanded 60 basis points year-over-year on a comparable basis. Core OP margin also saw a significant rise of 140 basis points.

As we grew our top line, core operating profit surged by 18% and diluted EPS grew 19%, excluding the mark-to-market gain from our equity investments. As a reminder, restaurant margin on a comparable basis excludes VAT deductions as well as temporary relief from landlords and government agencies received in the prior year.

Core operating profit further excludes foreign exchange impact and special items. We are immensely satisfied with this meaningful sequential improvement in our quarter 3 results. They demonstrate our ability to outperform the industry in both the times and bad. With our confidence on cash-generating capabilities, we plan to step up our capital return to shareholders.

First, let's take a closer look at our third quarter performance by brand, KFC system sales increased 6% year-over-year. Same-store sales were at 98% of prior year levels with 1% same-store transaction growth. Our strategy is to widen the price range and capture lower ticket average delivery orders are yielding results. Enterprise combos have driven incremental traffic and delivery sales continue to grow double digits. Our quarter 3 ticket average was RMB 38, 3% lower than prior year levels, an increase from RMB 37 in quarter 2.

More ticket items like coffee and breakfast continue to outperform. Pizza Hut system sales increased 2% year-over-year. Same-store sales were 94% of prior year levels with same-store transaction growth of 4%. Ticket average was 9% lower year-over-year. It is in line with our strategy to transform the brand to increase mass market SKU. Our enterprise pizzas, burgers and single person meals attracted incremental traffic from value-conscious consumers and solo diners, which, of course, lower personal spending. .

The WOW store model is positioned with even more accessible pricing. Pizza Hut's traffic has grown in response to our strategy and profit margins have improved year-over-year. Thanks to our team's relentless drive for operational efficiency and innovation.

Now let's go through our margin and key cost lines. Our OP margin as a percentage of revenue was 12.1% and 100 basis points higher year-over-year or 140 basis points higher on a comparable basis. Resilient restaurant margin and savings and G&A expenses helped us achieve that. Our restaurant margin was 17%, steady year-over-year.

On a comparable basis, restaurant margin was 50 basis points higher. Savings in the cost of labor and occupancy and other costs offset the increase in COS. Cost of sales was 31.7%, 60 basis points higher year-over-year or 30 basis points higher on a comparable basis.

We kept cost of sales rather stable compared to 31.5% in quarter 2, while continuing to offer excellent value for money. Key factors include favorable commodity prices and savings from spending better and buying better initiatives under Project Red Eye. Cost of labor was 25.1%. The 20 basis points lower year-over-year. Improved operational efficiency more than offset wage increases from our online staff and the impact of sales deleveraging.

Occupancy and other was 26.2%, 40 basis points lower year-over-year or 60 basis points lower on a comparable basis. This came from more efficient marketing and advertising initiatives as well as other cost optimization. Our G&A expenses decreased 19% year-over-year. This was due to operational efficiency gains and lower performance-based compensation this year, among other factors.

G&A expenses as a percentage of revenue were 4.5% in the quarter down by 130 basis points from 5.8% a year ago. For the full year, we aim to keep the G&A ratio around 5%. Operating profit was $371 million, growing 14% year-over-year. Core OP increased 18% year-over-year.

Our effective tax rate was 27.3% in quarter 3, on par with the same period last year. We expect a full year ETR in the high 20s. Net income was $297 million, growing 21% year-over-year. Our mark-to-market equity investment had a $26 million positive impact in quarter 3 this year compared to a negative impact of $3 million in the same period last year.

Excluding this impact, our net profit grew 9%. As a reminder, we received lower interest income this year from a lower cash balance. Diluted EPS was $0.77, growing 32% year-over-year or 19%, excluding the mark-to-market equity investment impact.

Now let's turn to capital return to shareholders. Since our spinoff, we've returned over $4 billion to shareholders. In the first 9 months this year, we already returned more than $1.2 billion, including over $1 billion in share repurchases and $187 million in quarterly dividends.

We bought back more than 27 million shares around 7% of our total shares outstanding, partially contributing to our EPS growth. Our cash position remains healthy with net cash of $3.1 billion as of the end of the quarter. We're committed to returning excess capital to our shareholders.

A year ago, we set our 3-year plan to return $3 billion to shareholders through dividends and share repurchases from 2024 to 2026. With our cash generation capabilities proven in good times and bad, we now plan to step up our capital returns by 50% 4.5 billion over the same period. This includes $1.5 billion in 2024.

Finally, moving on to our outlook. We are encouraged by the recent stimulus policies. These measures are a positive step forward, but as you all know, such things can take quite a while to trickle down to consumers and thereby move the needle in businesses like ours.

Entering the fourth quarter, will not observe significant changes in market conditions and consumer sentiment. Despite this, we remain confident in China's midterm and long-term growth opportunities. Quarter 4 is traditionally a low season for us with smaller sales and profits.

We maintain our focus on operational efficiency and innovation to pass on savings to our consumers. We expect these efforts to continue driving overall sales and profit growth. I am confident in our strategy and our ability to navigate this complex and evolving environment and achieve sustainable long-term growth.

As a reminder, in quarter 4 last year, we benefited from $6 million in temporary relief, equivalent to around 30 basis points in OP margin, which we do not expect to repeat this year. Let me pass it back to Joey for closing remarks.

[Joey Wat, executive]

Thank you, Adrian. Before we turn to Q&A, I would like just to recap the 3 key messages I want you to take away today. First, our quarter 3 results highlight resiliency and growth strategy with our dual focus on operational efficiency and innovation, we are well positioned to capture opportunities in this market.

Both system sales growth and same-store sales growth are key focus for us. Second, we remain bullish on China's long-term growth opportunities. Our widened price ranges optimized delivery strategy and breakthrough business models help us broaden our addressable market.

We continue to capture underserved customer segments with both equity and franchise new stores. Lastly, we maintain our due focus on sustainable growth and capital returns to shareholders. We plan to step up our 3-year capital returns to $4.5 billion for 2024 to 2026.

With that, I will pass it back to Florence.

[Florence Lip, executive]

Thanks, Joey. Now we will open the call for questions. [Operator Instructions]

Operator, please start the Q&A.

[Operator]

[Operator Instructions]

Your first question comes from Xiaopo Wei with Citigroup.

[Xiaopo Wei, analyst]

Can you hear me, Joey or Adrian?

[Joey Wat, executive]

Yes.

[Xiaopo Wei, analyst]

Congratulations on the strong third quarter. I probably want to ask a long-term question. It is a first quarter we are seeing your both your core OP margin and blending and same store was down. As you know, the market has been focusing on same-store sales for long, but it seemed to me that it's actually as Joey said, the system sales is equally important as same-store sales.

Shall we say looking forward, shall we looking more into the same-store sales base of transaction volume rather than the same-store sales value because as Joey readily pointed out, you guys have innovating format, menu actually widen your pricing range. So the mix of your products or the ASP actually distort the traditional understanding of same-store sales. If that's the case, is there any other areas you will build your economy scale in terms of enlarged volume to drive your margin resilience looking forward?

[Joey Wat, executive]

Xiaopo, thank you for your long-term question. If I'm allowed to indulge my give a comprehensive view of our long-term strategy. Quarter 3 actually is a good result and illustration of how Yum China secure our RGM 2.0 strategy in the long term. We build focuses on multiple areas. As a CEO, I mean over the questions post or decision present on either or such as either simple sales or system sales. But the fact is the only acceptable -- acceptable answer is to -- it's both. We want both. And then the same-store sales, obviously, is composed of the transaction. So the way that we deal with it is we really are pursuing still focus because we cannot just for all the other. So I refer to several in my earlier remarks, but just to recap, first, we have dual focus on system sales growth and same-store sales growth. .

And in quarter 3, obviously, we have a 4% system sales growth for the quarter and also 7 consecutive quarter of same-store transaction growth going forward because between the and I think you can see over the long term, we focus on transaction growth, which really is the most important -- one of the most important drivers for business like ours.

Not to mention the growth is also supported by 10 years of delivery growth. Second, and that's related to your margin question, we have still focus on operational efficiency and innovation. So -- and I certainly believe that any good company who want to drive to do both. So for Q3 alone, this year, we delivered 18% core operating profit growth through multiple margin improvement projects like Project Fresh Eye, Project Red Eye and then we reinvest our savings into multiple innovations such as food innovation and then value for money and then some breakthrough model innovations such as KCOFFEE and Pizza Hut. And with this kind of operational efficiency and innovation, both KCOFFEE cafe model and 150 Pizza Hut our store right now. They broaden our addressable market and capture new customer demand to grow the business.

Third, we have still focused on opening equity stores and accelerating franchise development and that helps obviously manage our capital return. And so far, this year, we opened 1,200-plus new stores in the first 9 months, and we are on the track to reach full year target.

The paper is good and 80% of the new stores turned profitable within 3 months, as mentioned in the earlier remarks. So at the same time, we are accelerating the franchisee opening to unlock opportunities in strategic location, remote or lower-tier cities. But last -- last but not least, the due focus on investing in business growth and returning capital to shareholders are also happening at the same time. So with the sales with the product at the end, we are growing the business and returning to capital at the same time. So to summarize, in each of the above 4 areas, we do our best to avoid unnecessary compromises. And we use all our energy, our capability, creativity to get both, including both same-store sales and system sales. Thank you, Xiaopo.

[Operator]

Your next question comes from Lillian Lou with Morgan Stanley.

[Lillian Lou, analyst]

Congrats again, Adrian, for your position. And also congrats for the very good result. My question is more on the near term because I think, Joey, you have been very clear on the long-term strategy. I think in the third quarter, I noticed that for KFC, our pricing actually recovered pretty nicely compared to the previous quarter's trend.

And I just want to check the thinking behind, i.e., do we see some elevated competition that make us less pressed by on pricing? Or have we done anything to really kind of support the pricing? So related to that, any thinking about the pricing strategy in the next couple of quarters?

[Joey Wat, executive]

Thank you, Lillian. So in terms of competition, we certainly see restaurant industry continue to grow. And then the global players are still trying to invest aggressively into China market and the current players are going deeper to lower Tier 3. And we also see some players rationalized promotional intensity in recent quarters and some aggressive players slowdown their store opening this year. For KFC pricing, we -- our strategy for KFC pricing and pizza pricing, actually, in the short to long term, relatively transparent. For KFC, we try to have stable pricing. So we -- our quarter -- this quarter is 38, I think. And then it's -- so that short term, it's slightly higher than the previous quarter. No, no, no, sorry, it's slightly lower than the slightly lower than the previous quarter, but it's higher than 2019. So it's relatively stable.

For Pizza Hut pricing strategy, we are very clear from 2017 onward. We try to be a bit more mass market driven. So we have continued to lower the pricing. So that is more accessible. So in the short term, long term, that's pretty much our strategy in terms of pricing.

[Operator]

Your next question comes from Ethan Wang with CLSA.

[Yushen Wang, analyst]

So my question is on the franchising model. I think I remember back in the Investor Day, we mentioned in the future, KFC franchisee store will be 15% to 20% of new stores. But obviously, we are now having a higher hope franchising model. So what makes this change? And if we expect more franchising model in the future, does that also mean we should expect lower CapEx spending going forward as well?

[Adrian Ding, executive]

Thank you, Ethan. I guess, firstly, on your question regarding what made the change, right? I think the key reason is we're ready. For instance, for KFC, we have the new store model, KFC small town Mini. As we communicated previously, the capital expenditure for store model is lower than RMB 0.5 million with roughly 1/3 of our regular KFC store. And for instance, for the newly rolled out Pizza Hut well, that model could be -- have a good potential in lower-tier city as well and good for franchising. .

Obviously, with the recent years, the franchisee quality in China has improved meaningfully as well. So overall, the store model revenues, our QA readiness, digital capabilities and the readiness of the franchisees, enabling us to speed up the franchise opening here in China. As we mentioned during the prepared remarks, for KFC, we aim to gradually increase our net new open percentage in franchise to be 40% to 50% down the road over the next few years. For Pizza Hut, it takes a bit longer.

But overall, we hope to achieve 20% to 30% of net new open for Pizza Hut being franchise model over the next few years. And speaking of franchise unit economics, obviously, we want to remind everyone here that for each $100 of system sales generated by our franchisee, we recognized $40 to $45 as our revenue, and that breakdown includes 6% to 7% of the 100 being our royalty fee collected and initial fee collected also the other $35 to $36 out of the 100 being the transaction with franchisees, the revenue from transaction with franchisees.

That's mainly in the areas of COS and other services, including AMP and others. And in terms of our cost, franchise expense, 3% of license fee will need to pay to Yum brands. and our expense for transaction with franchise fees is currently in credit around our cost. But in the future, there's a potential for us to retain certain margin in the services with franchisees because we have savings from Project Red Eye and Project Fresh Eye. And but that will lower our capital expenditure and in terms of our, I guess, ROIC, that's a real question. Over the long term, we do expect that will help enhance our ROIC, but in the near term, the impact will be immaterial because, as we mentioned, the overall pacing of step-up in franchising will be gradual over the next few years. Thank you, Ethan.

[Operator]

Your next question comes from Michelle Cheng with Goldman Sachs.

[Michelle Cheng, analyst]

So my question is still more on the short term. I think, Adrian, you earlier mentioned that quarter-to-date, we didn't see a significant changes yet, even we are positive on stimulus. But considering last fourth quarter, the base post should be easier. So are we still seeing like incremental sequential improvement in fourth quarter trend? And also, looking ahead, when we consider both KFC and Pizza Hut, KFC the same-store sales is still much more resilient than compared with the pre-COVID levels still much closer. So when we look for same-store sales growth going forward, are we seeing that Pizza Hut's pricing trend will be gradually stabilized and KFC actually have room to see the pricing improvement next year?

[Adrian Ding, executive]

Thank you, Michelle, for your question. As I mentioned in the prepared remarks, we are quite encouraged by the similar policies. Obviously, it will take time to influence consumer behavior and impact businesses like ours. I'd like to give some more color into quarter 4 performance, especially in the top line. So entering quarter 4, as I mentioned in the prepared remarks, we've not observed significant changes in consumer sentiment nor in the macro situation. In terms of the October Golden Week holiday, our SSSG slightly improved year-over-year during the Golden Week. However, the consumer spending remain cautious post holiday. I think that's a comment that we observed for this year after a long holiday. The consumer spending returned to be cautious for a of time after the long holiday. .

Overall speaking for quarter 4, we still face some top line pressure, but we are confident in our ability to outperform peers in both the good times and bad, and we are also reasonably confident that our quarter 4 same-store transaction index will continue to be positive for another quarter.

Lastly, but importantly, we really focus on things within our control. So we continue to execute on our strategy, which has proven to be quite effective to capture incremental traffic and protect our margins. We believe we are well positioned to capture -- continue to capture consumer needs with our flagship product, stunning value, deliver strategy and breakthrough models. I think to your second part of the question relates to the difference between KFC and Pizza Hut.

Obviously, given the consumers are more rationalized in their spending, Pizza Hut with their higher per-person spending currently is facing a little bit of bigger headwind compared to KFC, which is really having a super robust resilient model. However, I think we're doing all the right things for Pizza Hut, lowering the TAs, lowering the professional spending and also devising the new store models such as Pizza Hut WOW, which is even more accessible. And as we mentioned in the prepared remarks, both this quarter and the previous quarter that we do see some initial encouraging results for a WOW. But particularly on the dining side, we see a meaningful increase in SSG there for a WOW. Obviously, it's only 5 months since we opened -- since we're converting the first WOW store back in May. So we're still kind of iterating a development store model. Hopefully, over the steady state, the Pizza Hut WOW will enable the Pizza Hut to get to a different and much larger total addressable market.

And I think your final part of your question is more on the midterm for next year on the TA Pizza Hut and KFC. As we mentioned, for KFC, we looked at the TA, we expect the TA to be steady over the mid- to long run, although there might be some short-term fluctuations depending on macro and dynamics. For Pizza Hut, it' our strategy to lower the TA and then we have been doing that reasonably effectively with the positive transaction growth over the past quarters. And we look to continue that strategy down the road as well. Thank you Michelle.

[Joey Wat, executive]

Thank you, Adrian. I'll just add some color about the Pizza Hut same-store sales. So the Pizza Hut model, good progress on step at a time. As Adrian mentioned, we see a very nice improvement in the dining same-store sales. And out of 150 Pizza WOW store actually 1/3 50 stores in Guangdong in the South. And because of the scale, of the Pizza WOW relative to the to store, we see some meaningful improvement of the Guadong same-store sales, which is exciting.

But again, we have over 600 stores Pizza WOW around the country right now. So it will take some time. But the progress is good. Last but not least, the quarter 4 is a small quarter. So a lot of the numbers could pursuing either way. Thank you so much.

[Operator]

Your next question comes from Sijie Lin with CICC.

[Sijie Lin, analyst]

congrats on another strong quarter and general shareholder returns. I have one question. So we have seen some food safety cases overseas. So how do we balance on one hand, the cost control? And on the other hand, the quality of the product and service?

[Joey Wat, executive]

Thank you, Sijie. Well, first of all, I presume you refer to full safety case overseas that's caused by Roy Onion. First of all, we only use cook onion. So that should not have similar implication to our business.

When it comes to the overall food safety versus cost control, it's always our strong philosophy and operation that we put food safety at the most important position. We are fully compliant with regulation. And also we -- is one of the few issues that if there's any issue, we reported directly to myself and then we also reported to our Board, we have a full safety committee on this one. So we absolutely treated as highest importancy and priority. And it's reflected in a holistic quality assurance system and our comprehensive food safety process within our entire value chain from suppliers to logistics all the way to our stores.

And last but not least, I just want to reassure you that our investment in our digital supply chain in the last many years have paid off. We have very good visibility means digital visibility of our food safety without inventory. And to the point that stock replenishment to the stores is automatic. So it's absolutely important. Last but not least, we have more than 300-plus QA employees spread across China, focusing on this important matter in addition to the technology that we have invested to monitor this particular important priority. Thank you so much.

[Operator]

Your next question comes from Anne Ling with Jefferies.

[Kin Shun Ling, analyst]

Just a question on KCOFFEE. Now with 500 stores, so what we hear on the ground is that it's been doing amazingly good. So I just want to check like whether you can share with us like the incremental benefit because it's a side-by-side store with your existing KFC. So maybe would you share with us what is the incremental like same-store benefit? And also, like in terms of profitability, if there's anything that you can share with us?

[Joey Wat, executive]

Thank you, Anne. Well, launch store short, the incremental sales uplift to the store, we have observed is a single-digit sales uplift, and it does produce incremental profit because of our very neat operating model. So that is the short answer. In terms of longer answer, we are indeed very excited. And today, actually, we opened our 500 stores in in Shanghai right next to our headquarter and in a very prime area in Shanghai.

The increase of the sales and -- or the number of cups is 30% plus roughly. And this is very exciting, especially when we take the background of the overall market in coffee as the background. And the opportunity here is a significant majority of our members of our Yum China members have yet to try a KCOFFEE. And in our side-by-side model, the cross-sell from KFC to KCOFFEE is amazing. So we are excited about it. And it took us 10 years from selling coffee to build the first KCOFFEE cafe, but we see really good progress. We have 100 stores in March. And now we have 500 stores and then by year-end, we expect to exceed 600-plus stores. And we are expanding to campus and transportation location as well. The food is good. We have very distinctive coffee sparkling coffee, the float and then the or the gigantic attire. So things are looking very exciting and positive. Thank you, Anne.

[Operator]

Your next question comes from Walter Woo with CMBI.

[Wing Hong Woo, analyst]

Can you hear me?

[Joey Wat, executive]

Yes.

[Wing Hong Woo, analyst]

Congratulations on -- to your resilient results, and thanks again for all the efforts. So my question is about the Pizza WOW store performance. So can you comment on the sales and margin performance of the Pizza WOW stores and also the midterm room for potential growth? And are they suitable for all the regions in China?

And also, well, I remember the last time when I dined in the WOW stores, the many looks really appealing and there are lots of choices and the prices are cheap. And however, when I really ordered, many of the items were just not available. So this has disappointed me a little bit. And do you think this is a problem? And how do you see the WOW store format now and going forward? And also, we are also heard of your new store format called. Are there any inflows that you are ready to share?

[Joey Wat, executive]

Thank you. For Pizza WOW, I mean, let's take a step back. It's only really innovation that happened only 5 months ago. So I think our speed of going out is very fast already. We are at about 150 stores. And the breakthrough model is very exciting. As I mentioned in the prepared remarks, the impact on the buy-in thing calls is very exciting. There more work to be done for the delivery side.

And then in terms of the profit, we continue to work on it. Well, let me just bring back our deal focus. Innovations and operational efficiency. Operational efficiency and innovation. It goes both ways. So for our core business, we achieved operational efficiency, and we take the savings and we invest in innovation. For Pizza WOW, we have the innovation first, and that is reflected in exciting sales. But the operational efficiency will come later, which I hope address your disappointment of the product because it does not happen automatically.

And that's another reason why whenever we turn around business, KFC or later on Pizza Hut, we always focus on sales first, profit later one step at a time. So for Pizza WOW, go back to our framework, we have the innovation first and then operational efficiency later.

So I believe that things are in good progress. And I'm very happy to see what have we achieved so far for Pizza WOW, but a lot more work to be done. It's only 5 months. Regarding we have been opening a few small number of Kapooin Hangzhou, Shanghai, and it's still small right now, and obviously, target health conscious consumer with products, energy and smoothies, very healthy choices. And it's still in pilot stage, by the way. So there's still a lot to be learned. But that's one thing that we already are doing, which is sharing the learning from KCOFFEE is again, it's side by side. The new stores are side by side with the KFC coastal so that we can share start. We can share some investment of CapEx, but still early days. Okay. Thank you.

[Operator]

Your next question comes from Linda Huang with Macquarie.

[Linda Huang, analyst]

Yes. My question is regarding for our capital allocation. We appreciate that the company stepped up the total return to 4.5 billion. And please correct me if I wrong because based on your cash flow, right? I found that every single year, our free cash flow will be around $700 million to $800 million. But if we return back to $1.5 billion, that means that probably in 3 years, we can use all our cash in our balance sheet. So I'm just wondering, based on this capital return, does that mean that for the 3 years -- next 3 years, we will just purely focus on the organic growth, and we never think about anything like a big M&A will happen in the next 3 years or we can strike the balance. If there is a big deal coming up, and we are willing to take some debt to take any M&A opportunity. So that's my question.

[Adrian Ding, executive]

Thank you, Linda. I guess the 2 parts of the question. Firstly, regarding the sustainability of our capital return. Obviously, we're very confident in our ability to generate our cash. And as we mentioned, we have still focus on our business growth and return to shareholders, dual focus again. for 2024 to 2026, we plan to step up our return from $3 billion to $4.5 billion. That includes the $1.5 billion for this year 2024. And as a question regarding the longer term, right, obviously, as you correctly pointed out, we probably cannot do $1.5 billion every year forever, but I think in terms of our company's philosophy, we have always been shareholder value conscious. .

So we'll continue to evaluate how best to deliver long-term shareholder value. And obviously, I will not be surprised down the road, we will be able to return a meaningful portion of our free cash flow generated each year to our shareholders beyond 2026. Obviously, we have no concrete plans yet, but we'll provide some more concrete guidance down the road at the appropriate time.

On your second question regarding M&A and strategic opportunities, we have been very prudent in terms of our M&A approach. Obviously, we prudently and proactively evaluate potential M&A opportunities, both historically as well as in the future. and we'll only go ahead with M&A to the extent that makes sense and create value for shareholders. So obviously, for each of the M&A, as you know, we actually have a robust discussion with our board as well.

To the extent it very major M&A comes out and then to the extent, if it makes a lot of sense to Yum China, then we may or may not adjust our capital return plan. Obviously, we may or may not take on debt to fund M&A depending on size of the M&A. Again, we are very prudent in terms of our M&A approach. We'll only do M&As to to our shareholders. Hopefully, that will address your questions. Thank you, Linda.

[Operator]

There are no further questions at this time. I'll now hand back to Ms. Lip for closing remarks.

[Florence Lip, executive]

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

[Joey Wat, executive]

Thank you.

[Adrian Ding, executive]

Thank you.

[Operator]

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