Pizza Hut Delivers Growing Slice Of Yum China's Pie

Make room at the China dining table, Colonel Sanders.

Pizza Hut, sister brand to the KFC fast food chain, passed a major milestone last Friday by opening its 3,000^th mainland Chinese store in the coastal city of Qinhuangdao.

The store launch, symbolically set in the city at the eastern end of China’s Great Wall, also marks a coming-of-age for the chain that first entered China more than three decades ago in 1990, just three years after KFC became the first western restaurant chain to dip its toe in the market.

Pizza Hut celebrated the milestone with some on-the-ground festivities, including the introduction of new wait staff uniforms that will gradually be rolled out across the rest of China.

But the real story lies mostly behind the scenes, following an overhaul for the chain in China that dates back six years and is now starting to bear fruit. Before the overhaul, the brand was a laggard to the larger KFC, which are both operated in China under a master franchising agreement between U.S.-based Yum Brands Inc. (YUM) and its former Yum China (NYSE:YUMC; 9987.HK) arm, which was spun off as a separate company in 2016.

Much has happened since the overhaul began in 2017, including a drive to automate more functions and extend the chain’s footprint with smaller stores to serve a wider area for its growing delivery business.

At the same time, the chain has been adding more items to its menu, many adapted to local tastes, both for traditional restaurant food and also a growing number of semi-prepared meals, which were introduced during the Covid-19 pandemic in 2020, for cooking at home.

The result has been improving margins for the chain, driven by the greater efficiencies and also a return to more normal conditions following China’s scrapping of its “zero Covid” policy at the end of last year.

“This milestone underscores our focus on continuous innovation, from menu innovation and digitalization, to a range of new store formats,” said Yum China CEO Joey Wat. “We believe the brand holds tremendous growth potential in China, and we are committed to actively pursuing expansion opportunities to further grow the brand.”

The 3,000-store milestone makes Pizza Hut easily China’s largest chain for the popular pizza dish that is rapidly finding a place on the Chinese menu, alongside traditional hometown favorites like dumplings and noodles. The country’s overall pizza market was worth 37.5 billion yuan ($5.2 billion) in 2022, and is expected to roughly double to 77.1 billion yuan by 2027, according to market research firm Frost & Sullivan.

Pizza Hut sold over 100 million pizzas in 2022 alone, equal to seven every second. The chain has sold more than 1 billion pizzas in China since entering the market 33 years ago.

The overall market is also relatively underserved with just 11.7 stores per million people in China last year, well behind the 30 stores per million for the nearby Asian markets of Japan and South Korea.

Following the Pizza Hut overhaul, Yum China has been ramping up its spending on the chain in a bid to tap the expected growth in demand. The company opened 313 net new Pizza Huts in China last year and another 80 in this year’s first quarter. That was faster than the 235 net new stores in 2021, and light years ahead of the 115 stores opened in 2018 and 2019 combined when the overhaul was just beginning.

As the ramp-up accelerates, Pizza Hut accounted for 17% of Yum China’s total capital spending last year, up from 14.5% the previous two years. Yum China estimates 87% of all Pizza Huts in China have been either newly built or remodeled over the last five years, according to its latest annual report.

Return to revenue growth

Like nearly all restaurants in China, Pizza Hut, which accounted for about one-fifth of Yum China’s sales in the first quarter, suffered last year as a result of the country’s strict Covid control measures that frequently forced stores to close or limit operations.

After reporting a 7.1% revenue decline last year, the Pizza Hut chain in China bounced back sharply with 9.1% revenue growth to $597 million in this year’s first quarter.

Same-store sales also rose by 7%, while traffic for the chain was up 13% as people resumed dining out. Nearly two-thirds of all sales came from the chain’s customer loyalty program, which had 135 million members at the end of this year’s first quarter.

Unlike the west, where Pizza Hut is often seen as a lower-end takeout dining option, the chain is still popular for dine-in service in China, where it is considered a more mid-range brand with table service.

But delivery service in the country was already growing in popularity even before the pandemic, and nearly 43% of the chain’s sales were for delivery orders last year.

More than half the chain’s sales last year were either delivery or takeout dining orders, as Chinese follow their western peers in a growing preference to eat pizza at home rather than in restaurants.

As business has picked up with the end of pandemic restrictions, the chain’s restaurant profit jumped 44% year-on-year to $84 million in the first quarter, while its restaurant margin rose 3.5 percentage points to 14.2%.

The improving margins owe not only to better post-pandemic business, but also to some key adjustments to its business mix, some on the menu and others less obvious.

One key change has been a movement to opening stores in clusters, each led by a single management team based in a central main restaurant surrounded by smaller-format satellite shops. Such organization reduces the need for high-level managers, and also gives greater geographic reach for delivery service.

The company has also increasingly automated and digitized its processes, reducing the need for more expensive human labor. One-third of its stores had robotic servers by the end of last year, while 91% of all orders now come over digital channels – triple the level from 2019.

The chain has also expanded its menu to include items you won’t find in any western Pizza Hut, including many rice-based dishes and pizza topped with the pungent durian fruit. And lest anyone think Pizza Hut is just for pizza lovers, the chain has also become China’s biggest steakhouse. Steaks are now its second most popular item, second only to the pizzas that make up almost 40% of sales.

Investors seem to like Yum China’s unique flavor of KFC + Pizza Hut + China, giving the company a forward price-to-earnings (P/E) ratio of 28, slightly ahead of parent Yum Brands’ 26. The figure is also ahead of the forward P/E of 23 for Domino’s (DPZ) and 25 for Papa John’s International (PZZA), which are both also active in China.

DPC Dash (1405.HK) is rapidly expanding in the market as the Domino’s master franchisee for China, and is now Pizza Hut’s biggest rival with 588 stores at the end of last year. But the company is still losing money, unlike Pizza Hut, which has maintained profitability, even during the difficult years of the pandemic.

Disclosure: None

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