Yum China (YUMC) Q3 2023 Earnings Call Transcript

Yum China (YUMC -1.05%)
Q3 2023 Earnings Call
Oct 31, 2023, 8:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Thank you for standing by and welcome to the Yum China third quarter 2023 earnings conference call. I would now like to hand the conference over to Michelle Shen. Please go ahead.

Michelle Shen — Director, Investor Relations

Thank you, Zach. Hello, everyone. Thank you for joining Yum China’s third quarter 2023 earnings conference call. On today’s call are our CEO, Ms.

Joey Wat; and our CFO, Mr. Andy Yeung. I’d like to remind everyone 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 the 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. We held our Investor Day in September in Xi’an, China. It was wonderful meeting investors face to face. At the event, we unveiled our RGM 2.0 strategy with a strong focus on growth.

We have set ambitious growth targets for the coming three years. These include reaching 20,000 stores by 2026, achieving double-digit EPS CAGR and returning $3 billion to shareholders in dividends and share repurchases. With our long-term growth commitment in mind, let’s zoom into the third quarter. Our results reflect continued strength.

The quarter net new stores, revenue, and adjusted operating profit all reached record levels. We accelerated new store openings with 500 net new stores in the quarter while maintaining healthy store payback period. Our portfolio now exceeds 14,000 stores. System sales grew 15 % year over year in constant currency.

Adjusted operating profit, excluding temporary relief grew 21% year over year in constant currency. In the first nine months, adjusted operating profit exceeds USD 1 billion. Our team’s relentless efforts produced these remarkable results. To drive sales in the peak summer trading season, we bolstered crew resources for excellent service, ensured supply pipeline readiness, and executed traffic driving campaigns.

Same-store sales growth in the third quarter was led by strong transaction growth. During the summer holidays, same-store sales at our tourist and transportation locations surged more than 50% year over year. It’s important to remember though that consumers have continued to be cautious in their spending. Our formula to capture sales growth has always been simple: good food, good fun, and exceptional value.

Now, let me go through what we have done. First, food innovations on a big scale. Our $100 million club showcased at Investor Day illustrates our success in building huge categories to boost sales. Recent innovations at KFC include our juicy whole chicken and beef burger.

To put things into perspective, in the third quarter, these two categories combined exceed 6% of KFC sales mix. This is higher than our original recipe chicken, which we have been proudly serving in China over the past 36 years. It shows our ability to innovate but also build very big categories. We are continuing to expand these categories with new flavors like Sichuan style spicy whole chicken, Szechuan [Foreign language], offering it from Friday to Sunday only.

This spicy whole chicken is perfect for a home consumption. We also collaborate with Ultraman to promote our premium Ultra Cheese 2.0 Beef Burger. [Foreign language]. Consumers love them.

At Pizza Hut, we sold over 100 million pizzas in the first nine months of the year. One out of every five pizzas we sold was a durian pizza. That’s over 20 million durian pizza, nearly 70% more year over year. Our in-house supply chain worked with suppliers to secure durian supplies and expand capacity to satisfy the growing demand.

Second, we are offering our customers amazing value for money on top of the innovative food. KFC Crazy Thursdays, [Foreign language] is no longer just a marketing campaign. It has become a cultural phenomenon. Crazy Thursday sales consistently outperformed other weekdays in the third quarter by around 40%.

To keep customers engaged, we rotate offers and regularly launch new flavor variations such as spicy nuggets, [Foreign language]. We chose products that utilize existing ingredients and involve simple cooking process to provide exceptional value, while ensuring operational efficiency. At Pizza Hut, we are expanding our selections for pizzas priced below RMB 50, which is a very significant portion of the overall pizza market. Around 20% of our pizzas we offer are priced below RMB 50.

And that’s not enough, we could do more. By enriching our lower-priced pizza offerings, we are tapping into this substantial opportunity that’s currently underserved by Pizza Hut. Other than pizzas, we are adding new snacks that customers love. Our new Cheese tart, [Foreign language], became our best-selling snack in September and an amazing traffic driver.

Not easy for a snack item to be a traffic driver compared to pizza. Next, keeping users engaged and having fun along the way. Our loyalty programs top 460 million members in Q3, up 15% year over year. Notably, sales from members continue to be high at 65%.

We collaborate with pop culture icons that resonate with young generations. KFC’s campaign was HonKai Star Rail, [Foreign language]. A popular eGame generated huge social buzz and attracted many new customers. Almost 40% of traffic generated from the campaign came from new or inactive members and a significant portion are young adults, and that’s fantastic news for the brand.

We’re proud to be exclusive Western food catering supplier for the Asian Games in Hangzhou. Over 250 of our crew members from across China were chosen to serve at the sporting event. KFC and Pizza Hut set up nearly 30 pop-up stores and serve over 1 million athletes and fans. And it shows that our food is good enough and healthy enough for the professional athletes too.

We also ran nationwide campaigns offering exclusive gifts at our restaurants and through our Super App in celebration. In closing, I want to thank all of our teams for their hard work in delivering a strong quarter. Next week, we will hold our RGM Convention for our restaurant General Managers. This marks the first in-person convention for 13,000 attendees in 2019.

Very excited about it. It’s an excellent occasion to honor our RGM’s dedication, celebrate our achievements, and reaffirm our goals for the coming year and beyond. Looking forward, the growth potential in China remains vast even with moderate economic growth. RGM 2.0 provides us the strategic framework to grow sustainably.

Evolving consumer preferences in the post-pandemic environment require us to stay agile and vigilant. Our robust supply chain and innovative digital ecosystem has enabled us to quickly adapt to changing market conditions. I’m confident we can continue to create long-term value for our shareholders. With that, I will turn the call over to Andy.

Andy?

Andy Yeung — Chief Financial Officer

Thank you, Joey, and hello everyone. Let me share with you our third quarter performance. But before I do that, I want to point out, foreign exchange had a negative impact of approximately 6% in the quarter. Overall, we achieved solid results growing across key metrics.

On a year-over-year basis, revenue grew 15% and adjusted operating profit grew 10% in constant currency. Compared to pre-pandemic levels, we have a much larger stock portfolio. Although same-store sales remain at approximately 90% of 2019 levels, system sales grew 22%, compared to 2019. With that, let’s go through the financial in more detail.

Third quarter total revenues were $2.91 billion in reported currency, a 9% year-over-year increase. In constant currency, total revenue grew 15%. System sales also increased 15% year over year in constant currency. The growth was mainly driven by new unit contributions and same-stock sales growth of 4%.

Dine-in sales continue to rebound year over year. By brand, KFC same-store sales grew 4% year over year. A strong rebound at transportation and tourist locations contributed to the growth. Same-store traffic grew 9%, while ticket average decreased 5%.

These results were mainly driven by successful traffic driving promotions, lower delivery mix, and rebound of the breakfast daypart. Delivery typically carries a higher ticket average than dine-in orders. Thus, a decline in delivery mix lower the overall ticket average. Breakfast orders tend to have a lower ticket average as well.

So, the rebound in breakfast sales contributed to traffic growth, but lower ticket average. Please note that overall ticket average in the third quarter was similar to the second quarter and higher than 2019. Pizza Hut same-store sales grew 2% year over year. Same-store traffic grew 12% and ticket average decreased 9%.

We want to highlight that by design. We are expanding our price ranges to enhance Pizza Hut’s value propositions and to capture their underserved markets. Consistent with Pizza Hut’s remarginalization plan, we want to enhance Pizza Hut’s value propositions to consumers. Particularly, we are targeting the sub-RMB 50 pricing range, which represents a very significant segment of the pizza market in China.

We also intend to increase the sale mix of delivery and off-premise dining over time. For Pizza Hut, delivery sales generally have a lower ticket average than dine-in. Finally, we aim to bolster the sales of single-person meals. This is a different market segment compared to Pizza Hut’s existing customer base, which tends to be group or family dining.

Restaurant margin was 17%, 180 basis points lower than the prior year. This was mainly due to lapping of last year’s temporary relief of $30 million, which translates into 120 basis points margin impact. Excluding this impact, year-over-year margin change is only 60 basis points. Wage inflation normalizations of staffing at the store level increased promotional activities, also impacted margins.

On a positive side, occupancy and other expenses improved year over year, primarily due to sales leveraging and ongoing benefit of cost structure rebasing efforts. Now, let’s go through the key items. Cost of sales was 31.1%, 40 basis points higher than the prior year. We increased promotional activities to drive traffic sales — I’m sorry, drive sales.

And we also faced higher poultry prices in the quarter. This was partially offset by more favorable prices for commodity, including beef and cooking oil, as well as full utilization of chicken. Cost of labor was 25.3%, 180 basis points higher than the prior year. Last year, we benefited from temporary relief of $17 million, which translates into 70 basis points margin impact.

Two other key factors that impacted labor cost comparison were, one, mid-single digit wage increase for frontline staff due to annual wage adjustment; and two, normalized staffing level at our stall compared to the pandemic last year. These were partially offset by sales leveraging. Occupancy and other was 26.6%, 40 basis points lower than the prior year, benefiting from improvement in rent and depreciation expenses. We continue to secure more favorable rental terms for new store.

Lower depreciation resulted from lower upfront investment and store portfolio optimization. It’s important to note that 45% of our stalls have been built after 2019. This was partially offset by lapping of $13 million in rental relief and austerity measure associated with the pandemic last year. G&A expenses increased 14% year over year in constant currency, mainly from higher accrual of performance-based incentives.

And to a lesser extent, near increases and higher travel expenses from the resumption of business travel. Operating profit was $323 million, increasing 9% in constant currency, excluding $30 million in temporary relief received last year, adjusted operating profit to 21% in constant currency. Our effective tax rate was 27.5%. We continue to expect our full year effective tax rate to be around 30%.

Net income was $244 million, and diluted EPS was $0.58, both increasing 18% in reported currency. Excluding the foreign exchange impact, net income increased 26% and diluted EPS 27% in constant currency. We generated $410 million in options cash flow and $243 million in free cash flow in the third quarter. We returned $211 million to shareholders in cash dividends and share repurchase in the quarter, on track to return $600 million to $800 million for the full year 2023.

Our balance sheets remain strong with around $4.2 billion in net cash positions by the end of the third quarter. Now, let’s turn to our outlook. Regarding store opening, we opened 500 net new stores in the quarter and 1,155 net new stores year to date. We are on track to meet our 2023 full year target of 1,400 to 1,600 net new stores.

The new store payback period for our KFC and Pizza Hut store remains healthy at two years and three years respectively. With our healthy new unit payback, together with flexible formats and modules, we are confident to reach 20,000 stores by 2026, as we unveiled at our Investor Day. Looking ahead, the fourth quarter is seasonally a small quarter for both sales and profit. On the sales side, since the late September, we have observed softening demand, which extended to October.

Consumers have become more value conscious. We have been focusing on food innovation and widening pricing ranges to tap into underserved market to drive growth. Regarding margins, sales remain the biggest factor. Fluctuation in sales may have a pronounced impact on margins in the fourth quarter.

As a reminder, in the fourth quarter last year, we also received 26 million in temporary relief, which we do not expect to repeat this year. We also anticipate wage inflation of mid-single digits and returning to more normalized staffing levels at our store. Just as a reminder, in the fourth quarter last year, we experienced labor shortage due to widespread COVID infections. The post pandemic economic recovery is shaping up to be a wave-like and nonlinear process.

So, we will maintain our focus on tracking sales and cost efficiency. However, the overall trend toward recovery is evident this year, and many of our performance metrics are setting new records. We have demonstrated our ability to quickly adapt to changing consumer preferences and seize opportunities under different market conditions. We are confident that the successful execution of our RGM 2.0 strategy will help us expand our store portfolio, grow sales, and boost profit, delivering sustainable value creation and long-term returns to shareholders.

With that, I will pass you back to Michelle. Michelle.

Michelle Shen — Director, Investor Relations

Thanks, Andy. Now, we’ll open the call for questions. In order to give more people the chance to ask questions, please limit your questions to one at a time. Zach, please start the Q&A.

Questions & Answers:

Operator

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

Michelle Cheng — Goldman Sachs — Analyst

Hi, Joey and Andy. Thanks for taking my question. My question is still about the competition. Especially you mentioned that the trend turned softer since the end of September.

So, can you share with us how do we see the competition landscape evolve? And also with this value campaign, how should we think about the balance between the top line growth and also the food cost control? Thank you.

Joey Wat — Chief Executive Officer

Thank you, Michelle. Regarding the competition, we see it as a positive trend in time, because despite some concern toward the macro situation in China, in the media, in reality, both international and domestic players are investing aggressively in our industry. That shows that these players, competitors, are voting with their money and voting with their seat. And that’s consistent to our view toward the business and our industry in China, particularly for the chain store business model.

On top of that, we see very vibrant competition in the lower-tier city. Again, that is good because if you remember back to our Investor Day, we have very aggressive store opening plan, especially in the lower-tier city. And that resonate well with our view that there’s a lot of opportunity in the lower-tier cities. So, we’re quite happy to see that.

And then when it comes to the point about value-driven consumer, we have been a player that has benefited from the more cautious and more rational spending for the consumers. We’re a fast-food company. When customer becomes more value driven, it’s good for us, as far as we have the capability to deliver and we do. And it has been a consistent focus for our company, to focus not only value, but innovative products and fun experience, because value itself is never enough for our customers and we’ll continue to do that.

And you can see that in this quarter, in the past many years, we have been very consistent with our ticket average. With the ups and down, our ticket average compared to the last sort of more stable year, 2019, is still up a little bit, because we are very careful about it. We can see price increase every year and Pizza Hut during the turnaround time for the original product, we kind of keep the price the same, but then we get a bit more opportunity with the new product. But the ticket average has been relatively stable.

And even in the last quarter, you can see we have very healthy growth of transaction, TC. And our business, TC growth is sober. I mean, it cannot be better to have TC growth. So, it shows that we react very quickly and we are very agile and we get the sales.

Last but not the least, while we are doing all this innovative product, we deliver value products for our [inaudible]. We are able to prepare our margin with our innovations and value campaign and that is very important. In fact, our year-to-date margin has already exceeded that of 2019, which is pre-pandemic. There’s some movement, I mean Andy — I’m sure Andy will go through it later on.

There’s some movement between the different lines of cost structure, but the restaurant margin, that’s what we could tell. We reduced the rent, we reduced the O&O, and then we put the money into food and to service, to serve our customers. So, net-net, our competitiveness is good, because we see it’s a vote of confidence for our industry and our market. Thank you, Michelle.

Michelle Shen — Director, Investor Relations

Thank you, Joey. That’s very clear.

Operator

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

Sijie Lin — CICC — Analyst

Thank you, Joey and Andy. So, I have one question regarding the margin. So, Andy has mentioned the reasons behind the margins year-over-year change, but if we compare Q3 with the same quarter in 2019, our revenue increased 26%, but operating profit only increased 8%, which is quite different with Q1 and Q2. So, could you please help us better understand this? Thank you.

Andy Yeung — Chief Financial Officer

OK. Thank you for the questions. And so, as you mentioned, if you look at the year-over-year comparisons, you definitely need to take out the impact from the temporary relief last year. And when we compare to 2019, obviously over the past few years, we continue to see the labor costs that was increasing over the past few years.

But we’re able to possibly offset that by improvement in our O&O, which is occupancy and other expenses. And then if you look at by item, you see that COS is actually pretty stable, about 31%. Our COS as mentioned, because of wage inflations and a high mix of delivery, we have seen some increase there. However, O-to-O side, we are much better, mainly benefiting from store portfolio optimizations and rent negotiations and better lease terms.

And we also have other initiatives to rebase our cost structure to possibly offset that. If you look at the same-stock sales, which is about 90% level of the 2019. Now, looking at that, as we mentioned a little bit earlier, looking ahead in the fourth quarter, fourth quarter is a smaller quarter for us in terms of sales and profit. And so, as we have mentioned, we have seen some softening demand since September, so sales fluctuation will have a more pronounced impact on the profitability and margin.

Now, again, in the fourth quarter compared to last year, last year we received $26 million of temporary relief, which we do not expect to repeat this year. Now, in terms of wage inflation, let me just repeat it again, mid-single-digit wage inflation, normalization of staffing levels at our store. Longer term, as we have mentioned at our Investor Days, we — our goal is to maintain a stable margin and potentially improve it over time. Obviously, we have to work hard to continue to offset wage inflation impact every year and potentially commodity inflation in the long term.

It’s important to keep, a short-term and long-term balance in mind. We will continue to benefit from cost-structural rebasing efforts that will stay in place for a long time. For example, high level rent; our megastore restaurant staff sharing program. We also have more flexible and lower investment for our store model.

So, we’ll maintain our discipline in cost, efficiencies, and also continue to improve productivity. That’s how we look at the margins in both short-term and long-term. Thank you.

Michelle Shen — Director, Investor Relations

Thank you, Andy.

Operator

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

Christine Peng — UBS — Analyst

Thank you, management. I actually have a question which is also related to competition, but I want to ask more details specifically in terms of this Chinese-style burger. I think in the Investor Day, [Inaudible], your KFC management actually shared with investors, KFC’s plan to launch the Chinese-style burger products in the very near future. So, can management share with us the timetable, as well as more specifics about this product in terms of price strategy, product strategy going forward? Thank you.

Joey Wat — Chief Executive Officer

Thank you, Christine. We actually have test launched this particular product in three provinces already, Tianjin and Fujian in particular. So, it’s interesting that we test launched it — not in Guangzhou, Beijing or Shanghai. We do it instead of second tier cities.

And the progress has been good, and we are happy with the result and we continue to work on a plan and then move to next stage when we are ready. The price point is competitive. It’s very affordable. And it’s one of our strategies that for the lower-tier city, we have slightly different product and a more affordable pricing.

But at the same time, we still maintain the margin for the business. But it’s going well. I tasted the product myself. It tastes great.

So, hopefully next time we can get it closer to Hong Kong where you can — you don’t have to travel that far to try it.

Michelle Shen — Director, Investor Relations

Thank you, Christine.

Operator

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

Chen Luo — Bank of America Merrill Lynch — Analyst

Hi, Joey and Andy. So, my question is also on competition. In fact, last time in Xi’an, I also raised a question on testing and the likes of TikTok coupons. And I think given our current value campaign and our initiatives to broaden our price range, as well as to sell more coupons on TikTok, do we think that the ticket average decline that we saw in Q3 could actually extend into the coming few quarters? And would the ticket count increase, can be enough to offset the ticket average decrease? Lastly, in terms of our food and paper cost as percentage of sales, do you think that in the near term, it could be under some pressure on a year-on-year basis into the coming few quarters? Thank you.

Joey Wat — Chief Executive Officer

Thank you, Chen Luo. Let me just point out that the ticket average compared to last year is not exactly the best comparison because last year is during the pandemic. Ticket average is unusually high because people are locked down at home. And when they order, they order big ticket size, right.

What is more comparable is we look at the ticket average compared to sort of the more normal year. Although we are — our business is very different compared to 2019, but we can compare the ticket average with 2019. The ticket average is still slightly higher in 2019. So, that is sort of more normal.

So, I ask our investor not to be overly concerned about the ticket average drop compared to last year. And usually when our sales move, the more focused number is always the ticket transaction, TC. And the fact that our TC grows at almost double digit is a good sign. So, in our business, over many, many years, just go beyond one quarter, go through the five years or 10 years, you will see our ticket average is always rather stable.

So, that hopefully addresses your concern about the ticket average. And, go on —

Andy Yeung — Chief Financial Officer

Yeah, let me just address this TA. As I tried to, in the previous remarks, I’m trying to decompose what is driving the TA. Obviously, promotion is a part of that, but it’s only one of the, right. If you look at for example for KFC, today the TA is still higher than what we have seen in 2019, as Joey mentioned.

And part of that is delivery mix, right. We have high delivery mix compared to 2019. And then, if you look at compared to last year, we actually will decline in the mix for delivery as people returning to the store. And so, that would have an impact on the TerrAscend, because the delivery TA for KFC obviously is higher than the dining component.

The other one is, if you look at KFC for example, we also mentioned about breakfast daypart, right. So, last year because of the pandemic, the breakfast daypart was impacted more so than the other daypart. With the rebounds in, breakfast daypart, and which tend to also have more TA. So, the increase in traffic for breakfast daypart would also have impact on that.

So, there’s a number of components. And if you look at our fuel ads, you will notice that it’s actually very stable, right. Compared to last year, only 40 basis points difference. Compared to 2019, 10 basis points.

It’s almost flat line, right. So, we have ability to manage overall our possibilities, our margins with different drivers for TA.

Joey Wat — Chief Executive Officer

Just coming back to lower density of food and paper costs, I mean, I think we have shared in our Investor Day that we’ve been managed, we’re being able to manage the food and paper costs at a very stable number over many years. When there’s some factors driving up the food cost, well such as commodity inflation. We are able to deliver a very stable growth, because of our innovations and using all parts of chicken and being flexible with our supply chain. So, we are always quite stable here.

And I keep reminding our team internally, the problem, the food and paper cost become a problem is when it becomes too low. That means that we are not giving the value for money, the quality of food and the volume of food to customer. So, it’s a relatively stable percentage for the food and paper costs over the many years. Thank you.

Chen Luo — Bank of America Merrill Lynch — Analyst

Yeah, thank you, Joey and Andy. So, we also have confidence in the management ability to stay agile and take the right measures to address competition and further reach share. Thank you.

Joey Wat — Chief Executive Officer

Thank you.

Andy Yeung — Chief Financial Officer

Thank you.

Operator

Your next question comes from Wilkins Tong from Morgan Stanley. Please go ahead.

Unknown speaker

Hey, sorry, this is Lillian from Morgan Stanley. Can you hear me?

Joey Wat — Chief Executive Officer

Yeah, we can.

Andy Yeung — Chief Financial Officer

Yeah.

Unknown speaker

Yeah, so I have a question again on margin side, but its different aspects. I think despite all this losing the subsidy impact and normalization of labor, staffing to stores. Is there any impact from acceleration of stock expansion to margin? Because I think going forward, we’re going to keep up this expansion pace. So, should we kind of rethink about the margin base given such a situation? I just wanted to really kind of get some color on how to quantify the impact of faster unit expansion to margin.

Thank you.

Andy Yeung — Chief Financial Officer

OK. Thank you, Lillian. So, when we look at our net new store opening, they continue to be very healthy. If you look at the overall cash payback period for our new store opening, it’s still three years for KFC and three years for Pizza Hut.

In fact, as we mentioned, the small store model actually performed even better. Now, if you look at how they ramp up, obviously there’s a ramp up period for the newest store. We have mentioned large majority of our new store actually breakeven in the first three months and they continue to ramp up through the years. It may have a short-term impact when they just open, because it’s ramping up sales and margins tend to be lower, but they tend to be very healthy, have good economics as they progress into a year or two from the opening.

So, there’s no change in the way we look at small openings. The important indicator for us really is to look at how the new stores are performing in terms of cash payback, in terms of economics. And as long as those are good, we’ll continue to stick with our plan. And as we mentioned, we have been quite disciplined about store opening, driven by our investment models and then also from ground up from our market.

So, we have an automatic acceleration, deceleration based on the performance of the store.

Unknown speaker

Thank you, Andy.

Joey Wat — Chief Executive Officer

Yeah, thanks.

Operator

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

Anne Ling — Jefferies — Analyst

Hey, hi. Hi, everyone. Thanks for taking my call. Questions regarding the current trading environment.

You guys mentioned about being a little bit softer and with sales fluctuation. Would you elaborate a little bit on that? Is it like you’re talking about post festive event, that there is a fall-off in terms of sales performance, regardless of like any promotion or innovative product that you launch or is it because certain day part that you noticed that didn’t really perform as expected? Maybe — or a certain geographical area. Would love to hear a little bit more about, what drives the softness? Is it like, is there anything that we can do about that? Yeah, thanks.

Joey Wat — Chief Executive Officer

Sure, Anne. So, at the high level, I mean, summer was vibrant, particularly July, there’s some tenant demand. So, as I mentioned earlier, transportation helped traffic going to increase 50% year over year, which is really a good sign. And then comes to the just reason, national holiday during the first half of October.

It’s quite interesting here actually. We observe sort of first half and second half during the national holiday. Because this year, particularly this year, the national holiday at the beginning is at the same time as mid-autumn festival. So, we see softness during the first half, because after three year pandemic, mid-autumn festival for Chinese people, what do we do? Go home.

So, the first half of the holiday, we see massive number of customers going home, go back to see their families, spend time with them. So, the demand was soft. And then by second half of the holiday, after seeing mom and dad, I think people decided, still decided I want to travel a little bit. So, the second half of the October festival, actually the traffic picked up.

So, that’s a little bit of this natural human behavior happening during the national holiday, during mid-autumn festival. That’s the point one. Point two is, in terms of the consumption, cautious spending, we do see customer spending a bit less on the premium product. Although our premium burger, our premium product and pizza still are doing quite well, but there’s that little trend going.

And then it comes to the third point is, what are we going to do about it? Well, we have been working on, and we have been doing it quite well actually with pretty good result. It’s widening the price range. So, it’s not only the bottom, the top bit, because we serve very large customer base and there’s always some customer who want to treat themselves, the same customer who want to treat themselves during a certain time. So, the premium beef burger, etc., we do that.

But at the same time, we also enrich entry price offering. Pizza Hut, the pizza is a good example. We have sort of single digit revenue coming from pizza below RMB50. And in fact, this is a very big settlement for both international and domestic player.

We see this as a big opportunity here. So, you can imagine, we are going to have more and more product in this particular segment. Not only the below RMB 50 pizza, but also single person meal, because for Pizza Hut business, our business model, our average number of customer per transaction is over two people. Well, that shows that we have the opportunity to serve the one-person meal as well, and we see good progress in it and we could do more and get more market share in the one-person meal sector.

And then for KFC, we also continue to work on the choices of products at the entry price offering to capture untapped potential of customers, particularly those in the lower-tier cities. So, we can operate at a wide price range, all the way to Tier 6 city. And that’s what we do, and therefore we see very good traffic growth. On top of that, in terms of the state part, we say are still doing better than we can.

And why the weekend traffic is still a bit soft and that has a lot of reasons behind it? But the point is, our focus on the whole chicken, which is mainly at home consumption product, our focus on certain other products to support the weekday traffic. We’re doing the right thing and we see very good results from customers. And therefore, for quarter three, we deliver record revenue, record profit. But of course, the biggest challenge for us is the foreign exchange, that you know 6% of our revenue and profit, which is the problem.

But in constant currency, we are doing quite well. So, we will continue to focus on the few things that I mentioned, a really good product and very good price and good experience, but still protect the margin for the investors and shareholders. Thank you, Anne.

Anne Ling — Jefferies — Analyst

Got it, got it. And can I ask another question regarding the franchise business? We talk a lot about this during the Investor Day. Can you share with us the latest update with your captive franchise, i.e., those specialty, those hospital, Uni and also the highway centers? When will we see the ramp up on the franchise business?

Andy Yeung — Chief Financial Officer

Right, so if you — I’ll just be quick about this one. As we look at the third quarter, for example, our franchise, number of new franchise is growing pretty fast, like 20% plus compared to last year and so like for new opening. So, I think we’re making progress there, but obviously things is not going to happen overnight. It’s going to come to the ground.

So, that’s how we look at it.

Anne Ling — Jefferies — Analyst

OK, thank you. Thank you, Andy.

Operator

Your next question comes from Ethan Wang from CLSA. Please go ahead.

Ethan Wang — CLSA — Analyst

Hi, Joey. Hi, Andy. So, my question is on the same-store sales. So, we see that ticket price at KFC and Pizza Hut, the kind of ideas that is understandable with China’s consumption space and consumption space competition.

And yeah, it’s good to do more promotions if you have more traffic. It’s always a balancing act. But I just wonder if we decrease ticket sales and maybe prioritize on the traffic, is that going to cause some pressure on future margin, especially from labor. Because with more people, we need to have more staff, but with every order, the ticket price comes lower.

We understand that’s the impact from the delivery, but just want to understand what have some more color on the thinking, on the trend going forward. Thank you.

Andy Yeung — Chief Financial Officer

OK, so let me try to address that. And then, so in terms of the TA, I think there’s a couple of questions concerning TA. Let me try to help folks understand a bit more in detail. Again, if you look at the — for example, KFC TA shift, there are three key components to it.

Obviously, a number of people have mentioned traffic driving promotion activities. But that’s only part of the story and it’s not the even main part of that, we also have the lower delivery mix shift, right. So, last year, during the pandemic, we have seen very high delivery and when this delivery come back, especially what we call like group ordering delivery, last year right, group buy delivery. And so, when this year, when things return to more normal, we do see the delivery mix to be slightly lower than last year.

And so, that’s normal, because people are coming back to the store and so that’s about impact. The other one is, as we mentioned, that certain dayparts right, the office shift would also have an impact on that. For breakfast as we mentioned, generally have a lower TA. And so, when that’s going faster, then you would also see a TA impact on the overall KFC TA.

Same for Pizza Hut, maybe slightly differently as we have mentioned, besides the promotion activities, we are actually by design trying to target and tap markets which is below RMB 50 segment, which is very underserved by Pizza Hut, but it’s a very big part of the pizza market overall, which is obviously right now, a number of players are active in that. So, we want to penetrate that market. The other one for TA, for Pizza Hut as Joey mentioned, is our purposeful targeting of single person user app. Pizza Hut — while KFC, if you look at a TA and then you look at Pizza Hut, you will see that Pizza Hut always have high TerrAscend, and then a part of that is because it’s in group dining and also in family dining.

So, when we have product that defines particularly for single person news set, especially working lunch and whatnot, you’re going to see the TA shifting there. And finally, as we go back, even before the pandemic, we have done a pivotal job to actually increase the value proposition to consumer. One of the biggest challenge for Pizza Hut before their high new program was that the volume proposition to the consumer. And so, we’ve been working very hard to hold the price stable and whatnot to drive that, and so that’s why by design doing that.

Because when Pizza Hut is going to try to expand and address a bigger customer base, you’re going to have a wider pricing range and so that’s why you continue to expect TA or have some movement there. So, that’s a lot of component there by our strategy. But the key point is that despite all that stuff that’s going on, you see that our sales is very stable, 31% right, because we have product innovation. We have a very strong supply chain managing that.

So, overall, that’s how we want to keep a balance between driving the traffic, expanding our addressable market, and at the same time, maintaining our TA. Now, obviously for COL, the biggest concern on the long-term is demographic change in China and whatnot. And so, it’s very important for us to continue to invest in our information digital and to improve our operation, so that we can continue to improve the labor productivity of our workforce. And we’ve been quite successful doing that before the pandemic and coming off the pandemic, we’re also pretty stable at about 25%, 26%, and that’s the thing that in the long run as we mentioned, China maintained the overall margins and expanded potentially over time.

Thank you.

Joey Wat — Chief Executive Officer

Maybe I just add some color on the COL side in particular. If we look beyond just one quarter, we look at our COL over the last few years, as we share in the Investor Day, when we have few thousand stores, 6,000, 7,000 stores, we have 430,000 people or 450,000 people actually. Now we have 14,000 stores, almost double, we still only have 430,000 people. So, as Andy mentioned, we use automation, digitization to manage labor costs.

When it comes to sort of more — when it comes to handling the promotion and while managing the COL, well as I mentioned in my prepared remark, we tend to pick those products that utilize the existing ingredients and that they are very easy to make. And we’re very careful about maximum number of items that the staff can handle in our store. And that’s why having an amazing, I would say second to none operation team is important. We do have pretty dedicated and a good balance of how many items we sell in a store and what’s the impact on the COL.

And most important, what’s the quality of food that we can protect in order to deliver in the short term and long term. Thank you, Ethan.

Ethan Wang — CLSA — Analyst

Got it, that’s great. Thank you, Andy. Thank you, Joey.

Joey Wat — Chief Executive Officer

Thank you.

Andy Yeung — Chief Financial Officer

Thank you.

Operator

Your next question comes from Xiaopo Wei from Citi. Please go ahead.

Xiaopo Wei — Citi — Analyst

Morning, Joey and Andy. I have a quick follow-up question on restaurant margin. In the third quarter, did you see any widened divergence of the restaurant margin of high-tier city versus low-tier city? And also, Andy, in the prepared remarks, he’s playing a lot about — we are having concession rent for new store, etc. Looking forward, shall we expect our occupancy and other expenses to sales ratio to keep low, because in the past two years, this has been very good factor to mitigating other inflation component in the restaurant margin? Thank you.

Andy Yeung — Chief Financial Officer

Thanks, Xiaopo. So, in terms of the difference, I think there’s not material changes to the way margin actually pan out as we have mentioned before. Obviously in Tier 1 cities, Tier 2 cities, the high-tier cities, generally those stores have higher throughput at the store. And but generally you have a slightly lower margin, because high cost, labor and rent.

And then in low-tier cities, although you have a smaller throughput through the store, generally cost of lower labor and all that, so the margin is slightly higher in the lower-tier cities. But on all, because also their investment, I think investment is different in different tiers. So, we end up having a pretty good payback period for both top tier and the lower-tier cities. And so, that’s in terms of the variance between margins in different tiered cities.

Now in terms of O&O, I think as we have mentioned, obviously last year we have some temporary relief, but all-in-all, like O&O, even including those, you see continuing improvement there. Those contracts are longer term contract, and when you get favorable long-term lease, you’re going to have favorable long-term impact. And then we also have other cost structure initiative and portfolio optimization. So, I think O&O improvement would stay, but obviously that’s also in terms of how low it can get right, no one’s going to give you free rent.

But I think in the long run, I think we’ll continue to see pretty healthy O&O as a percentage of sale.

Xiaopo Wei — Citi — Analyst

Thank you.

Andy Yeung — Chief Financial Officer

Thanks, Xiaopo.

Operator

There are no further questions at this time.

Michelle Shen — Director, Investor Relations

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

Andy Yeung — Chief Financial Officer

Thank you.

Joey Wat — Chief Executive Officer

Thank you.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Michelle Shen — Director, Investor Relations

Joey Wat — Chief Executive Officer

Andy Yeung — Chief Financial Officer

Michelle Cheng — Goldman Sachs — Analyst

Sijie Lin — CICC — Analyst

Christine Peng — UBS — Analyst

Chen Luo — Bank of America Merrill Lynch — Analyst

Unknown speaker

Anne Ling — Jefferies — Analyst

Ethan Wang — CLSA — Analyst

Xiaopo Wei — Citi — Analyst

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