Understanding YUM! (Owner of Taco Bell, KFC and Pizza Hut brands)

Yum! was founded in 1997 as Tricon Global Restaurants under Pepsi and spun off in the same year. Headquartered in Kentucky, the company was rebranded as YUM! in 2002. As of 31st December 2019, YUM! “franchises or operates a worldwide system of over 50,000 restaurants in more than 150 countries and territories, primarily under the concepts of KFC, Pizza Hut and Taco Bell”, according to its latest annual report. Let’s get to know a little bit about the business that owns and operates three brands that are well-known among Americans and thousands around the world.

Business Description

YUM! revenue comes from two primary sources: Company Sales and Franchise Revenue. Company Sales refers to the sale of food items at company-owned restaurants which make up about 2% of YUM’s total restaurants. Franchise revenue includes upfront fees in order to be a franchisee, continuous percentage of monthly revenue (typically around 4-6%) and contribution to advertising. In terms of expenses, YUM! is responsible for all expenses at their own stores. For franchised stores, YUM!’s costs consist of lease, depreciation of the buildings/lands that YUM! owns and leases to franchisees, direct marketing support and others.

Over the past 5 years, the new unit growth rate is pretty steady at the mid single-digit while the franchise segment makes up an increasing part of the whole business

The shift towards franchise is understandable, if you look at the margin of company sales and franchise revenue. In 2019, YUM’s own restaurants’ margin stood at 20% while margin of the franchise segment was almost 93%.

The company sales decreased by over 50% in 2019 compared to 2017 level. Franchise and property revenue continued to the biggest revenue generator for YUM!. The company-wide operating margin stood at a respectable 34% in 2019, even though it is down from 46% in 2017.

KFC Division

As of the end of 2019, there were about 24,000 KFC restaurants under YUM!, of which 83% were outside the US and 99% were operated by franchisees. Revenue has been declining since 2019 due to the drop in company sales and shift towards more profitable franchise model which helped push operating margin

Franchise revenue rose to 56% of KFC’s total revenue in 2019, up from 38% in 2017. While restaurant margin largely remained at 15%, franchise margin rose by 400 basis points in 2019, compared to 2017.

Pizza Hut

As of the end of 2019, there were around 18,700 Pizza Hut stores, of which 61% were outside the US and 99% were operated by franchisees. Revenue for Pizza Hut has been on the rise since 2017, albeit the fact that its operating margin slightly dipped

While restaurant margin fluctuated as the company didn’t even make money at its own stores in 2018, franchise margin has been on the rise, reaching 93% in 2019. As in the case of KFC, YUM! shifted Pizza Hut’s model towards franchise model which made up 56% of the chain’s total revenue in 2019

Taco Bell

Taco Bell has much smaller footprint than its siblings under YUM!. As of the end of 2019, there were around 7,300 units of which 92% were in the US and 94% were operated by franchisees. Revenue has been on the rise while operating margin remains steady at around 30-35%

Franchise revenue made up a smaller chunk of total revenue for Taco Bell than it did for Pizza Hut or KFC. While franchise margin is in the same ballpark as that of the other two brands, restaurant margin is much higher for Taco Bell

The difference in restaurant margin, overall operating margin and the number of stores explained why KFC led the way at YUM! in terms of franchise sale contribution and operating profit contribution while Taco Bell was the leader with regard to restaurant sales

Even though these fast food chains share the same high franchise margin, they differ from one another in terms of restaurant margin. I am curious about what factors result in such a difference. Is it because of the competition in each vertical? Is it due to specifically how each product line is made as in pizzas carry more expenses than chicken wings/fries or Mexican tacos? I’ll try to dig deeper in the near future, but that’s it for today. Hope that it is helpful to you guys. Have a safe and pleasant weekend!

Cues on changes in consumer behavior during Covid-19 crisis from Walmart’s latest earnings report

One way to keep a pulse on consumer behavior during the crisis is to listen to companies that play a big part in consumer lives in the US. Take Walmart as an example. The firm is a household name in this country and can be found in most of its counties. This is what it commented on how consumer behaved during the crisis. It shed some light on the changes in preferred categories as the crisis went on

After supporting our associates, our next priority is serving customers. In the U.S. the first quarter started out as expected. And as the pandemic spread, we saw the mix of sales ship heavily towards food and consumables, as we’d previously experienced in China. This was the first stock update that we all saw so vividly. We experienced unprecedented demand in categories like paper goods, surface cleaners and grocery staples. For many of these items we were selling in two or three hours what we normally sell in two or three days. As the quarter progressed, we saw a second phase related to entertaining and educating at home, puzzles and video games took off. Parents became teachers. Adult bicycles started selling out as parents started to join the kids. An overlapping trend then started emerging related to DIY and home related activities. Think games, home office, exercise equipment and alike. It was also clear a lot of people were taking a do-it-yourself approach as they bought items like bandanas and sewing machines to make masks. We can see customers looking to improve their indoor and outdoor living spaces, our home categories in stores and online took off.

Towards the end of the quarter another phase emerged, COVID relief spending as it was heavily influenced by stimulus dollars leading to sales increases in categories such as apparel, televisions, video games, sporting goods and toys. Discretionary categories really popped towards the end of the quarter.

Source: Walmart’s Earnings Call Transcript
Source: Walmart
Source: Walmart

The intensified fear of the virus and the stay-at-home orders also changed shoppers’ behavior

ECommerce sales remained strong throughout the quarter while store traffic was quite variable due to the various stay in place orders and social distancing around the country. February sales were stronger than expected with comp sales of 3.8%. As the health crisis intensified in mid-March, we saw a surge in stock-up trips with March comps increasing about 15%. Store pickup and delivery spiked in March and remained elevated in April with sales growth of nearly 300% at peak.

Store sales slowed during the first half of April due to soft Easter seasonal sale and additional social distancing measures. In mid-April, sales reaccelerated across the business as government stimulus money reached consumers with general merchandise sales particularly strong. April comp sales increased 9.5%.

During the quarter, we saw customers consolidate shopping trips and purchase larger baskets in stores, which drove a ticket increase of about 16% while transactions decreased about 6%. With the shift in purchasing behavior, eCommerce sales contributed approximately 390 basis points to segment comp. Pickup and delivery services continue to run historically high volumes. 

Source: Walmart’s Earnings Call Transcript

Consumer preferences in a particular category such as food also changed due to societal impact of the virus

We have seen some inflation in categories like milk, eggs and dairy later in the quarter, and that seems to have subsided somewhat. And then protein inflation has picked up over the last few weeks, as plants have been inoperable in certain parts of the country. And as those have gotten back to limited operating capacities, we will continue to moderate that.

Source: Walmart’s Earnings Call Transcript

It’s quite interesting that more folks 50 years and older shopped online during the crisis than before

we have seen an increase in not only new buyers, but also repeat rates across the board, both for pickup delivery from the store and delivery out of the FC (Fulfillment Centers).

we have seen higher growth rates, most customers who are 50 years of age or older than what we had seen in previous quarters. Other than that it’s been across the Board, the repeat rates have been higher

Source: Walmart’s Earnings Call Transcript

The value of increased switching costs via a membership

Another interesting point is how memberships play a role in consumer behavior. As we know, everyone can shop at Walmart, but only paid members can at Sam’s Club.

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Comparable sales refers to the comparison of sales at the same stores during the same period compared to sales last year. It’s important to exclude fuel due to fluctuating fuel prices.

As you can see, comp in-store transactions at Walmart, which is almost limitlessly accessible, went down because of the stay-in-home order, social distancing and other options including but not limited to Whole Foods, Target. However, comp average ticket at Walmart went up due to consumers stocking up and panic purchase.

On the other hand, at Sam’s Club, where access is more limited due to mandatory paid memberships, both in-store trans and average ticket increased. Average ticket rose by only 0.1%; which I guess is due to the fact that shoppers did more trips to the stores and didn’t buy in bulk as much as Walmart’s clientele. Shoppers shopped more because they already bought the paid memberships which increased what we call in business terms as “switching costs”. What happened this last quarter with Sam’s Club is what executives hope to achieve when launching a rewards program: increased stickiness.

Barriers to entry become liabilities during Covid-19 & remote working

Barriers to entry become liabilities

For the past few weeks, I have seen people claim that Disney is doomed because it reported millions of loss due to the closure of its parks and resorts which, in normal times, bring a lot of revenue and margin to the table. In the same vein, airlines are called a horrible business since there are a lot of costs involved and it’s capital intensive, making it extraordinarily vulnerable in the face of a pandemic like the one we are going through.

They have a point.

However, it’s also important to remember that the current liabilities are what make barriers to entry in their industries so high. Restaurants have low barriers to entry, so it’s not unusual to see a new restaurant in town every day. How often do you see a new airline come up? Because the barriers to entry are so high, airlines at least don’t have to worry too much about a new competitor enter the fray often. Similarly, operating a park like Disneyland is no joke. It requires employing hundreds of employees and a tremendous fixed cost as well as maintenance expenses. How many parks at the same scale as Disneyland enter the market every week/month?

This crisis will blow over. It has to. It’s unfathomable to think that we will be in this self-quarantine forever. Once we get back to normal, whatever it may be, people will fly and go to Disneyland again. Although I don’t deny that what reduces new competition for those businesses now becomes sort of liabilities, it’s worth remembering that nothing good comes easy. The same logic applies to business

Remote working

Plenty of discussion online has been about how people will adjust their working style post-Covid19. Even in my company, talk has been going around on how folks will continue to work remotely for a while and how preparation should be looked into to accommodate that need. Personally, I think there will be a mixed working style moving forward. Indeed, working remotely saves everyone time from having to dress up and driving to work. Nonetheless, there is also value in face-to-face and human interaction. There is a reason why companies design common areas, hoping that folks will randomly bump into each other and creativity will spark. Plus, speaking from personal experience, I am sick of sitting at my desk, staring at the screen for hours and putting more time into work. I miss my workplace, my coworkers and casual conversations at work. So, even though folks will prefer working remotely 100% in the short term, in the long run, I expect it to be a mix.

Notes from Uber’s Q1 2020 Earnings

As a student of business, I find Uber an interesting business. It is interesting because there are a lot of aspects that go into the operations of this ride sharing player, including geographical segments, different lines of business with different margins (Eats, Rides, Freights), add-on services to improve profitability (Rewards, Credit Card), exiting marketings where it is losing money and focusing on the ones where it is a dominant player, and different stakeholders (riders, drivers, restaurants, corporate customers and authorities).

Like many other companies, Uber had its operations seriously disrupted by the Coronavirus. Rides bookings had a YoY growth of 20% in the first two months through February before plummeting to a decline of 40% and 80% in March and April respectively when the lockdown took hold. Eats, on the other hand, had a 54% YoY growth in bookings and 124% YoY increase in net revenue with take-rate of 11.3%, not too far from their long-term goal of 15%. Eats, for this quarter, remains the biggest loss-making segment, even though Freights’ loss growth is significantly bigger while Rides is still the only profitable business

Source: Uber

Uber shed a bit of light on the effect that Covid-19 had on its business. Airports make up 15% of Rides bookings and 16% of its EBITDA. Obviously, when traffic to airports declined substantially, that significant chunk of business was gone. In terms of cities and countries, Uber provided the following

Last week, we saw 9% [indiscernible] growth and 12% gross bookings growth globally weak-on-weak. We believe the U.S. is of the bottom. U.S. gross bookings were up last week by 12% overall week-on-week, including New York City up 14%, San Francisco up 8%, Los Angeles up 10%, and Chicago up 11%. Perhaps more interestingly, gross bookings in large cities across Georgia and Texas, these are two states that have started opening up significantly, are up substantially from the bottom at 43% and 50%, respectively. Hong Kong is back to 70% of pre-crisis gross bookings levels.

Second, at a time when our Rides business is down significantly due to shelter-in-place, our Eats business is surging. We’ve seen an enormous acceleration in demand since mid-March, with 89% year-over-year gross bookings growth in April, excluding India.

Source: Uber’s Earnings Call

According to the quarterly filing, Eats bookings annual run-rate was about $18.8 billion. However, on the Earnings Call, the CEO said: “And just last week, Eats crossed the $25 billion gross bookings annual run rate”. If I understand that statement correctly, it meant that for the 3rd or 4th week of April, Eats bookings was around $480 million. Given that it reported the annual run-rate around $18,8 billion for the first three months through March, the increase to $25 billion only in April was extraordinary. Plus, Uber seemed to be confident that this level of growth in Eats would be sustainable, moving forward. So it’ll be interesting to see how it is 3 months later.

As for now, it’s an encouraging sign for Uber that their economies of scale seem to go in the right direction as revenue increased disproportionally compared to the driver incentives required.

Picking their battles

Uber commented on the recent exit of 8 Eats markets:

Uber Eats: On Monday, consistent with our long-term strategy, we announced a change to the geographic footprint of Uber Eats operations affecting 8 markets. We will discontinue Uber Eats in the Czech Republic, Egypt, Honduras, Romania, Saudi Arabia, Uruguay and Ukraine, and will transfer Uber Eats operations to our Careem subsidiary in the United Arab Emirates. The discontinued and transferred markets represented 1% of Eats Gross Bookings and 4% of Eats Adjusted EBITDA losses in Q1 2020.

Source: Uber

For what it’s worth, the management team deserved credits for exiting unprofitable markets, especially some that bled them dry such as China or Southeast Asia. In their presentation as of 31 Jan 2020, Uber presented their footprint map like this. Obviously, it’s better than being in more markets, yet with smaller presence

Source: Uber

Some other interesting points

  • As of Q4 2019, Uber for Business made up around 9% of Uber’s Rides bookings
  • Uber reported in Q1 2020 that there were 31 million members of Uber Rewards Program. Given that they have 103 million monthly active users, that means out of 3 active users, one is a Rewards member. It’s promising and interesting especially because Rewards had been available in 5 markets only, with France recently added to the fold
  • In Q4 2019, an average Rides trip was $9.5. Uber reported in the same period that an average Eats order was 50% bigger than a Rides order. That means an average Eats order in Q4 2019 was about $14.25
  • “Eats insurance costs as a percentage of Gross Bookings are <1/5th that of Rides”
  • Uber claimed that 46% of US national vehicle trips were less than 3 miles. It can be an opportunity for micro-mobility. However, it’s worth noting that scooter companies like Lime or Bird are notoriously not profitable. Lime recently saw its valuation plummet to around $510 million after previously being valued at $2.4 billion
  • “Finally, we expect that shared Rides will be less important in the near-term. This was historically sweet spot for a primary competitor in the U.S. with around a 50% category position on shared Rides.”
  • 23% of our Rides Gross Bookings from five metropolitan areas—Chicago, Los Angeles, New York City, and the San Francisco Bay Area in the United States; and London in the United Kingdom” – Source: Uber 2019 annual report
  • In 2019, cash-paid trips accounted for approximately 11% of Uber Global Gross Bookings, about $7.5 billion.

Revenue and margin makers

What I noticed in many businesses is that there are revenue makers and margin generators. Revenue makers refer to activities that draw in the top line numbers in the income statement, but small margin. In other words, these activities can bring in $10 of revenue, but about $1 or less of gross profit (revenue minus cost of revenue). On the other hand, margin generators refer to activities that don’t bring in as much revenue as revenue makers, but act as the source of most margin. Usually. these two complement each other. Let’s take a look at a few examples.

Apple sells their products and services that can only be enjoyed on Apple devices. Products bring in multiple times as much revenue as services, but products’ margin is much smaller than that of services. Take a look at their latest earnings as an example. Products’ margin is about 32% while services’ margin stands at 65%. Folks buy Apple devices mainly to use the services and apps that are on those devices. Apple continues to sell devices to maintain their own monopoly over their unique operating systems and ecosystem.

Source: Apple

Amazon’s eCommerce segment is a revenue maker. They warehouse the goods and ship them to customers. It generates a lot of revenue, but the cost is high as well. Built upon the infrastructure Amazon created for eCommerce, 3rd party fulfillment is a margin generator. In this segment, Amazon acts as a link between buyers and sellers to ensure transactions go smoothly without having to store and ship the goods itself. Margin is significantly higher than that of eCommerce. Amazon takes it to another level with Prime subscriptions and AWS. While trying to figure out how to keep their sites up and running 24/7 smoothly, Amazon came up with the idea of selling unused IT resources. Long behold, AWS is now a $40 billion runrate business and Amazon’s arguably biggest margin generator.

Costco is a household name in the US. Families go to their warehouse-styled stores to stock up essentials and groceries. Due to the volume they sell every year, Costco manages to keep the prices low, but thanks to the cut-throat nature of the industry they are in, the margin is low, about 2-3%. That’s their revenue maker. To compensate for the low margin, Costco relies on their membership fees. Whatever customers pay to be able to shop at Costco is almost pure profit to Costco. There is virtually no cost to process an application and issue a card.

McDonald’s essentially has two business segments: their own McDonald’s operated restaurants and franchising. The brand’s own operated restaurants serve as references to franchise owners for how good McDonald’s brand is as an investment. However, it offers the brand way lower margin than their franchised restaurants.

Airlines make money by flying customers, but there are a lot of costs involved such as planes, airport services, food and beverage, fuel, etc…Airlines can generate more margin with their branded credit cards. Many airline-branded credit cards come with an annual fee. Plus, card issuers may pay airlines a fixed fee for new issued cards and a smaller fee for renewals. Plus, there may be a small percentage for first non-airline purchases. Agreements vary between airlines and card issuers, but it brings a lot of margin to airlines.

Ride sharing apps are notoriously unprofitable. Uber and Lyft lost billions of dollars in their main operations. Recently, they tried to launch a subscription service and in Uber case, a credit card, hoping that these services could help generate the margin they need.

We all know the saying in business: cash is king. Cash can only increase, from an operating perspective, when margin increases. Revenue is crucial because, well, a business needs to convince folks to pay for products or services first. Nonetheless, a business is more robust and valued when margin increases.

A few notable graphs from Amazon and Apple earnings

Tech giants reported their earnings this week and proved how resilient their businesses are amid arguably the most challenging environment ever. In this post, I’d like to demonstrate with visuals how important AWS is to Amazon, and how China, Wearables and Services are to Apple while it has become less of an iPhone company.

Amazon

Apple

Teams vs Zoom and the art of reporting confusing numbers

Since the stay-at-home order started around the globe, demand for videoconferencing has skyrocketed. Facebook even introduced a new video service for its users. What has caught my interest, though, is the battle between Zoom and Teams by Microsoft. Zoom stock has surged significantly for the past two months, especially after it reported that it had 300 million daily active users. Or so we thought

Zoom has confused the comparisons, though. Zoom originally stated it had “more than 300 million daily users” and that “more than 300 million people around the world are using Zoom during this challenging time.” Zoom later quietly deleted these references from its blog post, and it now only claims “300 million daily Zoom meeting participants.”

The differences are important, as is Zoom’s transparency around them. Daily meeting participants counts multiple meetings, so if you have five Zoom or Teams meetings in a day, then you’re counted five times. Zoom has not yet revealed exact daily active user counts, and it looks like Microsoft could be a lot closer to Zoom usage than many had assumed.

Source: The Verge

For comparison, Microsoft announced today that it reached 200 million daily meeting participants in April. Since the two use the same label, does that mean Zoom has taken Teams’ lunch? Not quite there yet.

The daily meeting participant count can be misleading. For example, Teams doesn’t have a limit on call duration, to the best of my knowledge, while Zoom puts a 40-minute limit on calls that involve more than three participants. So if the participants are willing to set up another call after the free 40 minutes expires, it will bloat up the daily meeting participant count, even though it’s still one meeting that has the same folks involved.

Daily usage can be misleading as well. For instance, I use Jabber at work and it is powered up automatically on my work station. If I don’t interact with anyone on the app, does it mean I am among the daily users still? To be fair, the two companies don’t elaborate on this, but there is one comment from a Microsoft executive

It’s been phenomenal, if I’m honest with you. Let me just start with the DAU thing because there’s a lot of needling on this and we define the DAU. Daily active user for us is the maximum number of users who take an intentional action over a 24-hour period. That’s really important for me to hit. What we call passive actions do not count. So auto boot does not count. Minimizing a window does not count. Closing the app does not count. We also got a lot of questions about that. Skype does not count. So when we release our numbers, we just don’t feel like we want to get in the weeds of kind of argue with people, but the DAU very real.

Source: Microsoft

Another reason is the mix of added users/usage. In its latest investor call in March, Zoom’s CFO commented the following

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Granted, there may have been more development since the comment. Frankly, it’s unclear how the surge in usage benefits Zoom financially without the company’s disclosure. Nonetheless, it’s not surprising that the majority of the increased usage comes from the free tier.

On Teams side, it’s not particularly providing a clearer picture either. Back in January, during the Q2 earnings call, Microsoft announced they had 20 million daily active users. 3 months later, the figure stands at 75 million. Quite an achievement. But like Zoom, Microsoft has a free tier that allows video or calls. As a result, barring a comment from the Seattle-based company, it’s not clear how many Microsoft added as paying customers.

Source: Microsoft

The point is that it’s really hard to determine which videoconferencing tool is the better performer between the two leaders Zoom and Teams. The way data is reported by the two companies makes it really challenging to have an apple-to-apple comparison.