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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for standing by, and welcome to Yum China’s 2020 Third Quarter Earnings Conference Call. At this time, all participants will be in a listen-only mode. There will be a presentation, followed by a question-and-answer session. [Operator Instructions] I must advise you that this conference is being recorded.
I would now like to hand the conference over to your speaker today, Ms. Debbie Ding. Thank you. Please go ahead.
Thank you, operator. Hello, everyone, and thank you for joining Yum China's third quarter 2020 earnings conference call. Joining us on today's call are our CEO, Ms. Joey Wat; and our CFO, Mr. Andy Yeung. Before we get started, I'd like to remind you that our earnings call and investor presentation contains 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 the non-GAAP and GAAP measure is included in our earnings release.
Today's call includes three sections. First, Joey will provide an update regarding recent developments, then she will offer some highlights around our quarterly results. Andy will then cover the financial results and provide an update on our full year outlook. Finally, we will open the call to questions. You can find the webcast of this call and a PowerPoint presentation, which contains operational and financial information for the quarter on our IR website.
Now I would like to turn the call over to Ms. Joey Wat, CEO of Yum China. Joey?
Thank you, Debbie. Hello, everyone, and thank you for joining us today. As I respect on this challenging period, I want to thank our employees, our customers, our partners, and our shareholders for your continued trust in Yum China. Resilience is the only proven when tested and we certainly will test it. Following two challenging quarters, we delivered system sales growth for the third quarter. This is the result of the tireless dedication of our staff and partners, working to safely provide good food, great value and convenience for our customers across our 10,000 plus stores.
Help us stay true throughout the COVID pandemic, we hold to our key operating disciplines, food safety, employee care and customers focus, guide our actions. In over 1,400 cities we operate, we provide employment, career progression and a commitment to improving our local communities. We stay true to our culture of innovation, building on our leadership in digital and delivery. All these add to the resilience of Yum China.
We achieved much in 2020, despite the COVID challenges. First, we opened our 10,000 stores this quarter, marking a significant milestone. Secondly, our brand demonstrated innovation and execution, excellence, capturing the shift to off-premise signing early. KFC and Pizza Hut pioneered contactless delivery in late January. We engage with over 20,000 companies regarding corporate delivery, tapping into another segment of new customers.
Pizza Hut celebrated its 30th anniversary by driving menu innovation, improving its takeaway and individual set offering. Third, we formed a joint venture with Lavazza and opened the first flagship coffee shop in Asia, we will continue the journey to get us to explore the China coffee market. Fourth, we completed the acquisition of Huang Ji Huang and formed a Chinese dining business unit to tap the massive Chinese cuisine market opportunity.
Last but not least, we're listed on the Hong Kong Stock Exchange in September becoming the first Delaware incorporated company to list on both NYSE and Hong Kong Exchange. This listing in one of the most vibrant trading markets in Asia brings investors closer to our consumers and partners. At the same time, we maintain our strong corporate governance and discipline. The Yum China of the future will have a much larger footprint across China. Stores will remain new or freshly remodeled. We will continue to serve innovative food across day parts and occasions. A portfolio of brands built organically and through a disciplined M&A process will target strong growth segments.
This will be supported by key infrastructure whether in supply chain logistics or digital marketing. We are committed to investing in this future. A future of market leadership enabled by growing stores, growth in our portfolio and growth in digital and membership capabilities. Let me elaborate on each of these growth initiatives.
Firstly, store growth. It took us over 15 years to open the first 1,000 stores. In the last four quarters, we opened over 1,000 stores as well. We have the capability infrastructure improvement store models to build profitable new stores at scale. Importantly as delivery and takeaway become more popular, we are adapting our new stores to smaller sizes and lower CapEx.
Increasing store density gets us closer to our customers, serving them faster and better while capturing incremental sales and profits. We are piloting store models which are tailored for lower tier cities to penetrate new markets with greater flexibility and efficiency.
Localized menus, store layouts and operating models enable us to serve a more value culture customer. China is a large diverse market with regional differences, economic environment and policy. We will adopt regions specific strategies to create the flexibility and pursue a saturated growth trends regionally. Multiple channels, different models and regional strategies are crucial to expansion, enable us to develop a strong franchisee network.
Market leadership will also require investments in our infrastructure from more logistics centers to IT solutions. We will need to strategically deploy capital for both offline and online assets. Future-proving our leadership as we built the next 10,000 stores. Secondly, portfolio growth, we are proud to welcome the Huang Ji Huang and Lavazza brands to our Yum China family this year.
In addition to our core western dining brands, Chinese dining and coffee with exciting new segments for growth, over the past few months, we have found opportunities to collaborate between our Little Sheep and Huang Ji Huang brands in the areas of franchisees environment, seasoning distribution, and supply chain. Huang Ji Huang franchise partners are already leveraging Yum China’s strong delivery capabilities to improve store economics. And we are excited for further synergies. Similarly, leveraging our COFFii & JOY experience, our partnership with Lavazza has seen early success.
The three Lavazza stores in Shanghai are receiving great customer feedback. Yum China's capabilities in digital data and delivery are creating an ecosystem for consumers and will drive growth across a portfolio of brands. The third growth initiative is in digital and membership. Last quarter, we shared some of our thinking around digital memberships and their importance as a growth driver. We will invest in creating a customer-centric digital marketing platform.
Additionally, end-to-end digitization and the application of AI technologies by tools from farm to fork. Our goal is to track, analyze and automate across our value chain. From receiving of goods to real-time control of inventories and operations, investments in digitalization empower us to improve operational efficiency and drive customer satisfaction. Crucially, this will give us add confidence to accelerate working with our franchisee partners and reach further into more remote areas, strong digital and membership programs create synergies within our portfolio of brands. This improves unit economics in turn driving store growth.
All of these growth initiatives are interdependent. Investments across all three are necessary to build on our leadership and agility. Now a few observations from this quarter, KFC sales demonstrated improvements in the third quarter, supported by our value campaigns and digital initiatives. Domestic tourists and transportation hub volumes slowly recovered, but international travel and tourism is still weak.
Pizza Hut continued to make great progress with new offerings, with fresh restaurants and strong execution capability. Pizza Hut recovered sales to 93% of prior year period. Our actions across the pillars of revitalization continue to bear fruit as ticket average improved sequentially. Restaurant margins improved by over five percentage points and operating profit grew 59% year-over-year in constant currency.
Value for money is important to consumers during this difficult period. Across our brands, we ensured a strong value proposition, KFC extended Crazy Thursdays to Wednesdays and Fridays.
Pizza Hut brought back a hugely popular all-you-can-eat program in September. Apart from great value, our innovative products attract customers. At the national level we launched the Durian Chicken Burger at KFC and a Chinese-style braised beef pizza, Dongpo new row, at Pizza Hut. We also tried regional flavors into Latin markets, such as Wuhan Hot-Dry Noodles, Wuhan Re Gan Mian and late night delivery of seasoned spicy crayfish, seasoned nacho chips.
Delivery drove strong growth across our entire portfolio, accounting for approximately 28% sales in the third quarter. We continued improving out takeaway menu and offered to complement delivery. Together, off-premise the menu account for over 55% of sales at KFC and 40% of Pizza Hut. Digital orders were 78% of sales, we’re about pre-COVID levels. Cumulative digital members grew to over 285 million. During the quarter we sold 19 million privilege memberships at KFC and Pizza Hut covering multiple categories.
Other than the signature delivery and family privileges we sold over eight million chicken lovers membership in Chinese we call it [indiscernible] at KFC during the summer holidays. This pay membership, tripled frequency and sales per member during the subscription period. We generated meaningful progress in this quarter. Despite the pressure from sales deleveraging our $320 million of operating profit, excluding special items was the result of the strong efficiency improvement we have made.
As we look forward to end of the year and into 2021, we remain cautiously optimistic. We must continue to be vigilant and agile. I need to remind our stakeholders that China is a large, diverse market and regions will experience varying levels of COVID impact until the new vaccines are developed. The recovery will continue to be non-linear and uneven, so we are well positioned to navigate these uncertain times.
With that I’ll hand over the call to our CFO, Andy Yeung. Andy?
Thank you, Joey. And hello everyone. I will first address key financials and developments in the third quarter, then provide some color on our outlook. Unless noted otherwise, figures mentioned refer to the third quarter of 2020. All percentage changes are before the effects of foreign exchange.
Revenue was flat year-over-year with same-store sales recovered to at 94% of the prior year period. All brands have sequential improvement in sales. This is a testament to the hard work and dedication of our employees to drive topline in the challenging environment.
KFC’s same-store sales recovered to 94% of the prior year period, compared to 90% in the second quarter and the 89% in the first quarter. Improvements were largely driven by effective value promotion and digital initiatives. Same-store traffic recovered to 90% from 80% in the second quarter. Our transportation and tourist hub sales improved, but still remain under pressure.
Pizza Hut, same store sales recovered to 93% of the prior year, compared to 88% in the second quarter and 69% in the first quarter. Value campaign, all-you-can-eat and membership initiative, were effective in driving traffic and ticket average.
Overall, dine-in volume to recover to over 80% of higher yield for our core brands. Strong contributions from delivery and takeaway continue with over 50% of our sales being all premise. The consolidations of Huang Ji Huang contributed 3% to total system sales in the quarter. Together with consolidation of Suzhou KFC, the contribution to total revenues was 2%.
We opened 312 stores. New builds accelerated as our development team secure favorable locations with more flexible store formats, also helping expansion.
Despite the same-store sales decline, restaurant margins were 18.6% up 0.9%, compared to last year. Sales deleveraging was more than offset by our aggressive efforts to control cost and improve operational efficiencies.
Cost of sales was 31.2%, almost flat year-over-year. This was largely driven by a 1.7% reductions at Pizza Hut, as they lacked aggressive promotion May last year. KFC has a 0.7% increase in cost of sales. The impact of more aggressive promotions and value campaign to drive store traffic and sales was partially offset by commodity inflation of 1% at KFC. In particular, we work closely with our major poultry suppliers to take advantage of a more benign inflation environment.
Cost of labor was 21.6% almost flat year-over-year. Rate inflation was 3%. It was subdued in many of our markets as government mandated minimum wage increase will differ. Labor productivity improvement has largely offset the impact of wage inflation and increase in delivery write-off cost. Labor productivity improvement was accentuated by shortage of part-time workers in the quarter. We intend to increase staffing levels in coming months to balance service and efficiency.
Compared to $40 million in the first quarter and $50 million in the second quarter, we received approximately $10 million in rent reductions and government relief. However, we expect this to phase out.
G&A expenses increased 6% mainly due to a lapping of prior year's government incentives and impact of consolidating G&A expenses at Huang Ji Huang and Suzhou KFC. Excluding the impact of consolidation, year-to-date G&A expenses decreased 1% year-on-year. We achieved operating profit of $556 million, including re-measurement gain of our existing equity stake in Suzhou KFC of approximately $239 million.
Excluding special items such as re-measurement’s gain, adjusted operating profit was $320 million, representing a year-over-year growth of 5%.
Our effective tax rate was 25.6%.
Net income was $439 million and adjust that net income was $263 million. If we exclude $29 million net investment gain in Meituan, it would be $234 million, up 8% year-on-year.
Diluted EPS was a $1.10. And adjusted, diluted EPS was $0.66.
I would like to touch on our capital allocation strategy. Following a capital review off our financial position we will resume our cash dividends at $0.12 in the fourth quarter. Our capital allocation focuses on driving a long-term growth of Yum China, while providing adequate liquidity to navigate any sudden disruption to our business.
With the capital raise in our secondary listing in Hong Kong, we will focus on: one, accelerating new build and maintaining stall remodeling cost for the Yum China portfolio. Two, stepping up investment in our digital, logistics and delivery infrastructures to support and drive growth. Three, maintain a disciplined approach to M&A and investment while exploring opportunities to invest in brand with excellent growth opportunity, new capacities and technologies.
As this year have shown having sufficient liquidity is paramount to operate in an uncertain environment. Our strong balance sheet provides us the capacity to deal with potential contingencies, while allowing us to make targeted investments to drive growth and capture market opportunities. We believe this approach to capital planning will drive long-term shareholder returns.
In terms of outlook, as we look ahead to the fourth quarter, we are encouraged by sequential quality improvement. However, we must be mindful that the pandemic is not over yet. The remaining journey to recovery is going to be challenging.
We expect our store traffic and sales continue to be impacted by: one, the lingering effects of COVID-19 on consumer behavior; two, transportation and tourist volume while recovering continue to be heavily impacted; three, additional precautionary measure that consumer and/or company may take as we enter the colder months and as flu season approach. At the same time, we also expect margins to be impacted by sales and leveraging and a continued focus on value campaigns to drive store traffic. Facing out of COVID-19-related relief, increased staffing levels to balance services and efficiencies. And finally, store impairment reveal factoring in the impact of COVID-19.
It's important to note that the fourth quarter is not only seasonally, the lowest quarter for sales, but also the biggest quarter for stall remodeling. Small changes in operating results or investments can have a significant percentage impact on operating profit. In term of inflation outlook for 2020, we now expect wage inflation to be low to mid-single digit, commodity inflation to be flat to low-single digit driven by lower quoted prices.
In term of store opening, including Huang Ji Huang we now target to open more than 900 new stores. As a reminder, following our secondary listings, we ended the third quarter with 419 million shares outstanding. As for 2021, we are operating under the new normal of reduced travel and social activity.
Sales momentum will continue to be impacted until the pandemic is over with balance of COVID-related disruption if and vision of market will likely experience varying performance. In October, there were regional outbreak in Qingdao and Western China, which we started in testing for millions of people. This is a good reminder that the recovery will be non-linear and uneven.
We continue to face cost pressures on multiple funds as part of our commitment to the environment. We will begin to face our the use of plastic packaging. This is expected to materially increase our cost of sales. Rate increases have been mostly defer or delay in 2020. We expect these to catch up. We will also step up investment to build out our digital logistics and delivery infrastructure accelerate investment in these areas will be critical in maintaining our market leadership. With additional infrastructure, solid exclusions and strong balance sheet, we are prepared to capture opportunities while recovery and growth. We will provide additional details on specific 2021 target with our Q4 earnings release in early 2021.
With that, I will pass you back to Debbie to start the Q&A. Debbie?
Thanks, Andy. We’ll now open the floor to poll questions. In order to get as many people as possible the chance to ask questions, please limit your questions to one at a time. Operator, please start the Q&A.
Thank you so much. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] And our first question comes from the line of Sijie Lin from CICC. Your line is now open.
Hi management, thank you for taking my questions, and congratulations on the good performance. So I can ask one question, right. My questions is Pizza Hut, because for Q3, we see that the near 17% of restaurant margin, it’s really a high level even through its history. So could we know more about what happened behind this and is it sustainable looking forward? Thank you.
Thanks. This is Andy. So I will address your question regarding margins at Pizza Hut. I think overall margins, if you look at the overall margin for the quarter, we do have three strong performance on both KFC and Pizza Hut. Overall, if you look at Pizza Hut for example certainly we still impacted by healthy leveraging roughly more than 2%. For inflations, we do see continuing commodity pressure – pricing pressures for the cost of goods, but that’s more than offset by the labor productivity improvement.
Now, if we look at each class items, if we look at for example cost of sales, we see that these improvement about almost quarter like 1.7%. Main part of that is commodity inflation that’s offset by 11 of promotions in 2019. Now for cost of labor, we see about 1.4% improvement despite sales leveraging wage inflation we see that labor productivity gains offset as I mentioned on the prepared remarks is exaggerated by shortage of seven worker on this quarter.
And so it also – we also benefit a little bit from the lower social insurance contributions. The big improvement here is actually on what we call O&O and that has a lot to do with the number of part initiative at the restaurant level, including utilities, maintenance costs. We also got some…
Okay. Thank you, Andy.
Thank you.
Thank you so much. And your next question comes from the line of Brian Bittner from Oppenheimer. Brian, your line is now open.
Thank you, and congratulations on navigating this environment. Your unit growth outlook for 2020 continues to be very strong despite the pandemic. Are you able to give us a look into the pipeline for 2021 or give us any color on how you’re starting to think about the unit growth opportunity in 2021?
Hi Brian, this is Andy. So I would give you some color and then Joey may want to feel free to jump in later. I think as we mentioned, we – at the beginning of the year, first half this year, we suddenly have little impact from COVID-19 income of our store opening. As we have mentioned in our prior earnings call, our development teams have a lot of project in the pipeline at the time, but obviously because of the pandemic, there was some delay in infrastructure, because the limited mobile eat in March, April timeframe.
So they have been trying to catch up, obviously. So and they have done a pretty good job this quarter. We – in that’s why we confidence that, we can meet the target and raise that to from fiercely we guided to about 800 to 850 stores to now more than 900 stores. As we have mentioned, as Joey mentioned, our next milestone would be another 10,000 stores. It took us quite a while to get to the first 10,000. It was almost 33 years. We suddenly think that we will do it much faster this time around.
In term of the pipeline for 2021, I think we’re now with doing a planning process look to early to provide you that information, but we would give more details and have planning. However, but if you look at our current situation right now, we do think that we still have a lot of opportunities in China to put growth for store network expansion. If you look at the number of cities that we have – we’re in right now, a little bit more than 1400 for KFC and I think 800 plus in for Pizza Hut. So that we feel tracking about probably close to 500 to 600 or more cities that, that we can penetrate in the future, so those are the white space.
Also in term of increasing penetration in the top tier cities, I think and also we’ll obviously – we think there’s also a lot opportunity as well. Looking at the small density compared to not only to North America, but also to other Asian country and regions our small density is still water below. So I think the shift towards smallest store format and also with catering more to delivery and take away I think we do have a lot more opportunities in terms of increasing the penetration across our store network in the existing market that we’re inviting. Hopefully I address that your question.
Thank you, Andy. Brian, I would just try to add three comments of your question. One is, we always emphasize on the quality of stores. So we will be aggressive and open-minded about new stores, if we see the opportunity of opening good store, profitable store or at least breaking even stores. So that’s the bottom line. We hold very, very close to our heart and that bottom line at the bottom up approach is if we find those we’ll open them.
Second is as Andy mentioned earlier, I just want to make it more specific is at the Tier 1 city, Tier 1, Tier 2 city, we are going for smaller stores to adjust our store portfolio strategy, because the growth of delivery and takeaway and also to handle the rent and other costs as well. And it’s a quite a efficient model to fill in the gap of the tracing. For the lower tier city, we have been working on the lower tier city star models. And this year, we have further breakthrough in our models. Not only the – in last month cost for the lower tier city model is getting even lower. We find the innovations to do that, but also we have cut the my menus for the lower tier city. To give you a example, we have open a few such stores this year. We feature something called crazy store manager, which will feature a combo, a lunch set of RMB 15, which is a bit more than $2.
And our normal combo for four items in Tier 1, Tier 2 city will be 30 to 35, et cetera. So you see the gap and the products are different. We are not going to sell the same product as such big price gaps. But the lower tier city in some – particularly in the Western and the Northern part of China require a different understanding of our menu.
Point three, Pizza Hut. We have been talking about a satellite store models since last year, and we’ve be working on it. Because essentially, what the satellite store means is huge reduction in terms of CapEx in last month and quite a different store operating model. For example, our kitchen need to move from 140 square meter to a much more on a size, cut it by half per se. And the menu style is different too. And so this year, we’re going to have about more than 20 satellite stores and I will be happy to say that the initial results encouraging. And we are happy to see what we are seeing right now for both satellite store, for Pizza Hut and for the lower tier city stores for KFC. Thank you, Brian.
Thank you, Joey. Thank you, Andy.
Thank you so much. And your next question comes from the line of Linda Huang from Macquarie. Linda, your line is now open.
Hi, management. I have one question regarding for the store expansion. Because I noticed that the payback period, especially for the Pizza Hut slightly increased before, I think payback periods of three to four years, but right now that is to five years. So I just want to know that, whether in the future we continue to expand that the store and do we worry about operational efficiency issue? And can you also share with us about a Huang Ji Huang it’s a payback period. Thank you.
Hi, Linda. So let me adjust the ones you want. And then I get back to the top of that. For [Foreign Language] is mostly a franchise model? So almost all the stock large majority of the store franchise model, that same goal for leadership. And so – it’s not very meaningful for us and especially the franchisees of what we can say that, the franchisees themselves actually lots of be happy with that payback. And that’s why we continue to see pretty decent few out in term of the franchise operations over there.
It’s the payback period for Pizza Hut. Linda, for the Pizza payback period, I think, because of the COVID-19 and the way that we calculate numbers are rolling number. So of course, during Q1, Q2 impact are payback period a little bit, but we still overall confident with the overall trend of the payback period of Pizza Hut, particularly, with the innovation on satellite store. We are quite happy to see what we’re seeing right now in Pizza Hut. Thank you, Andy.
Right. Right. So Linda, so I just want to remind folks that, when we disclosed the period genuinely we are using actual number. So they will reflect the impact on the recent month, which is, I guess, Joey, mentioned impacted by COVID-19, right. So but overall, I think, if you look at, there’s stall recovery in terms of the sales recovery, we own a – I think the right directions overall look at SSG, back to 94% for KFC and then 93% for Pizza Hut.
So in that sense, I think, we may feel seeing that lowering average being impacted, but that should, I mean, we can fundamentally, we haven’t seen a material change in term of how it’s all performing. And then also in terms of longer term outlook, I think as to the recovery, even though it’s going to be non-linear and then even. But I think, eventually, the pandemic would be over. And then I think we’ll be comfortable with that. We will not fundamentally change our store economic.
Obviously, there was some operational changes in term of, how our store, as Joey mentioned, we would continue to experiment vertically store format to Pizza Hut for example, we also have this satellite store format that being well. So it would – but nonetheless, I think definitely happened change maybe more delivery, more takeaway sales, a smaller scale format going forward. But I think haven’t changed our view on the payback in the future.
Okay. Got it. Thank you.
Thank you so much. And your next question comes from the line of Xiaopo Wei from Citi Group. Your line is now open.
Good morning, Joey and Andy. Congratulations again for the strong recovery in the fourth quarter. So we are now in the fourth quarter, which is a low season. I will be more interested in upcoming 1Q next year, which is a peak season. In my view, that is Joey and team have to facing tougher choices next year in first quarter, because we one hind, you have to be more proactive in terms of recovery sales further. On the other hand, you have to hedge against any risk of disruption due to any coming back over to COVID cases. And so like Chinese say, [Foreign Language] So how could you balance the two with your strategy and operation in terms of innovation, value campaigns, deliberate and the menu offering, et cetera. Thank you.
Thank you. Thank you, Xiaopo. That’s a good way to put it on someday. In fact, that’s exactly sort of our approach for this particular year since generally the happening of COVID-19. How are we going to do that for 2021? It’s not going to be too different in terms of the general approach, we will be prepared. We’ll be agile, we’ll be flexible. And we’ll be cautious, but we’ll also be optimistic. We look at particularly Q3 that all of our brands improve in terms of the SSG actually continuing to recover. But we also were very hot on strong value campaign to drive traffic for both KFC and Pizza Hut. But at the same time, we are very well aware of the lingering effect of outbreak and that our repeat caution to our investors and analysts about the uncertainties of COVID-19. We just have to live with it.
But when we come to the business, we still have to focus on each core pillars of the business, and we have to make sure each pillar is strong and shine and agile and flexible, because we are in very good position to manage all the challenges and actually still achieve innovations and resolve for our shareholders, for our customers and for our employees. And if we just recap, what let’s say, KFC and then Pizza Hut, what happened here for Q3 or for this year so far? As I mentioned earlier, we focus on the value promotion, LTL, the new product and then we focused on the privilege suspicion. So our membership throughout the COVID-19 particular, during the most difficult times, when we actually could not do advertisement very effectively we actually could focus on our membership to still launch new products come back marketing campaign.
And on top of the pillar of the membership, we work on our delivery and our delivery improve, continue to grow with the double-digit growth for Q3, Q2 and Q1. So delivery is very agile and resilient business. And transportation hub for tourists, it’s still being challenged. The sales is still below pre-outbreak period. It’s still about 20% less. So we continue to work on it.
And then the regional differences. Regional differences also means regional opportunities too. But Eastern China is still better than Northern China, the lower tier city is still better than higher tier city. And then the recovery weekend or weekday right now even now. But in the past, we were doing a bit more promotion in weekdays a bit last weekend, because or weekend traffic was quite stable and quite encouraging and vibrant. But COVID-19, the weekend traffic is the pattern change, but it’s okay, we will make ourselves more agile and flexible, and we learn better way how to deal with the weekend with a traffic recovery.
And then that’s the KFC. and for the Pizza Hut despite the COVID-19, we still fulfill our promise of sales first and profit later, which we have been talking about for few years now and we have seen progress in the menu, the value campaign, the perception of value and expanding takeaway channel. and thus by Q3, we’ve recovered ourselves to 93% and driven not only due to the improvement traffic, particular average and how do we do that, let’s discount well actually more targeted discount, marketing campaigns, increased party size and all you can eat.
So all in all, with our flexibility and with our focus on each of the pillars driving the business, I think we have demonstrated our resilience for 2020, and I would like to believe our resilience and our team’s ability to deliver during very difficult time of 2020. We shall continue to do that for 2021. Thank you, Xiaopo.
Great. Thanks, Joey.
Thank you so much. And your next question comes from the line of Chen Luo from Bank of America. Your line is now open.
Thank you, Joey and Andy, and also congratulations again, on the strong q3 results. So, got a question on Pizza Hut, which actually offer a quite big surprise for q3. Typically in the past, same-store sales growth for Pizza Hut should be weaker than KFC, but at this time, Pizza Hut was quite close to that of KFC. And the pace of Pizza Hut recovery also seems to be faster. What’s the reason behind that? Is it because of all the measures that we have taken to revitalize Pizza Hut, or it is also partly, because of the assumption that maybe casual dining in China is actually recovering at a faster pace for the industry as a whole? And also with regard to margin, the food and paper costs as potential sales declined by dramatically for Pizza Hut. Even if we are – and at the same time, we are getting less promotional than last year. If that is the case, how should we reconcile that with encouraging same-store growth trends for Pizza Hut in q3? Thank you.
Let me make a comment on the sales recovery side and then Andy can address lot of questions on margin. I would say your thoughts about the pizza hut recovery is due to the overall model recovery, overall business recovery is what I agree and what we believe. And that’s what we have been working on. And we have been – as I mentioned earlier, we’ll be talking about our focus, our promise of self-service and profit later for pizza Hut for few years now.
Actually, Pizza Hut 2019, we delivered the first recovery of traffic particularly the driving traffic, which was very, very critical for our business, because before 2019, the last time we have positive traffic growth in Pizza Hut dine-in business in particular was back in 2014. So, 15, 16, 17, 18 was a hot word, and by 2019, we get our customers. And that’s the most important part of the improvement and we have been also talking about a few pillars of the revitalization. The menu food, we change the 50% percent of the menu. So, the food is very, very different. The delivery, we built our delivery team, we took it in-house, it was painful. But we got it done without impacting the sales growth or the margin.
We work on the perception of value retained surface level dine-in environment. I don’t know whether it’s clear to our stakeholder, but we actually, had the commandment for Pizza Hut for not increasing the price or three years. No price increasing for three years, it’s a very strong commitment to bring back the value for money, which is absolutely critical for Pizza Hut business model.
And during the COVID-19, we also look at it as a word, of course, it’s a challenge. But it’s also a trigger point to do even more innovation in take away, because we were building the system before that the sales or the mobile or the system before that, and we launched in a big way and the take away business took off.
So, another leg to our business. So, it’s not due to one or two thing, it’s due to many things that we have been doing. All the three pillars of the transformation are delivering the results. Thus, we are quite pleased to see the progress. And I’m certainly quite proud of our team’s hard work that’s producing the result right now. And we do believe that the fundamental change and improvement of the business model will continue to help Pizza Hut deliver ongoing improvement is not done yet. We are still working on the breakfast paper, for example, because it’s still an opportunity for us as well. But that’s just ongoing. With that, I’ll pass the question to Andy to give some color about the margin question?
Sure. Thanks, Jeoy. Actually, I want to supplement, comment a little bit. I think, it’s important for us to put things in perspective, I think KFC actually have improved quite well into SSG. last quarter, the SSG was about 90; in this quarter, they’re about 94. if you look at Pizza Hut the last quarter there, SSG was 88, obviously, we’re pleased that they’re at 93 down.
So, both brands have actually seen quite a bit of improvement in the same-store growth and recovery. And more importantly, I think, if we look at the impact in the third year for example, at the beginning of the third quarter, we were still having impact from the regional outbreak in Beijing. And then we also further impacted by obviously, struggling school holiday.
So, in light of that, I think we are pretty pleased with both brand trajectories. obviously, as we mentioned before, the recovery pace as we get closer and closer to full recoveries is going to be more challenging. The reason is because we still are not held with. and so if you look at transportation and tourist location, as we mentioned, you have quite a bit right, more than 20% of traffic over there. And those are important part of our business account for high single-digit of business.
We would look for that even more, we still have some in cognitive at the time of business, right. the traffic at our store, right now, is 90% of last year’s levels. And so – getting, the last group of people to feel comfortable and venture out in dine-in may take a bit more time and we – so we – that’s why we say like, it’s been pretty good about it so far, we felt that we are cautiously optimistic in the fourth quarter in the emphasis and the cautious, especially what as we go into the winter season – and winter flu seasons, so that there we should expect some – potentially, we should outbreak our additional measure that will be seen by consumer or government has had growth.
in our margins, I think, if we look at the overall margins, especially at Pizza Hut, I think, they obviously, as Joey mentioned, they have always been to fix the fundamental in charge saw traffic and sales, and then profitability. This is obviously, a little bit unusual and extraordinary in the sense that we, at the beginning of the year, we see that can decline in sales typical with 2019 and we’re very glad that this has been very quick actions, in terms of cost savings, as well as a new product for the situation.
So, when we look at causal sales sample overall for Pizza Hut dimensions, it was like a 0.7% better. We’re still under some inflationary pressure in total commodity size for Pizza Hut. But no, obviously, this year ignored a focus on cost savings and also targeted market promotion. We would benefit from the lapping of very heavy promotion, competitive comparison to last year.
So, in terms of cost of labor, we still have wage inflation, but it’s much more moderated this year, for both brands, because a lot of the minimum wage increase mandated by government have been delayed or postponed. So, it’s more benign, I think, you look at wage inflation; we probably at low single digit this year. And so – but we do expect some catch up there.
The other one is that, they have been some labor shortage that also accentuated. The labor productivity became right. So, people actually have to work with extra harder. So we – as we mentioned on prepared remarks, we do think that in the coming months, we may have to increase the staffing levels to ensure that we have accounts of efficiencies, as well as service level.
In terms of – you mentioned, all in all I think, there's a lot improvement there. And I think, again, this is coming down to a number of things. It's not just one initiative. There's a lot of cost initiatives. We have seen lower utility cost. We also see lower maintenance cost relatively there as well. So I think, in terms of the market perspective, I think the commodity inflation in certain area is monitoring a little bit, compared to early part of this year, but we still have been looking through that, especially when we go into next year in 2021.
We basically would be stacking up, two years of inflationary pressure, for example, wage increase as I mentioned before, likely there could be some catch up in terms of those costs. Some of those initiatives are sustainable. So if you look at, for example, in cost of labor, we do see both gain from using technology as we have mentioned a few times, the after mid scheduling through the pocket store manager we'd have tracking all of these would have a new longer-term focus it could be improvement.
But, as I mentioned, the labor shortage issue and increasing the staffing levels in the coming months, you may reverse some of those gains. So, and then, subdued wage inflation this year may have some catch up with you next year. But all in all, I think, some of those names with the improvement would stay, some of them may need to ease up a little bit so that we don’t go for before it.
In terms of commodity inflation, I think, if you look at overall inflationary pressure is easing a little bit, still we probably see very elevated prices probably 20%, 30% higher compared to last year. But for poultry like, chicken that pressure have ease a bit as the supply come back in. So, that may help us a little bit on those cost of good sold. [ph]
However, as Joey mentioned value promotions – value for money is very important proposition for consumer in this new normal. And so, we may get back some of those savings in terms of pushing prices back in consumer to drive more traffic back to that spot. So hopefully I addressed all the questions.
Yes. Thanks a lot, Joey, Andy, and congratulations again.
Sure.
Thank you so much. And your next question comes from the line of Lillian Lou from Morgan Stanley. Your line is now open.
Thank you, Joey and Andy, and congratulations again. So I think my question on margin is well answered by Andy personally. So I think my next question is more on the development of China cuisine. So I know that the fasten the expansion of units partially is from Huang Ji Huang, but I want to check was more longer-term sauce behind the development of this newly set up division. Thanks.
Hi, Lillian. This is Andy. Let me try to address your question here on the Chinese cuisine business. Obviously, we think that, the Chinese cuisine is a very big market. Chinese cuisine takes the lion's share for consumer here in China in terms of our dining outside. So there's a lot opportunity for us.
In terms of Chinese cuisine business, with the consolidation of Huang Ji Huang and with our existing kind of leadership [indiscernible] we formed the Chinese cuisine business this year, is the unit lead by Ben Lee and he has been obviously responsible for the turnaround of new ships over the last couple of years. In terms of Chinese cuisine business, we have – our goal is really try to leverage Yum China’s scales, supply chain, our franchise communications, and our delivery partnerships, for example with a different aggregator which offer significant preferential rate for us.
In terms of, we also want to take advantage of the full innovation capability. So if you look at the Little Sheep, we will launch a [indiscernible] product, similar product. And we are also looking into for Little Sheep for example, where we out of product category like barbecue, for example.
And then we also, we can see a great opportunity in the seasoning in sauce business. And so, we have seen Little Sheep growing that business over the past couple of years. Why don't you also have a very good sauce that they use at the store? And we see an opportunity for them to actually leverage that up to the consumer visits.
So if you look at Chinese cuisine business this year, I think, obviously what we would be closing on integrations of Huang Ji Huang, making sure that we can drive that synergy not just about costs, but also product innovations, about issue in China about franchisee-based opportunity there. So, in terms of next year, I think, we would like to see they moving into multiples mode, seeing more growth in the franchise space as well as more progress on the seasoning and in sauce business. So this is sort of like, our current view looking at China specifically.
Thanks a lot Andy.
Thank you so much. And your next question comes from the line of Michelle Cheng from Goldman Sachs. Michelle, your line is now open.
Hi, Joey and Andy. Congrats for the good result again. And I just want to – I wondering whether you can share some color about the recent trends. I think earlier you mentioned that transportation hobbies do around 20% plus below the normal level. So trying to understand whether we are seeing a more significant improvement like October, since we hear some relatively positive data point for other retailers and the restaurants. Thank you.
Hi, Michelle. For the trends I mentioned a bit earlier about KFC the key pillars for the business recovery. The delivery is still growing. The regional difference continue, but the gap reduce. The recovering in weekends and weekdays even now and when it comes to the transportation hub and tourist location, the transportation hubs business for KFC because Pizza Hut does not have much business in transportation hub. So it's mainly for KFC. It’s still below the barbecue [ph]. And we mentioned about – probably about minus 20%. Even during the big holidays and the international traffic, and still very limited due to the ongoing concern of the COVID-19.
But one thing we would also like to caution our investors and analyst is post holiday trading is still a challenge. And that's very interesting phenomenon because usually when customers have concerns, still have the little concern of the overall economic situation, the job, et cetera. You tend to see pretty good trading during holidays. But after the holidays, the little weakness actually it shows the psychological impact. It's not only true in one country. It’s been generally true across different culture, different country. So we see a little bit of that too, which would just like to caution our analysts about that.
But the overall trend is good. I mean, for China, we are grateful for that. The life in China is quite normal right now compared to U.S. and Europe. And the trading is vibrant. So we are very, very grateful for that. And let's hope that the good improvement, the ongoing recovery of our life back to normal will continue. So that's where we are thinking Michelle.
Thank you, Joey.
Thank you so much. And your next question comes from the line of Christine Peng from UBS. Your line is now open.
Thank you, Joey, Andy, for the very detailed explanation about the result, as well as very positive outlook towards the future. So I have a separate question, which is – which may not be related to the quarter result, but Joey I want to get your thoughts. So recently, we reached out from some news reports that your company is launching COFFii & JOY [ph], which is a packaged food brands throughout and China, starting from KFC retail units. So can you share with us your need to long-term sorts of towards this business initiative? And if you can share with us more colors in terms of the branding, pricing, distribution strategies, that’ll be much appreciated. Thank you, Joey.
Thank you, Christine. I mean, obviously it will be hard to serve you [Foreign Language] But hopefully we will be able to have the opportunity for yourself to try our catering type products. For our experiment in the retail business partly is natural, why do I say that, I'll explain it later, partly because of the innovations that we come up with during the COVID-19, so during the COVID-19 time obviously we have seen the trend which is related to Michelle's question earlier is one trend is the increase of the home consumption [indiscernible] right, the people, product and occasions.
So the home occasion is – the consumption is increasing, and we can see that, and Pizza Hut respond during the COVID-19 very quickly by launching the stake – the prepare steak, but it's cooked at home and the result is very good. And KFC has its own take off the home occasion opportunity. And we leverage our product innovation team, which is a fantastic team, they come up with all sorts of very yummy and great product and they come up with a lot of these products that could be consumed at home.
And so far we have launched chicken soup – chicken, we have launched [indiscernible] and is a kind of rice noodle from punchy area with very strong smell. And then we have launched others like the chicken breast, right. So we launched a product innovation team, and right now we are testing it and setting it in mainly top peer cities because it takes time to fill up the volume, because this is a volume game as well. And the result is very encouraging and we leverage our current existing channels such as the e-commerce channel, such as our own app, such as our own current stores to sell the product and customer can buy the product through our stores as well, so they can buy the product in the store and they can be delivered via our own in-house delivery team.
So you can see how we do it, we leverage all the product innovation team, our distribution channel, our store team, our delivery infrastructure to expand the business. So that's where we are right now and still early days, so we are quite excited about the progress and the name of COFFii & JOY, I probably mentioned it before if I repeat, I'm sorry, it's a name that customers in China, cheese KFC, this is the local version, local name for KFC, but it's more in a funny way. We just took it as a compliment, so we call ourselves COFFii & JOY and people got it immediately, because that has been a name being used for many, many years, but never been used officially. So we make it official, so that's what we are.
And of course, you might notice that we have also launched a coffee capsule, we call it [indiscernible], because it's in a little tiny small coffee cup and it's upgraded version of instant coffee with different flavors, stuff like that. And again, we try in top tier city and we are happy with the testing and the progress. So the retail business of KFC and Pizza Hut is an area that we are still learning. And we are looking forward to delivering more this kind of yummy products to our customers. Thank you, Christine.
Thank you, Joey.
Thank you so much. And your last question comes from the line of Anne Ling from Jefferies. Anne, your line is now open.
Hi management team. Thank you for taking my question. Just one minor thing, regarding management mentioned earlier that in third quarter delivery business one of the key driver has been like the corporate delivery. May I know, is this a corporate delivery, mainly from KFC or it’s also for Pizza Hut? And what is the growth potential over here? How much of the sales is – or the delivery sales has actually come out from this corporate delivery. And I understand that we also start to launch, delivery to park and all these initiative. So just wanted to see the new growth stressor for the delivery side. Thanks.
Thank you. And for the corporate delivery, we have been working on the system government, because all these need to be supported by very strong IT system. Since last year and originally we targeted sell – to expand our business to like 5,000 companies for this year, and then the COVID-19 hit. And we deliver a lot of free meals about 107,000 free meals to over 1,450 hospitals and community centers in over 28 provinces. And suddenly we became famous for the corporate delivery due to our effort in COVID-19 by trying to make the right things, because no matter how different the delivery is, even for the food is free, we always emphasize on hot food and that's our commitment.
And so that gave us extra opportunity for company delivery, because when the business recover – start to recover back to March, April, KFC and Pizza Hut is one of the few trust brands that we still have majority of our store open and people came to us trusting our brand and food quality. So we have this unique opportunity and certainly the demand is much higher than we thought. And we respond very quickly and the benefit of corporate delivery for KFC and Pizza Hut and Yum China is we don't have to hire a new set of sales team to do that, which is something quite essential, if you are operating the business.
We have all our stores, we have more than 10,000 stores right now in 1,400 cities and our store manager, and their managers, they often tested people and drive behind it. So as of right now, we have work with more than 20,000 companies on that, and not only the breakfast, but it's the overtime meal and the W11 is coming. You can imagine we'll provide restaurant support as well. To do that, not only it require more customized menu, but also require system integration, the payment, because we want it to be very convenient for staff to order KFC or Pizza Hut or other brands food in their own company website or with their own payment or partly subsidized by their company, et cetera, et cetera.
It could be very complicated combination, but we would make it all easy and convenient for them. And thus this business kind of – it's growing from strength-to-strength. But with that said KFC and Pizza Hut and Yum China, the base is so big, so when it comes to your question about what's the percentage of sales, it's still quite small. And it's very, very hard to get 6% or so, given our base is so big. It's very meaningful, particularly meaningful for the stores that have opportunity to support some companies. You can imagine the sales increase is meaningful.
So that's where we are right now. We continue to expand our network of providing good food and good value for our customer. So you can imagine we have the network of over 10,000 store right now and between one store and other store, there are a lot of connection here. We can do more by offering corporate deliveries or working with our business partner to deliver the service required for our customers. So that's where we are right now, and when it comes to smaller thing like opening stores in part or even having a debenture those small kiosk in some very convenient location, you can see it from the paradigm that we are trying to use our store as a network to further increase the connecting point with our customer by improving the convenience to the customer.
And you actually will start to see some – it's not a lot yet, but one example is [indiscernible] is the delivery box, there is a more of delivery box and customer will pick it up at certain spot of the office buildings, et cetera, et cetera. So these are all the things that we are exploring, but it's all from customer's point of view, a good value, good food and convenient. Thank you, Anne.
Thank you.
Thank you so much. There are no further questions at this time. Speakers, you may continue.
Thank you very much.
Thank you for joining the call today. We look forward to speaking with you on the next earnings call. This concludes today's call. Have a great day.
Thank you everyone.
Thank you.
That does conclude our conference for today. Thank you for participating. You may all now disconnect.