Hello, everyone, and thank you for joining Yum! China's Q1 2021 Earnings Conference Call. Joining us on today's call are our CEO, Mr. Joey Wat and our CFO, Mr. Andy Yang.
Before we get started, I'd like to remind you that our earnings call and investor presentation 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 the non GAAP and GAAP measure is included in our earnings release. Today's call includes 3 sections. Joey will provide an update regarding recent developments in our Q1 2021 results. Andy will then cover the financial performance in greater detail. 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. Our first quarter results demonstrate the resilience of Yum China. We delivered RMB342 1,000,000 in operating profit. System sales grew 34% year over year as same store sales recovered with 10% growth.
We accelerate our store expansion, opening 315 new stores in the quarter. 1st quarter trading was adversely affected by the resurgence of COVID outbreak and Titan Public Health Measures. The impact was particularly pronounced in Northern China where cases spike and in transportation locations due to sharply lower passenger volumes. I would like to thank our 400,000 plus employees and riders for their contributions during this difficult period. Many of them did not return to their hometown to celebrate a holiday with their families who is serving our customers and communities.
We delivered these strong results with the dedication and agility of our people. The pandemic has introduced volatility and uncertainty to our trading patterns. Our team acted and react nimbly to changing conditions. By planning for a variety of possible situations and deploying resources flexibly, We overcome operational challenges. Partnering with our suppliers and through inventory and production planning, our in house supply chain manage complexities and potential disruptions to fulfill the demand of our 10,000 plus store network.
Our operations team ensured best possible level of restaurant staffing and delivery riders. Our operational effectiveness is facilitated by our digital capabilities. Amid the fluid situations, we were able to quickly adjust offers and deploy labor as demand patterns shifted. It certainly reinforces our determination to continue investment in digital, technology and supply chain to fortify our competitive advantage. Let me now update you on our core brands.
First, let's start with KFC. KFC delivered operating profit of RMB327,000,000. System sales grew 24%. KFC continued to rapidly expand, opening 253 new stores in the Q1. During Chinese New Year, we kept our operations simple to address the heavy food traffic.
We focused on our signature products of fried chicken and burger. Our golden bucket, Xincheng Jintong, offered abundant value and resonate well with customers. With a variety of buckets, we captured different party sizes. And off peak periods, we brought back KFC's signature beef wrap, and add crayfish to make it more premium and exciting. We also launched the new Chongqing Chili Pop Burger, Mala xiang Guo Bao.
As part of the offering, we ran a special promotion with the popular action role playing game, Jiangxin Impact Yuan Shen, which was very well received by younger Smith. Our leading digital and delivery capabilities enable us to stay agile in this fluid situation. Despite the recovery in dining, delivery remains popular and accounts for 28% of sales, up 10% compared to pre COVID level in Q1 of 2019. We drove this rapid pace of growth through our hybrid delivery model, omni channel, marketing in our own super app and aggregators drive demand, while fulfillment is done by our own dedicated riders. This allowed us to capture delivery demand with sufficient riders, which was especially crucial in ensuring the success this Chinese New Year.
Delivery growth was also enabled by our continuous investment in strengthening our delivery capabilities. We started trade zone based rider sharing in 2019. Last year, we upgraded our rider platform to improve zoning, rider routing and monitoring. We also started testing rider sharing between KFC and Pizza Hut. This is the first time we put the platform to test during Chinese New Year peak period and we are pleased with the progress.
Leveraging our digital assets and direct connections with our over 290,000,000 members. We were able to shorten the lead time of our marketing campaign and modify them so that we can be more responsive changing market conditions and consumer demand, of course. Our digital infrastructure also allow us to deploy the appropriate supply and staffing level were needed. Digitization is essential to operating efficiently. As part of our end to end digitization initiatives, we pilot launched an AI enabled restaurant inventory management tool, leveraging historical data, recent trends and real time industry levels.
This tool improves forecast accuracy for our limited time offer. This enables us to optimize inventory and improve productivity. Now let's move on to Pizza Hut. We are encouraged by Pizza Hut's strong recovery in the Q1. Same store sales grew 38% and operating profit reached RMB 60,000,000.
These results reflect our efforts to improve fundamentals. Let me provide an update along the 4 key pillars. First, our product offerings have significantly improved over the past few years. We have several successful product launches during Chinese New Year, such as surf and turf platter with sea bass and stick, a flower shaped stuffed crust pizza, Zixin Huaron Pizza and Year of the Off holiday feast set featuring signature products, feast and June New Year. These products were great for sharing and were well received by consumers.
In March, Pizza Hut refreshed its menu, replacing 40% of the menu with new or upgraded offerings, such as beef wellington and roast beef peppers. We also introduced Portuguese Chicken Curry, a popular dish on the delivery menu to Dai Inn. We also have been unlocking the growth potential of breakfast and afternoon tea. We strengthened the menu with new offerings such as French toast for breakfast and a 3 layer tea set for afternoon tea time. Apart from Good Food, we have also been actively engaging customers both offline and online.
During Chinese New Year, we celebrate the festival with consumers by bringing in some of China's intangible cultural heritage, such as Shadow Puppetry and Paper Cutting into our stores. And then on the digital front, We have been strengthening our membership program and super app to engage members and improve customer service. Our member base exceeded RMB90 1,000,000 and contributed 55% of total sales, up 9 percentage points year over year. Digital ordering increased to over 80% of sales from 65% a year ago as table side mobile ordering K more popular. We are also applying digitization and automation in our kitchens to improve operations.
As part of our multi space intelligent kitchen project, we started to roll out an AI enabled tool to pace food preparations and provide real time metrics of kitchen performance. Initial results have shown improved efficiency and customer experience. 3rd, Pizza Hut is strengthening its delivery takeaway and ready to cook offerings. Delivery accounted for 35% of sales, an increase of over 10% from pre COVID level in Q1 2019. While growing from a small base, we are expanding our takeaway and ready to cook business through menu innovation and making them more convenient for consumers.
Lastly, we enhanced our store portfolio through accelerated remodels and new store formats. Since 2018, we have refreshed nearly half of Pizza Hut stores to make them more relevant to our consumers. This is over 1100 stores. As we promised in the 2019 Investor Day, Average store age is now below 3 years. The stores look great.
The new small store format, which includes the hub and spoke model, which is also mentioned in the 2019 Investor Day, is creating more opportunities for Pizza Hut's expansion, enabling us to capture the growing demand for off premise dining. Of the 44 new units that we opened in the first over half are in small store format. I'm confident that we will unleash Pizza Hut's growth potential through this combination of much improved fundamentals, strong digital capabilities, multiple sales channels and Rejuvenated Assets. In summary, we're pleased that our brands react quickly to the fluid market conditions and deliver strong operating profits despite those pressures. Most importantly, We remain optimistic about our long term growth opportunity in China.
We will continue to accelerate store expansion for our core brands, grow our emerging brands and enhance end to end digitization and intelligent supply chain to build a bigger and nimble Yum China. While we are optimistic about our future, we remain cautious about near term conditions. Occasional COVID outbreaks like we saw recently in Vietnam are a constant reminder that we are not back to normal yet. Heightened public health measures continue to be a daily routine and continue to have a lingering impact on consumer behavior. Sign in volume is still well below pre COVID levels, but we are not sitting still.
Our nimble and innovative culture enable us to adjust marketing and operations quickly as things evolve. With that, I will turn the call over to Andy. Andy?
Thank you, Joey, and hello, everyone. Let me now provide additional details on our Q1 financials and then share perspective on this year's outlook. Unless noted otherwise, All percentage changes are before the effects of foreign exchange. Let me first cover our Q1 financial results. We experienced substantial year over year growth in the Q1 as we began to lap COVID-nineteen impact period last year.
Total revenue grew 36% year over year, led by same store sales growth of 10%, new unit contribution and substantially fewer temporary store closures. Because of the volatility induced by the pandemic In 2020, the year on year comparisons are less representative. Looking at the 2 year change gives a better sense of how we are trending back to pre COVID levels. So we are providing pro form a measures here for convenience comparison with 2019. Same store sales recovered to approximately 94% of the Q1 2019.
Total revenue grew roughly 7% compared to Q1 2019, benefited from new units and consolidation of Suzhou KFC and WangJi Wang. As we discussed in the last earnings call, the sales recovery was disrupted by the resurgence of regional outbreaks and significantly reduced travel. Travel volume during the 40 days Chinese New Year period was down approximately 40% year over year and 70% compared to 2019. These impacts were more pronounced for KFC as it has more stores in the transportation locations. On a year over year basis, KFC same store sales grew 5%, driven by the recovery of dine in sales, while delivery remains popular.
On a 2 year basis, sales recovered to approximately 94% with the same store traffic at approximately 87%. Average ticket grew roughly 87% sorry, 8% versus 2019 due to increase in delivery mix. The respective average ticket of delivery and dining remained flat. Business hub same store sales grew 38% year over year, driven entirely by the recovery of traffic. On a 2 year basis, sales recovery to approximately 95%, led by a 2% increase in traffic.
This is a true testament to the success of the brand has achieved in executing its revitalization plan. And like KFC, the increase in delivery and takeaway mix contributed to lower ticket average versus 2019. Restaurant margin was 18.7%, up 8 points compared to last year. This was mainly driven by sales leverage, operational excellence and favorable commodity prices. Cost of sales was 30.2%, which was 180 basis points lower than last year.
Commodity prices declined by 7% year over year, mainly helped by lower poultry prices. The impact was partially offset by investment in promotions to drive traffic. Cost of labor was 23.3%, 220 basis points lower than last year. Sales leverage and labor productivity improvement more than offset the wage inflation and diminished government subsidy. Given the labor shortage that we are experiencing, We are still actively seeking to hire additional restaurant staff.
Occupancy and order was 27.8%, 4 points lower than last year, mainly attributable to sales leverage and Savings and Charter operating costs. We also received approximately $6,000,000 in rental reductions and GAAP net revenues. Compared to 2019, restaurant margin was relatively flat. Productivity gains and cost control offset sales leverage, investment in value promotions and increased wider costs associated with the rise in delivery volume. G and A expenses increased 24% year over year, mainly due to a timing shift of government incentives, gradual phase out of COVID-nineteen related relief and the consolidation of Wangji Wang and Suzhou KFC.
Excluding this impact, G and A increased 3%, reflecting our ongoing cost control. Operating profit was $342,000,000 compared to $97,000,000 last year. The increase was mainly driven by sales and restaurant margin improvement, partially offset by the increase in G and A expenses. Our effective tax rate was 29.6 percent. Net income was $230,000,000 and adjusted net income was $233,000,000 Excluding $16,000,000 mark to market investment loss, it was RMB249,000,000 up 2 25 percent year on year.
Diluted EPS increased to $0.53 This reflects common shares that were issued as part of our secondary listing in Hong Kong in September 2020. Now let's turn to the outlook. As Joey noted, we are optimistic about our growth opportunities in China, but we remain cautious about the near term environment. While the pandemic impact is subsiding, We must be mindful that the pandemic is not over yet. The full recovery takes time with an uneven and nonlinear recovery tech.
We are confronting a couple of realities here. First, preventive measures will remain in effect. This will have a continued impact on consumer behavior. Sporadic outbreaks remain remind consumer of the lingering risk, social distancing and small gatherings may persist for some time. Dine in occasions are still well below pre COVID levels.
2nd, consumer spending is cautious. Government data shows that despite apparent recovery in domestic travel volume during Ching Ming holiday weekend in April, The related travel spending was still down over 40% comparing to pre pandemic level in 2019. In fact, sales and our transportation location remains well below 2019 levels. Against this backdrop, We expect it will take time for same store sales to fully recover to pre COVID level. We will focus on driving top line growth with compelling value propositions, more marketing campaigns, product innovations and digital engagement with consumer for both I'm in and off premise operations.
While necessary, this initiative will pressure our margin. Apart from that, we face other cost impediments. The tailwind of favorable commodity prices in the Q1 will likely gradually subside. At this time, we expect poultry prices to rebound and partially potentially turned into inflationary pressure later this year. In addition to replacing plastic packaging with eco friendly materials, who will also invest packaging upgrade for delivery and takeaway.
We expect labor costs to increase in the subsequent quarters. There are 2 components to that. First, wage inflation was 2% in the Q1 as minimum wage increases were deferred in certain markets. We expect wage inflation to pick up in the second half of the year. Full year wage inflation should stay at mid single digit.
2nd, increasing increased hiring. In the past few quarters, we have been short of part time workers Due to COVID related restrictions, we are working to increase restaurant staffing levels. While this will increase Training hours and wage expenses is critical for customer services and long term viability. We have approximately $6,000,000 of temporary relief from the government and landlord in the Q1. This was partly due to a timing shift of amount previously applied in 2020.
We expect this support to taper off as the year progresses. As a reminder, We are lapping over $100,000,000 to leave in 2020. In the Q2 2020 alone, who received approximately US15 $1,000,000 in relief. Set up investment in technology, end to end digitization and operational infrastructure will strengthen our capability and further solidify our competitive position. But in the near term, this will pressure our margins and operating profits.
Roughly up, We're working diligently to drive same store sales recovery and accelerate store expansion. We are also committed to invest to drive accelerated growth and create value for our shareholders in the long term. With that, I will pass you back to Debbie to start the Q and A. Debbie?
Thanks, Andy. We will now open the call for questions. In order to give as many people as possible chance to ask questions, please limit your question to 1 at a time. Operator, please start the Q and A.
Excellent.
Wat.
Our first question is from Brian Bittner from Oppenheimer. Please ask your question,
Thank you. I hope you all are doing well and staying safe. Can you help the investors in the United States just better understand who are not in China, better understand what type of consumer Wat. Trends you're seeing in your store base that are not located in the transportation hubs. I understand the transportation locations are challenged given the transportation trends.
But overall, you've already recovered 94% of your pre COVID sales volume. So you're pretty close to a full recovery. So are you seeing a more clear path to pre COVID sales levels in those markets That are outside the transportation hubs or is there still a lot of volatility and headwinds related to the pandemic in those more traditional markets?
Thank you, Brian. We are all staying quite safe in Shanghai. China is recovering quite smoothly despite Not completely out yet. Let me give you an overall picture about the Chinese New Year trend and then compare the KFC versus Pizza Hut and then a bit specific about the non transportation hub. Hopefully, that gives some ideas about what's going on here.
So let's start with the Chinese New Year. We had a lot of uncertainties before going to Chinese New Year because the trading was a bit soft. And what our company has done is to Pei, have quite a few scenarios planned, so we react quickly. And as we adapt to the market condition, the trading picked up during Chinese New Year and was robust. But after the Chinese New Year, we continue to see some weaknesses in trading, particularly in transportation hub.
Outside transportation hub, to answer your question, the dining volume is still well below the pre Wat, pre COVID level. That's why we remind our investors that we are not out of the wood yet. But what can we do? We stay agile and we plan for the possible scenario. So that's point 1.
In terms of point 2, which is a big picture of KFC versus Pizza Hut. We are happy with both Brands Recovery. Because the Q1 results show the resilience and energy of both brands, The sales was disrupted, but with the scenario planning, the year on year same store sales for KFC Pizza Hut, and I'm referring to 2 years, so pre COVID-nineteen level. KFCU was minus 6%, which is 94%, and that includes the impact of the transportation hub Pizza Hut, recovered to 95 compared to 2019 Q1 without much of the transportation hubs in their store portfolio. So that gives a sense because 2020, the numbers are a bit unusual.
And then when we look at the system sales, The Pizza Hut compared to 2019 is still minus 2 because Pizza Hut did not open that many stores last year, although we are in Q1. KFC system sales recovered to plus 6% versus 2019 because we opened a lot of store last year. So I hope that gives a sense that it's not with or without the transportation hub, The same store sales is still having a little bit gap within 2019. So come to the a bit more specific about the trend and the trading. Andy talked about the transportation hub business.
It's still 40% down compared to 2020 and that's the traffic. And in terms of sales, it's pretty much in line, although we do slightly better than the traffic number. And then in terms of city tier, I'm talking about KFC because KFC store covers of 1500 Cities in China, over 1500 in China. So that gives a better big picture of what's going on here. The lower tier cities have better sales same store sales than the higher tier cities, mainly because the higher tier city stores have the element and mix of transportation of stores.
And then the delivery growth is better in a lower tier city. And the eastern part and western part of China led the recovery. And northern part and northeastern part of China. Because of the regional outbreak, they have been a bit softer. And then weekend and weekday, our traffic is pretty much back to where it need to be or where we wanted to be, because we have a bit more promotion to drive the weekend traffic, which was a bit soft before, but now back to pretty normal.
And then for the non transportation hub stores, just singled out his sales tool. It's about 2% GAAP versus 2019 pre COVID level. So Brian, I hope that gives you a comprehensive view of the trading. From consumer behavior point of view, they are still quite value cautious and therefore, we still have to be mindful about the value that we can pass on to consumer. But that's not the only thing they want.
They still want new products. So Other than Vale, we still launched new products to make sure that we encourage the customer to come back. So I'll pause here. And Amy?
Yes. I just had a couple of things to add there. Brian, good evening to you. I think for the folks outside of China, I think it's important to keep in mind that we're still facing Wat. A bit of uncertainty and challenges related to COVID-nineteen.
So even though like the thing seems to have Hung down a lot here. We did have a regional resurgence at the end of last year beginning of this year, right? So that have an impact on our Q1 trading. So and then when we look around, I think we still have quite a bit of health preventive measures that is still in place. Wat.
So that was you and then Gautam, who will continue with Michael to stay alert, not to be alarmed, but stay alert on the COVID situation. And as we look outside of China and then we have seen the resurgence in some other countries in Asia, including Japan and more recently, the situation in India. So that remind us that like we're not out of the wood. So still a lot of challenging challenge ahead. As Joey mentioned, obviously, Chang'e Pay Hub is an important business for KFC, the account for high single digit of the Sales.
So that will continue to be sort of like a challenge for them to overcome to reach that Before we recover SSG compared to the pre COVID level. Same thing for the Dainin, right, Dainin, I think in the Q1, where traffic was still at about 87% level at the high frequency level. Our delivery business is doing fantastically well, right, so grew very strongly last year. I think this year, we're still growing at mid double digit number, right? So that continues to be a bright spot For us, Joey compared to the COVID level, obviously grew more than I think 60%, 70%.
So that's sort of like the overall situation. Thank you.
Thank you. Thank you both for the perspective.
Next telephone question is from Chen Lau from Boeth Securities. Please ask your question,
Thank you, Joey and Andy. I've got a question on the margin side. So it seems that Pizza Post a pretty strong margins for Q1 this year. And in fact, if my calculation is correct, It should be the highest ever since 2018 or when we started the revitalization process. So what's our future strategy with regard to GuitarHub in terms of balancing margins and same store sales growth?
Is it fair to say that the future margin trend of Pizza Hut could be above the level that we saw during the past few years while we are in the process of revitalizing Peter Hu. Thank you.
Hi, Suneul. This is Andy. So let me try to address your question And let's see if Joey, you have any follow-up. So I think if you look at Pizza Hut, obviously, we're very pleased with the execution there. I think over the past Couple of quarters, they have demonstrated that they have excelling their Wi Fi Xun program really well and then they are building on that resiliency, right.
So I think some of those, as we mentioned before, obviously, is improvement. I think if you look at the fundamentals, we continue to look at that improvement based on the fundamentals that we have laid out before, right, store, remodeling, We have menu, the food. We also work on the digitization program, which worked out very well for us in the pandemic, Right. We're able to pivot very quickly. So and if you look at the digit number for tabletop orders, it's Incredible right now.
It's almost like 50% of that. So I think they have did a really good job in the bottom line, I think, the fundamental. We see I mean, the recovery is quite strong, but I think I don't think we can say like as As a whole company, let's say that we are out the wood compared to the COVID level. So the top priority for them still is driving traffic, and we're glad that For the Q1 in 2021, we see actually the traffic increased not only year over year, but also compared to the 2019 level in the Q1. So the next one is obviously drive that sales Sales member.
And so let's do some work there. I think we will continue to emphasize on value for money, value as Joey mentioned, very important for consumer now when they're coming out from the impact from COVID-nineteen. So again, like we're pleased with the progress in cost control, executions, But I think profit is still not the number one priority for us. We're still for pizza and also KFC, obviously, to drive that store traffic, drive the consumer back to the store and then aim for that full recovery in the same store sales competitive pre COVID level. But I think like if you look at Pizza Hut, some of the improvement will definitely continue and some of that as we mentioned before, for example, as we see the poultry prices, the poultry prices are going up, that's in second half of May.
As the year progresses, we may see inflationary pressure there. Both brands are doing packaging improvement, right, transitioning from plastic to eco friendly material, but also investing more into packaging for Upgrade for delivery and also for takeaway products. That would also be somewhat overhang there. Labor productivity is we have been a lot of labor productivity improvement using technology to the AI tool that we enable the restaurant operation. But some of that is sort of like due to the labor shortage that we have seen in the second half last year.
We have mentioned that we continue to try to resolve that. We are looking into increasing staffing level, make sure that we continue to maintain a high level of customer And that's very important in the long term, but I believe, Frank. So those are the couple of things. And then again, like if you look at the overall Margin plan, last year, we received $100,000,000 from Daplan movie, right? So this year, it's already phasing out.
We have $6,000,000 in the Q1 and we will expect that to continue to phase out as the year progresses. So all in all, we have some positive and then we also see some headwinds in terms of project and cost.
Lawson, I think I just want to at 2 comments. One is we have been very consistent with the path of recovery for Pizza Hut since the time we commit to a turnaround. We have always been very clear about our priority, which is sales first, profit later, and we focus on improving the fundamentals of the business in the last few years, and we are grateful that we are seeing the results. So that's point 1. Point 2 is what is next.
The next is to focus on improving all aspects of the changes that we made in the last few years and cement the changes made to make Pizza Hut a resilient business model. That's what we want because that's what we have been trying hard to achieve for KFC, which is a very resilient business, and we want Pizza Hut to be a resilient business model as well. And at least in 2 aspects we want to continue. 1 is sales first populated that's the path in the last few years. Next, we won both sales and profit.
As I mentioned at the occasions before, sales is vanity, profit is sanity, and we will update both. 2nd, the second aspect of the resilient business model, you can see We have been increasing and building our off premise business. So now between the delivery and takeaway, the off premise business is over 40% of the business. And this is important because we are not relying too heavily on sign in business. It's much better to have sign in, delivery and right now takeaway or ready to cope product as well, 4 pillar of the business instead of 2 pillars.
So these are two examples of resilience that we are looking for. Thank you, Rotten.
Thanks a lot, Joey and Andy.
Our next telephone question comes from Zhou Chang from Goldman Sachs. Please ask your question, Michelle.
Hi, Joey, Andy. My question is about
the occupancy and other costs.
We actually noticed that these call centers
have been huge savings in the past few quarters. So can
you give us more color on
the breakdown and also more specifically on rental ratio. We heard from other like leading restaurant trends they have a pretty favorable rental term post COVID. So just wondering that compared with the pre COVID level, are we also seeing a good rental saving and how sustainable these other cost savings can be seen in the next few quarters. Thank you.
Michelle, thanks. This is Sandy. So regarding your question on O and O, I think you're right. Like we've seen quite substantial improvement Wat. Coming from the O and O segment, 7% year over year lower and then roughly 1.4% lower than 2019 same period.
I think as you can see these two number, O and O in a big part is driven by sales leverage. So that's the most important Factor that's driving that. The other one is that if you look at utilities, there's 2 things that's going on there. I think over the past few years, so So the government have reduced the utility costs to basically try to improve the business environment, Wat. So that will also help how long this will last, I think maybe end of the year or early next year.
The other one is, obviously, over the past couple of years, we have tried to improve our kitchen automation operations. We have mentioned smart utility device that we have installed in some of the store, some of the procedure, so that also lowered that. And then also we mentioned that some of the savings is due to rent relief, temporary relief and some of the government relief, in terms of security payments and whatnot. So that I think in the Q1, we still have $6,000,000 So All these combinations help us sort of improve that OTO as a percentage of our sales. But I think so I think some of those is carried forward, but a big part of that would probably have to do with the sales leverage that we
Yes. Thank you, Andy.
Sure.
The next telephone question is from Anne Ling from Jefferies. Please ask your question,
Anne. Hi, Andy. Hi, Joey. I have a question regarding the operating leverage. It's a very good margin that we have billions in the Q1.
I'm just wondering whether there is any like not one off, but it's like a catch up because the sales has been so strong. So there are some of the investments that we need to do it, but because of the time shift that we I mean, the question I want to ask is that What should we be expecting in terms of the operating margin in the coming couple of quarters? Is that some of the other investment that we need to play a catch up because Q1 was so good that there are some of the costs that might have lagged behind. So that's my question. And also a side question On the delivery side, if we with this effort in terms of sharing the riders between Pizza Hut and KFC.
In that case, in the past, we have we talked about a little bit of the margin dilution for the delivery business. With all these exercise, do you think that at some point our margin for delivery business will be applied to who is
dialing in given
the fact that the sales mix is getting higher and higher on the delivery side. Thank you.
Hi, Anne. This is Andy. Let me try to address your questions about some of the one off and whatnot. So Obviously, I think like last year, we have received government subsidies and whatnot. And then as you mentioned, so that is continuing to phase out.
In the Q1, we have Wat. I think that will continue to be the trend there. On the other part, you said, for the Cost of sales, for example, we were I think after a couple of years of rising Poutine and commodity prices. Beginning of second half last year, we begin to see that easing up. We benefited quite a bit in the Q1.
We see a 7% year over year Wat. But as you have probably noticed that on the news, like We see corn prices, all the feeding stock that prices going up. We've already seen like the holding prices going up both here in China but also overseas. Our contract is locked up probably 1 to 2 quarter at half time. But we as we have mentioned, we would see that tailwind begin to subside as the year progress and potentially and likely potentially turning to inflationary pressure later on this year.
The other one is, obviously, We have embarked on the phasing out of plastic. So and then as we see Delivery and takeaway as an increasingly important part of our business, we are also investing into improving the packaging for those operations. So you would probably obviously see like the packaging costs would go up as the year progress as we continue to roll that out. When you have labor, I think this part of that is obviously labor productivity that We have been ongoing for a number of years now. The goal is really to continue to see that level of improvement by providing new technologies and toolkit to improve our commercial operations.
I think there's 2 issues there. One is that we did experience some labor shortage since last second half last year, as I mentioned. We tried to rectify that and then try to step up the hiring, but I think we still have not at the level that we would like to see. So we'll continue to drive that. The other one is obviously, wage inflation.
As the economy as the pick up As the pandemic impact of Tsai, as we mentioned, you'll get really kind of high term restriction by GAAP income mobility for some of the prime worker. But overall, I think the labor market will be getting tighter and tighter and then we're likely going to see wage inflation potentially also stepping up. And that is a you have to remember that it's compounded for 2 years, right? So that's something that we had to work through. For delivery, I think it's not always necessarily a it's more complicated story for the margin because we need to look at holistically.
Obviously, we have the delivery cost that just add up to it. But we also to see if we can improve our operation inside the restaurant, right, to improve margin. So if you look at our margin, for example, Before the pandemic, we see that the sort of like CLL margin market be stable Despite our delivery volume or percentage mix of sales increased from I think 6% maybe in 2016 to almost like 30% in 2019. So we are able to Wat. So we will continue to do that as we invest, But that will likely continue to be a pressure, but we're trying to find a way to offset that.
So that's overall. So I think like I know we have delivered very strong profitability and we're very proud of our team in the cost control. But you're right, like going into the next few quarters, we're going to see some headwind in terms of cost and expenses.
Hi. I just want to add 3 points to Andy's comment. In terms of call side, we continue to work on our calls such as the Delivery 3.0 upgrade with rider placement upgrade, AI enabled zoning rider routing optimization, they help. But what I really, really want to point out is 0.2 and 0.3. These are the other aspects of the equation.
0.2 is about the sales upside during peak trading period and peak trading hour. If we can have enough riders, we actually have more sales upside during the peak trading period and peak trading and Chinese New Year is a very good example. So It will be a bit misleading to ourselves if we just look at the cost side. So that's point 2. Point 3, if you think about this, Watt.
When Andy said earlier, it's a holistic approach, it is a holistic approach. It's not necessarily straightforward to think that having more store helped the delivery cost. But indeed, it was that way. When we increased the store portfolio's entity, then we reduced the average circle of delivery distance. For example, when we have more stores, we can reduce the delivery distance of the rider from 5 kilometers to 3 kilometers and back with you the call.
So it's not only just the call. We have other quite a few aspects that we can do to both increase the sales and to manage the cost and our number has shown that we have been able to do that in the last few years. Thank you, Anne.
Anne, it's Andy. I just want to add a little bit on Joey's comment. Two things, one is, Zoe has correctly pointed out, if the incremental sales, The profit margin is much higher, right, obviously the incremental margin is significantly higher. The other one is that in terms of the wider The wider network effect. It's a very interesting thing that I think we're still wanting to see how the dynamics work, Right.
The high density network. That's enabled by the fact that we run our own delivery network. We have a hybrid model. We work with the aggregator Wat. With the traffic and our own app, but the delivery, we manage that operation outside with a dedicated rider.
So we can continue looking to improvement on the network effect there Wat. That may be a little bit different from the U. S. Russian operators and some of the operators most Russian operators here in China. So we want to create these models.
Wat.
Our next telephone question is from Lillian Lau from Morgan Stanley. Please ask your question, Lily Anne.
Hi, Andy and Joey. I have actually one of the follow-up questions because most of the Wat. That's still about the comment that Joey just made about to look at the business on the holistic approach. So compared to a couple of years ago when delivery was still relatively smaller amount of the revenue, right now is close to 30%. And also the store network in the lower tier cities, the Hence, the intensity is actually higher.
Compared to then, what kind of margin impact to this Kind of dynamic changes, in particular like delivery, we know that it's still probably it depends on the calculation, it's probably still margin dilutive, but compared to a couple of years ago, what kind of margin impact of this delivery and also lower tiers store changes to the margin and what kind of projection we can make for the next couple of years. Will it be incrementally positive to margin? Thank you.
Okay. Thanks, Lillian. This is Sandy. Let me take a crack at this and then maybe if Joey has more, she can add a little bit more later. In terms of delivery, I think it's I don't know if it's fair to say the delivery margin is dilutive to the overall corporation.
As we mentioned before, like we generally look at the restaurant operation holistically, right? So we have multiple ways of delivering the product to our customer, Tai Yin, right, take away and deliver. Now if you want to look at, obviously, The restaurant margin for us because food is unlike e commerce, right? E commerce, you don't need to eat just warehouse and distribute to the consumer. Food, you need to deliver to consumer Wat, to ensure quality of the food and then customer satisfaction.
So having a production of restaurant location is almost a month. For us, if you look at the delivery, deliveries have been growing very rapidly. I think we believe that that's incremental to our overall sales. And then the other part is that if you look at overall restaurant margin, for example, for Pepsi Before the pandemic, it was wildly stable, right? So it's about 18% in 2017, 2018, 2019.
And then we are back to some similar level in the Q1 of this year. So All through this period, obviously, delivery has been increasing mix. As I mentioned before, like about Delivery was about 11% of our sales in 2017 and now it's about 30% plus. So we're able to maintain that margins. Obviously, it's hard work.
There's a lot of work going through it, but it hasn't been particularly diluted to The other one is that if you look at, for example, the labor cost expenditure, for example, for KFC, right, for example, It has been also quite a bit stable despite obviously we continue to see Raised inflation in China at before pandemic, Mr. High single digit level, right? So if you look at KFC's Wat. Cost of labor, which including the prior cost there, was about 20%, 21%, it's stable in 2018 2019, both rapidly speaking is probably 20 Wat. 21%, yes, over 21%, right.
So and then in this year, we're at about 22%. So Overall, I think as Joey mentioned, it's not necessary diluted for us. If this incremental sales coming bring in by delivery, we actually have higher margin because the marginal Contribution from additional sales is actually pretty high.
Thank you, Andy. I just have one more point to add Lillian. Actually, the shift to the delivery business actually helped our rental percentage as well, just maybe bring that into the equation. Why? Because if our store is relying too heavily on dining business.
The location cannot be compromised too much. It has to be very, very good location. Otherwise you don't get the business. But when we are building more and more delivery friendly stores, relying more and more on delivery. We actually opened up more opportunity for locations that are at slightly lower rent.
And that's not a small deal for us. So as we where our store portfolio moving towards delivery certainly it helps. Okay. Thank you, Lily Ann. Thanks a lot, Joey and Andy.
Sure,
Wat. I just have one quick question regarding the outlook provided by the management earlier. So you mentioned about there are still some uncertainties in China regarding COVID-nineteen situation. But having said that, we actually observed a very strong pickup in the domestic traveling activities, especially going into the Labor Day holiday. So Can you maybe give us more colors in terms of the sequential trend you are observing in China in the past 1, 2 months so that investors can get a better feeling in terms of what is the expectation we should be setting for the upcoming 1 or 2 quarters same store sales recovery compared with pre COVID-nineteen level.
Thank you.
Hi, Christine. This is Andy. So I think you're correct that if you know the domestic travel volume have picked up quite a bit, I think this year and especially spring festival and potentially going into the Labor Day holidays. So that's the overall traffic volume side. I think that that but the difference is that the consumer behavior You remain cautious.
So if you look at the trip that they take, generally, are short trip. So if you look at overall spending level, It's still down, I think, quite significantly, probably down 40% of us compared to pre COVID level, Right. So I think there's 2 things that we need to separate, right? The trip that they will take the type of trip that they take may be different and also the spending level is And I think that is similar to what we observed before, right, like as Joey mentioned. Generally, when we see there are Some pent up like sort of like urge to go out and to when this holiday, right, to relax.
But so we see that sometime the Wat. But then as post holiday season sounds like softening, people generally You still are cautious about the COVID situation and then also the economy, economic situations, right. That obviously includes that recent uncertainty for folks. So that's what's going on here. Like I think If you look at the overall situation, it's much better compared to 2020, obviously, in terms of the COVID situation, even compared to obviously, we but Again, as we have mentioned before, we need to stay alert, not to be alarmed, but to alert.
The reason is because if we look at In China, we have a mini resurgence of both situations in the end of last year early January. So when things come down, I think it's easy for folks to think like everything is back to normal, but I think reality is that we're not. We also I think that what's happening internationally would Wat. We have seen the situation in India, our hard go out Wat, to the folks in India that impacted by COVID-nineteen. It's a constant reminder for us that we're not off the wood.
We need to We continue to expect the recovery the full recovery to be nonlinear and uneven. And it's just not a saying. I think it's Wat. And this is how we operate and plan for different scenario, different situation. And we encourage analysts and investors to do the same Wat.
How to extract linearly linear extrapolations and that's how we plan that's why we say the full recovery for our same store sales Wat.
Wat. And our next question is from Leeny Yan from HSBC. Please ask your question.
Hi. Thanks management for the very detailed analysis on your Fomens. I have a question regarding the base effect of sales at the traffic hubs. I think you started to talk about the very negative growth at the traffic hubs from Q2 last year. So it has always been high single digit of your sales like from Q2 last year.
So would you comment that the base for traffic hub sales will become more favorable from Q2 onwards? Thank you.
Yes, likely, right. So because we have a big impact obviously The lockdown, I think, last year in the beginning in the Q1, I think we see rebound in the traffic over the year. But I think the volume is still significantly below the pre COVID level. So I think on a year over year basis, you will see movements on a 2 your period capacity preclinical level, I think it will take quite a bit of time for it to fully recover. And then obviously, we're encouraged Hi, the fact that the government's ruling out the vaccine program, the situation here in China is positively calm Wat, after the resurgence in December and also in January period.
So but I think it would more impactful for KFC because you have more store in the shops and in the couple of locations. The other part is that international, we don't forget we have international locations. So international travel is still pretty much Immaterial right now, right. So until country open up border and we see international travel, that will continue to be a big overhang for the subsidy company.
Okay. Thank you very much. So I think every comparison is referred to 2 year comparison basis. Thank you.
That's right. Yes.
There's no more further questions at this time. I'd like to hand the call back to the speakers for closing remarks. Please continue.
Thank you for joining the call today. We look forward to speaking with you on the next earnings call. This concludes today's call and have a
great day. Thank you.
Thank you.
Thank you, ladies and gentlemen.
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