Ladies and gentlemen, thank you for standing by, and welcome to the Yum China 2019 First Quarter Earnings Conference Call. At this time, all participants are in a listen only mode. There will be a presentation followed by a question and answer session. I must advise you that this conference is being recorded today, Tuesday, 30th April, 2019. I would now like to hand the conference over to your first speaker today, Ms.
Florence Lip. Thank you. Please go ahead.
Thank you, Rachel. Hello, everyone, and thank you for joining Yum China's Q1 2019 earnings conference call. Joining us on today's call are Ms. Joey Wat, CEO of Yum China and Mr. Jackie Lo, CFO of the company.
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 and reconciliation thereto.
Today's call includes 3 sections. First, Joey will cover Yum China's Q1 2019 highlights and Jacky will cover the financial results.
We will then open the
call to questions. The webcast of this call will be available on our IR website, A PowerPoint presentation, which contains operational and financial information for the quarter is available for download as well. At this time, I would like to turn the call over to Ms. Joey Watts, CEO of Yum China.
Thank you, Varun. Hello, everyone, and thank you for joining us today. First, I would give an overview of the quarter before providing more detail on our operational initiatives for each of our core brands. I'm pleased to report that we delivered our 10th consecutive quarter of system sales growth since we spun off from Yum! Brands.
Strong system sales growth on 9% was driven by accelerated new store openings, robust performance at KFC and a meaningful improvement at Pizza Hut. In the Q1 of 2019, we continued to aggressively expand our market leading footprint, opening 2 37 stores compared to 2 0 3 stores in the same period last year. Our new store openings continue to be dominated by KFC given the attractive cash payback period and strong growth opportunities. With excellent execution over the critical Chinese New Year period, KFC delivered an 11% increase in system sales and a 5% increase in same store sales, successfully lapping 3 very strong first quarters with healthy growth across all city tiers. We are also pleased to see the ongoing improvement at Pizza Hut, which achieved positive 1% same store sales growth, strong increase in traffic and significant margin improvement.
Excluding the Wuxi re measurement gain in the Q1 of 2018, we successfully achieved operating profit growth in the Q1 despite the margin pressure from rising poultry prices and wages. This reflects the benefit of sales leverage and our effective cost management initiatives. We were also very pleased to unveil our strategic partnerships with Sinoplast Sales Company and CMPC at our Investor Day. Through these partnerships, we will jointly develop the gas station retail business, which is an exciting example of the many untapped opportunities to grow our presence in China. Now I will provide more color on the performance and strategy of our key brands starting with KFC.
KFC is the leading QSR brand in China and it continued to demonstrate its resilient business model. In the Q1, KFC built on 3 years of strong growth with system sales up 11%, resulting in a full year CAGR of 9%, both excluding foreign exchange. Menu innovation, smart value, delivery and excellent execution drove strong same store sales which was complemented by a substantial contribution from accelerated new openings in 2018 early 2019. KFC opened 191 new stores in the Q1 compared to 144 in the same period last year. Expansion will continue to be a key priority as we pursue additional opportunities for growth in attractive underserved markets across China.
Now let me talk about our special offers and menu innovation during the quarter. Based on the popularity of the crayfish burger during the 2018 The crayfish burger has become one of our unique signature products. Other innovative products launched include the shrimp burger and lotus leaf rice, we call it in Chinese. Turning to Chinese New Year, we meticulously planned for this crucial sales window for months in advance and I'm very pleased to report we achieved very strong results on the back of innovative menu items. Wide brands, multilayered promotional campaigns and excellent execution.
We created sharing oriented specials that are well suited to friends and family celebrating Chinese New Year together such as our spring festival golden bucket and wind bucket. We also implemented local marketing initiatives and decorated selected stores with Chinese cultural treasures by partnering with the National Museum of China. In addition to Chinese New Year, we also catered to other Chinese festivals and regional specialties. For example, we serve a green rice dumpling called which is an Eastern Chinese specialty for the tomb sweeping holiday. We have found that customers are very receptive to regional specialties from all around China and the rice dumpling proved to be a very popular product in many regions across the country.
We also maintain our focus on smart value. Given the success of our Crazy Thursday promotion in the second half of last year, we are continuing to utilize this as our signature promotion. With an integrated approach to campaign planning and execution, this promotion succeed in driving strong incremental sales and profit. In digital, we continue to focus on enhancing customer engagement by further integrating online platforms with offline stores. Our members grew to over 175,000,000 by the end of the quarter, up 50,000,000 year over year and up 50,000,000 since the end of 2018.
Members accounted for 49% of our sales already, up 11 percentage points on Q1 2018. As we showed in our Investor Day presentation, our digital membership is driving significant increase in average spending per active user. Digital payments accounts for about 87% of KFC sales in the 1st quarter, 13 percentage points up on Q1 2018. In March, we also partnered with UnionPay to launch YumxiPay, which creates another convenient payment option for our customers. We ran a successful promotion, which generated strong social media buzz, ad downloads and most importantly sales and member uptick.
Digital orders accounted for 55% of sales during the Q1. One of our exciting new developments during the quarter was the national rollout of our AI enabled personalized menus and recommendations for all mobile play orders. We saw a meaningful acceptance of trade up recommendation. We will continue to refine this too and I believe it represents a huge opportunity to improve customer experience and satisfaction, while also improving ticket average. We continue to offer our privilege subscription programs to build loyalty, consumer frequency and average spend.
We sold over 1,000,000 privilege program subscriptions in the Q1 of 2019. One of our popular options is our super privilege, which combines delivery, breakfast and coffee privilege programs. This generates significant cross selling opportunities. Delivery similarly remains a key sales growth driver that caters to the evolving dining habits of Chinese consumers. We have begun rolling out our improved dispatch system, which we call Delivery 3.0.
We expect the improved efficiencies and delivery quality enabled by ongoing enhancements to our delivery capabilities will support the ongoing growth of this key sales driver. In the Q1, delivery represented 18% of sales, up 4 percentage points year over year. As a result of our digital initiative, the sales growth of delivery orders through own channels continue to exceed growth rate by aggregators. KFC's commitment to a smart value, continuous innovation in manual and daypart and leadership in digital and delivery have created a sensible profitable growth. We will pursue an aggressive store opening program for the remainder of 2019.
Looking ahead, we remain very excited about KFC's long runway for growth in China. Next, I'll provide some color on Pizza Hut's performance. As we shared in our Investor Day, we are continuing to implement the Pizza Hut revitalization program in 2019 we will focus on rolling out transformative initiatives at scale. We are pleased to see positive same store sales and strong traffic during the quarter, as well as a notable improvement in operating profit. I will provide some more detail on Pizza Hut's performance in each of the 4 pillars that we have mentioned many times in the past and they are fixing the fundamentals, driving digital, optimizing delivery and enhancing asset portfolio.
First, let's look at the fundamentals. A key component of our revitalization program is to improve our food taste and value for money perception. We launched our updated and streamlined new permanent menu in March. We have been systematically launching new limited time offers or LTO to trial new and improved menu options and adding the most popular items to the permanent menu. Products such as Australian Beef Pizza, steak platter and volcano cake in Chinese we call it were notable additions.
We enhanced key categories such as appetizers, pasta and drinks. Our key Chinese New Year special was the enormous thin crust 4 in 1 pizza, to cater to holiday sharing occasions. This generated excellent buzz on social media. We also offered customers great value for money with combo meals targeted at small and large groups. We are very focused on improving our value for money perception, introducing new value items and implementing a series of value based promotions.
Following the pilot in December last year, we launched our signature value promotion Screen Wednesday or Tianjiao Xinqishan nationally in January. Selected items were over at RMB19.29 or RMB39 every Wednesday. We have seen positive results with the campaign generating excitement and driving new customers and incremental sales. We will continue building the Screen Wednesday platform in 2019 introducing new products with disruptive value. Our consumer feedback scores for both value for money and most preferred Western casual dining restaurant continued to improve during the quarter.
We are also making progress with a number of efficiency initiatives enabled by disruptive technology, our large digital membership and our scale. During the quarter, we significantly improved labor productivity and lowered our cost of sales, while maintaining and improving our service and support team. This led to an improvement in margin, which Jacky will elaborate on further in a moment. Next, let's look at digital. Pizza Hut continues to make rapid progress by implementing learning from KFC, which is a digital pioneer in the restaurant industry in China.
We launched our digital membership nationally only back to 2017 for Pizza Hut. And by the end of Q1 this year, we have over 55,000,000 members, up 15,000,000 year over year and 5,000,000 since the end of 2018. Our family privilege program launched late last year has proved very popular as well with over 1,000,000 members. We have observed a meaningful increase in frequency and sales from members. We plan to build on this success in the rest of the year with new co branding partnership and new offers.
Pizza Hut also ran promotions in conjunction with Union Pay to promote the Yum!C! Pay as well. This campaign was also very successful in driving new member acquisition, new app downloads as well as sales in both dining and delivery. Turning to delivery. We continue to see double digit growth and it accounts for 24% of Pizza Hut sales already, up 2 percentage points year over year.
Growth in delivery orders through our own channels significantly outpaced growth via applicators. During the quarter, we completed the installation of dedicated delivery area in about 75% of our dining restaurants. These areas help to provide faster service to our delivery customers without disrupting our dining customers. As we previously highlighted in a 4th quarter earnings call, we have taken back control of last mile delivery with all of our orders now being fulfilled by our own team of dedicated riders. Pizza Hut has also begun rolling out our latest delivery dispatch system, delivery 3.0.
Combined, these two initiatives are driving significant improvement in KPIs such as on time delivery, complaint rate and customer satisfaction. Lastly, we continue to enhance our asset portfolio through accelerated remodels and multiple store formats. To provide a more comfortable and stylish dining environment, we target to do 500 remodels in 2019 and to complete the refresh of our entire portfolio by 2021. We refurbished 28 stores in the Q1 and will accelerate the pace in the rest of the year. We have further optimized the cost of refurbishment and we are seeing a positive response from customers with the post refurbishment sales uplift.
We built 34 new stores in the Q1 of 2019 compared to 41 in the same period of 2018. Together, these revitalization initiatives are having a positive impact on the brand in the short term and long term. It's encouraging to see the same store sales growth in the Q1, yet more work needs to be done to sustain a positive trend given the scale of the business and the competitive environment. Lastly, turning to our new standalone coffee concept, Coffee and Joy. The concept at 5 stores in 4 new cities in the Q1, taking us to 18 stores and doubling the number of cities we are in.
We also entered into an agreement with WeWork, one of the leading co working office space providers in China to provide coffee in 15 offices in Shanghai and Beijing. As we outlined in our Investor Day, the coffee market is a large and attractive segment in China and we will leverage our swings in our supply chain, new store development and digital capabilities to capture these new opportunities. We are continuing to test different formats and remain excited about the potential of this category. With that, I'll hand over the call to our CFO, Jackie, who will cover our financial performance in more detail.
Thank you, Joey. Good day, everyone, and thank you for joining us. Let me quickly go over our Q1 2019 financial results. Total revenues reached RMB2.3 billion in the quarter, up 10% year over year excluding foreign exchange translation. Total system sales grew 9% year over year ex FX, primarily due to strong same store sales growth and accelerated new store openings at KFC, as well as improving sales at Pizza Hut.
We opened 2 37 new stores during the quarter, an average of well over 2 stores per day and the majority were KFC stores. Our portfolio is now 8,653 restaurants as of the end of March 2019. Looking at our current pipeline, we are confident that our gross new openings will exceed the top end of our original target of 600 to 650 and we'll provide additional detail as we get greater visibility on our second half pipeline. During the quarter, KFC year over year system sales grew 11%, while Pizza Hut system sales increased 3%, both excluding foreign exchange translation. Yum China same store sales increased 4%, with KFC same store sales grew 5%, despite lapping 3 consecutive years of positive same store sales growth.
And Pizza Hut achieved same store sales growth of 1%, the first time since 2017 and a significant improvement compared to 2018. During the quarter, KFC traffic increased 3% year over year, while ticket average increased 2% year over year due to pricing offset by increased promotions. Pizza Hut traffic increased 8% year over year and was positive for both dining and delivery businesses as a result of successful value promotions and digital initiatives. Ticket average decreased 7% year over year as a result of our focus on driving value perception and the growing share of delivery. KFC restaurant margin was under pressure at 20% versus 20.9% in the Q1 of 2018.
Positive sales leverage and labor positivity improvement partially offset commodity inflation, including the previously flat pressure from higher poultry prices, as well as wage inflation and value promotions. Pizza Hut restaurant margin improved to 14.3% in the first quarter, up 3.8 percentage points year over year. Significant efforts to improve labor efficiency and reduce restaurant operating costs in areas such as utilities more than offset the impact of value promotions and wage inflation. Overall, Yum China restaurant margin was 18.5%, up 0.6 percentage points compared to the 17.9% reported during the same period last year. Wage inflation was up 6%, while commodity inflation was up 3% compared to the same period last year, with poultry inflation being the major driver of commodity inflation.
While we are actively working to manage the significant poultry price increase, we expect the impact will remain over the rest of 2019. G and A expense was up 5% year over year ex FX, or 3% when excluding one off benefits in both periods. Our long term goal remains to maintain a G and A expense growth rate lower than the revenue growth rate. As a result of implementing the new lease accounting standard ASC 842 effective January 1, 2019, we conduct an additional impairment review in the Q1, resulting in an impairment charge of 12,000,000. Dollars Operating profit for the Q1 of 2019 decreased 23% year over year or 66,000,000 dollars When excluding the gain of 98,000,000 from the remeasurement of our previously held equity interest at Wuxi KFC in the Q1 of 2018 and the negative impact of foreign exchange translation due to the depreciation of renminbi against the U.
S. Dollar. Adjusted operating profit increased 9% year over year. For the Q1 of 2019, KFC operating profit increased 3% year over year and Pizza Hut operating profit improved 57%, both ex FX. Based on the release of final regulations related to the transition tax under the U.
S. Tax Cuts and Jobs Act, we record a tax charge of $8,000,000 in the quarter. Our effective tax rate during the Q1 when excluding this transition tax charge would be 26.5%. Our best estimate of the effective tax rate in 2019 continues to be below 28%. Finally, diluted EPS was $0.57 in the Q1 of 2019, compared to $0.72 in the same period last year.
Adjusted diluted EPS was $0.59 compared to $0.53 in the same period last year. The current quarter adjusted diluted EPS includes a mark to market gain of $0.02 per share from our equity investment in Meituan. Next, let me cover our capital allocation strategy. In the Q1 of 2019, we generate net cash from operations of $344,000,000 and free cash flow of $234,000,000 after subtracting $110,000,000 in capital expenditures. Our balance sheet remains strong with over $1,500,000,000 in cash and short term investments.
With our healthy cash position, we returned $111,000,000 to our shareholders in the Q1, including a cash dividend of $46,000,000 and share repurchases of $65,000,000 There's approximately $900,000,000 remaining under the share repurchase authorization as of the end of March 2019. Based on our current quarterly dividend and existing share repurchase authorization, we have the capacity to return at least $1,500,000,000 to shareholders over the next 3 years, reflecting our confidence in our business model our ability to generate cash. Given our attractive growth opportunities and continued strong returns from newbuilds, Our first priority will continue to be reinvesting in the core business with CapEx for the full year expected to be in the range of $450,000,000 to 500,000,000 dollars Looking forward, we remain very excited about the long term opportunities in the China market. We will drive same store sales growth and leverage our leading development capabilities to expand our store network. However, please note that KFC's exceptional same store sales performance in the Q1 was primarily due to very strong execution during the Chinese New Year period, and it may be difficult to replicate that level of growth through the remainder of the year.
As I previously discussed, pressure on margins from higher poultry prices is expected to remain over the rest of the year. Of course, we'll look to mitigate this impact as much as possible by leveraging technology, our scale and our efficiency initiatives. At Pizza Hut, we are very encouraged by the progress of our brand revitalization program, but do note that there may be quarterly fluctuations as we continue to roll out the initiatives at scale and the revitalization takes hold. In the Q1, better matching of labor to demand during the Chinese New Year period led to an improvement in restaurant margin that may not be repeated in subsequent quarters. In addition, the aggressive program of 500 remodels during the year will put pressure on sales and operating profit in the short term.
But this is an important component of the long term revitalization of the brand. With that, let me turn it back to Joey briefly before we open up the call to questions.
Thank you, Jacky. To sum up, 2019 got off to a good start with strong execution during our critical Chinese New Year sales period. I want to take this opportunity to thank our operations team who are at the frontline of our business as well as all the supporting functions for their hard work. KFC continues to perform strongly. It's a very resilient and defensively profitable business model and is well positioned to manage market uncertainties.
We see a long runway for growth for KFC as we continue to add new units across the country and drive same store sales growth through daypart expansion and delivery. We are seeing multiple positive signals in our revitalization of Pizza Hut with positive same store sales significantly improved traffic and improved profitability as well as other trends in customer feedback. We know there's more work to do, but we remain confident in the revitalization plan for Pizza
Hut. At our Investor Day in
March, we outlined our commitment to our vision of becoming the world's most innovative restaurant company and demonstrated the powerful impact that innovation has on driving growth. By adapting to our customers' needs and utilizing new technologies, Yum China is focused on relentlessly driving defensible, profitable growth. For those of you who were not able to join us back to March, I encourage you to review the presentation and webcast available on our webcast. With that, I'll pass you back to Florence to start the Q and A. Thank you.
Thanks, Joey. We will now open the call for questions. In order to give as many people as possible the chance to ask questions, please limit your questions to one at a time. Rachel, please start the Q and A.
Your first question comes from the line of Sara Senatore from Bernstein. Please ask your question.
Thank you. I just wanted to follow-up on a comment you said on demand environment. We've heard from another Western QSR saying that it also has seen intensified competition around value, but that it's also seen a stabilization or improvement in its own trends. So I'm just trying to reconcile what I think we're hearing about the environment with a couple of data points that say that companies themselves are doing better. So are you seeing you're seeing something where sales players are taking a lot of share from smaller independents?
Is it local concepts that are losing some of that traffic? And is the distinction is it a better value proposition that you're offering? Is it the digital piece? Just trying to understand how it is that the environment is getting more competitive, but your businesses are improving?
Thank you, Sarah. It's very difficult to comment on the environment, but the good news is we definitely have seen KFC continue to be a very resilient business model in a range of demand environment. From competitor side or in a market we or from the customer demand, we certainly see the customer demand for good value product, but that's not enough. In what we have learned in the last few decades, it's a combination of fantastic products and great value. So it's a combination that gives great value for money for the customers.
And then at the store, it's the execution, it's the day to day operation. So for us, we just continue to focus on what we are good at and what we see customer want is great product, great value, really good operation, exciting marketing campaign. And then of course, supported by the digital innovation, which comes in both marketing and operation. So it's a combination of the key value proposition that customer want. It's very hard to sort of single out one particular reason really.
So I hope that gives you a feel of the competition that we are in and what do we do to please our customers really. Thanks.
Your next question comes from the line of Michelle Chung from Goldman Sachs. Please ask your question.
Hi, management. Congrats for the good results. My question is about the cost inflation especially for KFC. We noticed that in the Q1 the food cost increased significantly and as you have been mentioned that Japan price will continue to be the pressure, but also understanding from 3rd quarter last year, we launched this Crazy Thursday event. So, is it possible to help us separate the impact between these value for money promotion versus the Japan price impact?
And also I think earlier we guided full year low single digit commodity inflation. Are we still maintaining these expectations? Thank you.
I think, Jacky, you want
to? Yes. Well, Michelle, maybe I'll just give you some additional colors in terms of the KFC restaurant margin in this quarter. I can go through line by line. So overall, if you look at KFC restaurant margin, it was down about 1 percentage point year over year.
So we mentioned both on the Q4 earnings call as well as the Investor Day, poultry inflation will put some pressure on the restaurant margin. So initially, we said at least in the first half of twenty nineteen, but right now based on the current trend, we expect it will be continued for the remainder of the year. But overall, obviously, KFC has self leverage from the 5% same store sales growth in Q1, but that was offset by inflation and promotions, for example, like Crazy First Day. So let me give some additional colors line by line. So first on food and paper costs.
Since the crazy first day promotion was so well received by customers, we continue the promotional activities in Q1. So that actually put some pressure on the margin on the food cost. But commodity inflation was also mid single digit this quarter due to the increased poultry prices, which is higher than the typical low single digit we saw in prior quarters. And on labor costs, so there was obviously labor inflation. It was high single digit and we have worked very diligently on the labor productivity and also install efficiency to offset that impact.
And so, looking forward, in terms of chicken price, the market price were up about 30% year over year, but for KFC, we managed to keep the price increase at low double digit in Q1. So with our long term relationship with our suppliers, we were able to negotiate lower than market price increase during times of very high poultry inflation. And we also benefit a bit from a lag effect due to the inventories from the chicken we procure in the Q4 of 2018. So as I just mentioned, the commodity inflation was about 5% this quarter, which is higher than normal. And so we expect this to continue for the rest of the year.
But keep in mind, poultry is only one of many commodities in KFC and we'll continue to optimize our product mix and look for alternative cuts of chicken or alternative protein. So and look, I mean, we face inflation every year and price volatility is nothing new to us. So we have managed it very well for the last 30 plus years. But in terms of your question on inflation, so in this quarter, wage inflation was about 6%. So high single digit for KFC and low single digit for Pizza Hut mid single digit for Pizza Hut and commodity was 3%.
So as I just mentioned, it was 5% for KFC and a slight deflation for Pizza Hut. Looking forward, we maintain the guidance that we provided. So for the full year, we still expect low single digit commodity inflation and high single digit labor inflation.
Thank you, Jacky. Michelle maybe provide a little bit color on this one. So for our Crazy Thursday promotion, since last year, we have been able to find products with very good cost economics. Therefore, we are able to maintain the margin despite the challenges of poultry price increase. And as Jacky mentioned, we will continue to find some alternative products to promote during the Crazy Thursday.
And of course, at Crazy Thursday, the sales leverage helps the margin as well. So net net, it worked out and we'll continue to manage that for the rest of the year. Thank you, Michelle.
Thank you very much.
Your next question comes from the line of Brian Bittner from Oppenheimer. Please ask
This is Mike Tamas on for Brian. Just wanted to talk about the Pizza Hut margins a little more. You had great margins in the Q1. So I'm just wondering how much of that can actually continue throughout the year or were there some very specific things that are siloed to the Q1 that aren't going to repeat for the rest of the year? Thanks.
Sure, Mike. So if you look at Pizza Hut restaurant margin, it was up almost 4 percentage point year over year. So again, let me go through line by line. So in terms of food and paper costs, our investment in promotional activities and value campaign such as Scream Wednesday has been a very critical component of our strategy to drive traffic and offer value for money to customers. So with the step up in value promotion in this quarter, so we are very pleased to see that Pizza Hut restored positive same store sales growth and continue to see significant traffic growth.
But albeit that put some pressure on our restaurant margin for the short term. And the sales leverage and commodity deflation have to offset the impact of the value promotion. So on labor costs, labor inflation was mid single digit year over year and we have significant improvement in labor productivity during the quarter. But some of this is ongoing. A significant portion is related to better matching of labor and sales during the critical Chinese New Year period, which I talked about earlier during the prepared remarks.
So on occupancy and other costs, there are a few components in this line item, but the improvement mainly came from a combination of savings in utility from lower utility price and efficiency management and also less depreciating expense from all the stores impairment we hoped in prior years. So in addition, I want to point out one point. Before we took back control of the last mile delivery in the later part of 2018, the rider costs were amounts we paid to aggregators and they were recorded under occupancy and other costs, for example, in Q1 last year. But with the delivery being handled by our own dedicated riders now, the rider costs have been included under cost of labor, for example, in this quarter. Looking forward and for the remainder of the year, overall at a high level, we'll just continue to drive labor productivity and improve install efficiency, reduce restaurant operating costs and manage and tighten cost of sales to offset all the value promotions that we'll take and also wage inflation.
However, due to the one off items I just talked about, for example, the labor positivity. So keep in mind, we have a very low base last year. We talked about that extensively on Q1 last year's earnings call. So the year over year improvement is expected to taper off. And also the utility savings that we talked about, we expect that impact to reduce in the second half of the year.
So also we are adjusting the business model and is we have a very clear and deliberate strategy in the short term to drive traffic through investment in promotions. So I just want to reiterate at this point, our strategy is to restore traffic and sales followed by profit. But in the longer term, as the revitalization takes hold, we are very confident in restoring the margin back to the revitalization levels.
Thank you, Mike.
Your next question comes from the line of Chen Luo from Bank of America Merrill Lynch. Please ask your question.
Thank you and congratulations on the solid Q1 results. Just now, we commented that KFC's very strong same store sales growth in Q1 could not be an indicator for the full year same store sales growth. But in fact, heading to the coming two quarters, we're actually facing a very easy lap. So what actually makes us give a pretty cautious guidance of same store sales growth for the rest of the year? Is there anything that we have seen, I.
E. Communication or other factors that actually makes us a bit cautious. And also related to that question, given the rising pressure of the chicken cost, are we actually going to reduce the promotional intensity, especially in view of the easy lap to keep up better bandwidth between same store sales growth and margins for KFC? Thank you.
Thank you, Luo Chen. For the lapping for management, there's no such thing called easy lap to be honest. If we look at the 3 year CAGR, Q1 for KFC, the last 3 year was 5% and Q2 actually for 3 years CAGR actually was 4%. And then if we look at last year number, last year we had very exceptional Q1 and then Q2 was relatively flat as well. So we are quite cautious over 3 years' time, the lapping is still not so easy, it's still a challenge.
So we just sort of have a bit of caution about the simple extrapolation of the trend for Q1. The business particularly for KFC, the momentum is good. The business is doing well and it has proven to be very resilient. But we must always be prepared to respond to unexpected conditions rapidly. Of course, our business is structured and agile to do it, but we still have to be cautious.
Regarding your question about less promotion, given the high poultry price, as Jackie mentioned earlier, as I mentioned earlier, the way that we support the Crazy Thursday basically, there are 2 ways to support it. 1 is, we look for products that have very real cost economics. So that is a win win win situation. It's a win situation for us. It's a win situation for our supplier.
It's a win situation for customers. Alternatively, we will look for some sort of ingredient that probably has not been used before like Jianggu Jin, which we tried in the last quarter. So we are looking for sort of exciting product with good cost economics that please the customers. Driving traffic is very important. And as I mentioned at the very beginning of your first question, responding to Sarah, smart value is still very important to our customer as we have seen from last year and the Q1 this year.
So we'll manage the balance of the sales and margin, but I just want to emphasize smart value with exciting products still incredibly important to our customers. Thank you, Lawson.
Thank you, Joey.
Your next question comes from the line of Xiaopo Wei from Citigroup. Please ask your question.
Joey, J. K. Good morning. Congratulations on strong result. My question is focused on the restaurant margin.
If we look at the restaurant margin of both KFC and Pizza Hut, we are seeing that the occupancy and other operating expenses to sales ratio was down year on year in each of the division. My understanding is the benefit from the strong delivery and also your better efficiency may be some smaller size of new store which opened last year. So I'm seeing this component were offsetting the net impact of the higher poultry cost pressure looking forward. Shall we see this kind of trend will continue in the next few quarters, mitigating the impact of the commodity cost and also accelerate openings in the rest of the year? Thank you.
Yes, Xiaobo. So first of all, let me just give some additional colors on the occupancy and other costs. So this line item actually include a few components. So advertising and marketing expenses, utility expenses, rental expense, depreciation expense, the license fee we paid to Yum! Brands and all the other miscellaneous restaurant related costs.
So the improvement in this particular quarter was mainly due to obviously sales leverage. And also I talked about earlier the utility savings from lower utility price and efficiency management, which we started last year. And also there's less depreciation expense after the stores impairment we talked in prior years. And also for KFC, there was savings in advertising and marketing expenses because we are shifting from the traditional mass media to digital and targeted marketing. And I touched on this briefly earlier, also for Pizza Hut, you see a significant improvement is because we took back the last mile of the delivery.
So that was a classification difference quarter to quarter. So in last year's Q1, all these delivery riders costs were in occupancy and other costs, but in this quarter, it's in cost of labor. And looking forward, we expect some savings in occupancy and other costs in the first half of twenty nineteen, but it will gradually reduce due to the lapping year over year. And in terms of poultry, initially, we expect the inflation to be high in the first half and then it will gradually tail off in the second half. But right now, looking at the current trend, we expect maybe there will be some continuous pressure for the rest of the year.
So but occupancy and others, I already talked about is going to the impact will take off. So it may not necessarily like offset each other.
But Xiaopu, I think I sense your sort of your assumption behind the question is whether the smaller store have some correlation with all the savings. I think generally, have that assumption because for the new stores that we are opening in both KFC and Pizza Hut, we certainly go into a direction of smaller, faster and more delivery friendly stores. As you can imagine, with smaller stores or faster store basically smaller store and we management has done a lot to reduce the investment per store. So the combined effect is lower depreciation, lower rent, lower utility just because we are more strategic about the type of the new stores that we are opening. So I think if my sense of your assumption behind your question, I would say yes, generally there's such correlation.
I hope we answered your question or my second question of your question.
Yes. So, Julie, I just want to clarify. So why I ask the question is because last year, we have accelerated opening. And Jackie also mentioned in the presentation that we will accelerate opening this year as well. If we look at the Q4 result for the margin, actually we didn't see a lot of impact on the restaurant margin due to new opening as we've seen other global retailers in the same scenario.
That's why we ask the question.
Yes, Xiaobo, I mean maybe I can answer this and then Joey can elaborate as well. So I mean, yes, I mean, we talk about continue to accelerate new builds for KFC. So the main reason is to capture market share. So that helps to drive the strong system sales and operating profit you see in the this quarter, the significant growth. But all these new units, especially in China because of our 1st mover advantage, but also they will be dilutive due to the time it takes to nurture these stores and until maturity.
So there will be some short term pressure on the restaurant margin for sure from all this from this accelerated new unit development strategy. And also for Pizza Hut, I mean, I want to also talk about the remodel. Because we talked about we're going to aggressively remodel about 500 stores this year. And in the Q1, we only remodeled about 28 stores. So there's still over 470 plus stores that we have not remodeled.
So right now, we are looking at maybe way towards Q2 and Q4. We'll actually ramp up the remodel because Q3 is the summer rush period. So we want to maybe scale towards Q2 and Q4. So obviously, over the years, we have improved the speed and the cost of the remodel, but nonetheless, it's going to put some pressure on sales and operating profit. So because there will be lost sales for
a period of time. During the time we closed the store for remodeling.
So yes, also overall, the Asurion new builds, the Asurion remodels, all these initiatives will put pressure on the margin.
In the short term.
In the short term, right. Yes.
Thank you, Xiaopo.
Thank you.
Your next question comes from the line of Lillian Luo from Morgan Stanley. Please ask your question. Hey, thanks management because most of the questions were answered. So I have a bit follow-up on coffee because I think Joey, since March, the corporate day, I think the company formally put coffee as one pillar for growth in the long term. So I know that you share a little bit more information about the progress, but could you give us a little bit more idea of in terms of cups of coffee sold year to date compared to last year?
And also you start to do office delivery type of coffee. Is this under Coffee and Joy or it's under Keep Coffee or actually we are doing both? Thank you.
Lillian, hi, good morning. For the Q1, the cups sold, the index was 1.26%. So that's very nice for KFC. This is for KFC. And then for Kopi and Joy, we have not started kind of that way yet because it's still early days.
We look at how many stores we opened. We have opened 5 more stores for Q1. So right now, we are at
18 stores altogether.
So for delivery, we have been doing delivery for Coffee and Joy and K Coffee, but mainly K Coffee really. So Lillian, just for your question about delivery, just want to make sure I answer your question. Are you more curious on the C and J part or the K Coffee? I think both.
Okay.
K Coffee, we've been building K Coffee since 2015 and we are very pleased to see the scale of the business and the growth rate. And the proposition is mainly Ibeihau Cafe is a cup of good coffee with good price. So we'll continue to drive it in KFC. We'll strengthen the branding bit because we can see the potential in it. And delivery has been part of the business because we deliver K Coffee together with breakfast and other food.
And for C and J, the coffee delivery business is still early days really. We have figured out the business model as we speak. So it's a bit early, but we do some kind of we do delivery. We also mentioned in my presentation earlier that we work with WeWork. So the coffee in WeWork is not delivery.
We actually have our lovely coffee machine with the beans that produce coffee in the Weaver offices in Shanghai and then later on would be Beijing. So as you can see, because C and J is such a new concept in terms of business in terms of store model, business model, delivery model or even B2B model, we still exploring and we'll report that when we have more concrete conclusion and then we'll roll it out if we are convinced that. I mean, I hope I answered your question on that. But for further more detailed question, our IR team can follow-up with you afterwards. Okay.
Thanks a lot. We'll ask about pizza.
Your next question comes from the line of Anne Lane from Deutsche Bank. Please ask your question. Hi, management team. Just want to check-in the call and also during the Investor Day, you mentioned a couple of times regarding the use of alternative protein. Is that a new category that you're going to come out?
Or would you elaborate a little bit more on what is that that will help ease some of these chicken price increase? Thank you.
Sure. Well, in the Investor Day, we mentioned about, let's say, which is a part of a chicken that we somehow have not used in the last 30 some years, which is always amusing to ourselves. So that is the piece taken between the chicken wing and the chicken breast. So we will continue to explore with the introduction of new technology can we find another way to cut our chicken and introduce very good cost economic product to our customer. But I'll give you another example.
For example, shrimp and crayfish. Traditionally, these are pretty expensive protein. But if the chicken price right now, suddenly, they look fine and the economics work out again. I'll give you another example. It's coming soon, so I'm happy to do the advertisement here.
We're going to possibly have some duck in our product probably the wraps. So other than our famous chicken wraps, we are going to introduce the duck wrap. It just seems logical with the flavor that we already establish and explore with customer. So these are some of the examples that we can share at this point. And then we, of course, continue to search for other alternative protein alternatives such as seafood or that etcetera to make our customers happy.
I hope that makes sense.
Okay. Yes, definitely. And on Pizza Hut, on the same store sales trend, now that we have a positive for this quarter, do you think that we should be seeing a continuous improvement that we're more stabilized that Singeulous Health is more sustainable or like we might see some volatility throughout the quarter?
Thank you for entertaining me by asking me a question about Pizza Hut. About Pizza Hut. Of course, we are quite happy to see the positive sales term finally happen. It's a very clear sign of a good momentum of the business turnaround. What I want to comment is when we embark on the revitalization journey back to May 2017, we have focused on 4 areas, which we are all familiar with right now.
And 4 areas that we work on, they are all what I will call short term painful, but long term beneficial to our business. So back to 2017, one of the 4 pillars is the delivery. It's really delivering very good same store sales that lift the entire business. By 2018, the improvement in the delivery is no longer enough to support the decline in dining. But we continue to focus on the other three pillars such as digital, such as asset and the fundamentals, such as menu.
And all four areas in terms of the painful changes have bear fruit. What I want to say is the 2018 2019 Q1, the momentum is an aggregate result of some fundamental changes in all four areas. Delivery wise, it's not only just promotion. We integrate, we took back the last mile delivery and we integrated pizza home service and pizza dining and we went all the effort to put dedicated delivery areas in 75% of our dining assets. So these are all very, very big and fundamental change.
And then fundamentals such as in the menu, the menu originally we have 120 items on the menu. For the new menu we introduced March 2018, there were only there are only 77 items. And among the 77 items, only about a quarter of them are from the previous menu. The rest of the product on the 77 item is a new product that we launched over the last 2 years through LTO and proven to be good product
or upgrade
products. So again, huge effort to reduce the menu and to upgrade and to improve the 3 quarters of the menu. And then we come to the digital side. We start the super app. We launched the membership program.
Now we are at 55,000,000 and then we launched a privilege program, significantly improved the digital capability of Pizza Hut. And last fundamentally, the assets, we look at alternative design and we start to modernize the store and then we have many innovations in our store business model store models as well. So all these are fundamental changes. I mean we for your question about whether the positive change can sustain or not, it's very hard to predict the market uncertainties. What we can control is the fundamental aspect of the business that we can change.
And I would like to believe that we have such fundamental change of the business will help in the short term and long term. But our business the seasonality is better in our business. So the quarterly fluctuation might happen. But in the long term, we are confident in our business for Pizza Hut. Thank you, Anne.
Thank you.
One last question. Your last question comes from the line of Kristen Peng from UBS. Please ask your question.
Hi, management. Congratulate on a great result. I have two questions regarding the store opening strategies of KFC and Pizza Hut. Regarding TSB, so Joey, in your earlier presentation, you mentioned about the gas station plan with one of the oil companies in China. So can you elaborate the details in terms of the number of stores, in terms of the store revenue contribution profitability, etcetera?
And what's different between these stores and the traditional stores KFC has? I think that's the first question I have. The second question is regarding Pizza Hut. So basically, Q1 is very strong quarter. I think you also it's better than management previous guidance.
So given this situation, we do consider opening more Pizza Hut stores going forward? And I think you mentioned about hub and spoke model on United Way. So what is the new thought behind it? Thank you, management.
Thank you, Christine. For the strategic partnership,
there's a little bit of update since our last meeting at the Investor Day. As you recall, we have entered into exclusive rights in franchisee business with CMPC, but we also get the right offers refusal for both Sinopet and CMPC for about 20 years. And we also share about our prudent approach that we want to figure out the business model first before we become specific of the economics and the details. And right now, the update is we are testing 1 store and then we are identifying more suitable locations. So the aim is to open 100 stores in the next 3 years.
So I understand this is a modest goal given the fact that both great companies have 50,000 gas stations all over China. But we believe once we take out the gas station, we do have the credibility and ability to scale up really quickly. What's the difference between old and new? The first difference I can imagine is it will be it's likely to be slightly smaller than our sort of normal store. But at the same time, within our store business model, we have 8 or 9 business model and we do have the small store model already.
So the size wise, it probably will be sort of smaller and then it will be sort of more very focused on the convenience as you can imagine, speak is important in this kind of location. For the detail specific, we are testing it right now. For the Pizza Hut, you're right to point it out that the store opening plan or number is related to business performance. As you can see historically in KFC's number, we opened 191 stores this quarter. We opened 144 store last year Q1 and we opened 85 store Q1 the year before, if I remember my numbers correctly.
So you can see as the business improve, we do ramp up the new store opening. So Pizza Hut for this year we have modest target for the new store opening, but if the business improve, obviously according to our own internal new store opening target and more pipeline can pass the requirement than might have more stores would be more store might be open. But I mean, Jackie had mentioned in various occasions, usually we will have more visibility of the new store opening number after Q2 during the second half of the year. For your question about how we spoke, we are excited about innovations in store models. That's important part of the business.
So this is one of our innovations this year. And so far, I can report that we have about 15 hub and spoke stores open already. But all of these stores are open have only been open for less than 3 months. So there's still a lot to learn and a lot to tweak. But the initial observation is positive.
As you can imagine, the smaller store, lower investment, give us more flexibility to open stores in different trade zone and that flexibility is always good for business with our scale. So I think that's what I can report for the time being. So by next early release when we have more visibility hopefully we can share more. Thank you so much, Christine.
Thank you everyone. Thank you, Christine. Thank you, everyone. Thank you for joining the call today. We look forward to speaking with you on the next earnings call.
That concludes today's call. Have a great day. Thanks, Rachel. Thank you, Yunga. Thank you all.
Ladies and gentlemen, that concludes our call for today. Thank you for your participation. You may now disconnect.