Thank you for standing by, and welcome to the Yum China Q3 2022 Earnings Conference Call. All participants are in a listen-only mode. There will be a presentation followed by a question and answer session. If you wish to ask a question, you will need to press the star key followed by the number one on your telephone keypad. I would now like to hand the conference over to Ms. Michelle Shen, Director of Investor Relations. Please go ahead.
Thank you, Ashley. Hello, everyone. Thank you for joining Yum China's Q3 2022 Earnings Conference Call. On today's call are our CEO, Ms. Joey Wat, and our CFO, Mr. Andy Yeung. We are dialing in from different locations today. If we experience any technical difficulties during the call, please remain on the line as we reconnect. Before we get started, I'd like to remind you that our earnings call and investor materials contain forward-looking statements, which are subject to future events and uncertainties. Our actual results may differ materially from these forward-looking statements. All forward-looking statements should be considered in conjunction with the cautionary statement in our earnings release and the risk factors included in our filings with SEC. This call also includes certain non-GAAP financial measures. You should carefully consider the comparable GAAP measures. Reconciliation of non-GAAP and GAAP measures is included in our earnings release.
Today's call includes three sections. Joey Wat will provide an update regarding our performance in the Q3 . Andy Yeung will then cover the financial performance and outlook in greater detail. Finally, we'll open the call to questions. You can find a webcast of this call in the PowerPoint presentation, which contains operational and financial information for the quarter on our IR website. Also on the site, you can find a video we prepared that showcases our latest stores, offers, and activities. Now, I would like to turn the call over to Ms. Joey Wat, CEO of Yum China. Joey?
Thank you, Michelle. Hello, everyone, and thank you for joining us today. We achieved outstanding performance in the Q3 with fantastic growth, both top line and bottom line. This demonstrate our ability to operate in an uncertain environment by learning, adapting, and strengthening business fundamentals. During tougher times, our resilient business model and agility help us manage the negative impact. As COVID conditions were relatively calmer in July and August, we captured sales opportunities during the peak summer season. System sales recovered with 5% year-over-year growth. Operating profit surged 77% year-over-year to $360 million, even higher than 2019 level. Great teamwork make this possible. Key elements in our winning formula include our in-house and tailor-made supply chain, industry-leading digital and delivery capabilities, cost restructuring, and solid execution. Let's move to KFC and Pizza Hut.
We have been innovating new products to satisfy customer cravings. In the past two years, we have established strong presence in new categories such as beef burger, whole chicken, and durian pizza. This was enabled by our powerful supply chain by securing supply at scale, streamlining production, and optimizing costs. Let me share our success stories. At KFC, our extra juicy beef burgers rapidly capture meaningful market share. Since adding them to the permanent menu in May 2021, we have sold over 100 million burgers. That's about five beef burgers every second. For the full year, we expect to generate close to CNY 2 billion in sales from beef burgers. We cater to Chinese tastes by making the patty super juicy using our specialty ovens. Customers love our burgers for their great taste and value for money.
We source our Wagyu beef, Longjiang Heniu, locally from northeastern China and have signed a multi-year contract to secure price and supply. Our juicy whole chicken has also quickly gained popularity since it's launched late last year. Year-to-date, we have sold over 18 million whole chickens. Whole Chicken is a versatile product, good for both dine-in and take-home consumption. We use a different breed of smaller chicken with better cost that is the perfect size for an individual meal and particularly juicy, and it's good for sharing on the dining table at home as well. At Pizza Hut, Durian Pizza has become a customer favorite. In fact, during Q3's promotion, every fourth pizza we sold was a Durian Pizza. Our limited time Durian Trio Pizza, [foreign language] with three types of durian, was especially popular with durian lovers. Customers are increasingly value-conscious, yet we do not compromise on quality.
Last quarter, we shared about KFC's wildly popular Crazy Thursday campaign [foreign language]. Since 2018, we have been offering delicious food, including the latest innovations at amazing value. The campaign continued to be a phenomenal event, generating a significant boost in sales every Thursday. Our customers create witty and playful social media content using the Crazy Thursday theme. Many of these postings has gone viral, creating huge hype for us. Now, to drive weekend traffic for families and kids, we have introduced a Sunday Buy More Save More campaign in July. Customers can get a bigger discount when they buy more, up to 50% off for eight items. This new promotion platform has built wonderful momentum with good value perception while protecting our ticket average. Apart from abundant value, we also launched a Golden Salty Egg Chicken Breast Burger[foreign language]. This is our first successful chicken breast burger.
We add an extra step in the preparation process to make the breast meat super juicy and tender. This entry-price burger widens our choices for customers and is a great product for lower-tier cities. We try to keep our brand appealing to youthful customers. In September, we transformed select Pizza Hut stores into social hubs for gamers. Partnering with the popular RPG game Genshin Impact, we decorate stores, outfitted restaurant crews, and offered exclusive gifts. The campaign generated extraordinary social buzz. In just three minutes, we sold over 300,000 themed combo meals. Our super app recorded its highest activity ever. I'm looking forward to more successful events with this partnership. Let's move to digital and delivery. We have been enhancing our delivery and digital ecosystem to make our business fundamentally stronger. Customers love convenience. Delivery sales are growing fast.
Empowered by our dedicated delivery riders and leading digital capabilities, delivery grew 19% year-over-year and reached 38% of sales mix in Q3 . Together with takeaway, off-premise sales were over 60%. Our ability to capture off-premise demand not only enable us to flexibly serve customers, but also cushion store closure impact due to COVID conditions. This 60% off-premise sales is so fundamental to our business model because it really protect our downside in both sales and profit despite the fluid situation. We have been maximizing delivery coverage and flexibility using AI technology. Most recently, we launched Smart Delivery to dynamically adjust delivery coverage for each store by depot, taking into account the operating hours of nearby stores. The upgrade system help us serve more customers more efficiently. Our digital capabilities serve as key touchpoints with customers.
In Q3 , we reached two milestones in our digital ecosystem. One, our loyalty program reached 400 million members. Two, cumulatively since 2018, KFC sold over 100 million privileged subscriptions. Our privileged subscriptions offer great value for money and have been an effective tool in driving frequency and spending. Our digital capabilities are also crucial to streamlining restaurant efficiency. Digital orders optimize in-store labor efficiency and account for more than 90% of sales in the quarter. Pizza Hut's tableside mobile ordering sales have grown exponentially from just 2% at its launch in 2018 to 45% in Q3 2022. This helps mitigate rising wage inflation and frees up crew members to enhance customer service. To improve digital experience, we introduced intelligent order sequencing at KFC in the Q3 . This system automatically arranges orders to shorten customer wait time.
Now let's move on to coffee, our third growth engine. Lavazza is making solid progress along its clear four-pillar strategy. The pillars include brand building, menu upgrades, expanded digital and delivery capabilities, and store development. Here's how we build these out. Branding. Lavazza has a century-long reputation for coffee expertise. We will continue to accentuate its brand positioning as the leading Italian coffee brand offering an authentic Italian experience. Menu upgrades. We are broadening food and drink offerings with more unique Italian products, including cover premium single origin beans and tigelle, which is a Italian flatbread with meat or egg stuffing, something like our Chinese. We also launched localized products such as coconut latte, buffalo milk latte, and even osmanthus latte. Osmanthus, Gui Hua, is a very lovely fragrant flower used in many Chinese desserts. These new products capture the latest coffee trends and have been well received by our customers.
Digital and delivery. We are building our membership program and digital fundamentals to improve customer experience and attract online traffic. Delivery reached almost 40% of sales mix in Q3 . Store development. Now with 78 stores, we have further refined our store models, paving the way for growth. We have made great progress so far, but work remains. Good things do take time. We want to grow this brand right, with every step at the right time. In close partnership with Lavazza Group, we are confident to build a successful Lavazza business in China. We decided to wind down our COFFii & JOY operation. From branding to site selection to operation and more, we learned a lot with COFFii & JOY. This invaluable learning experience will help us capture growing opportunities in the coffee market. Going forward, we will grow our coffee business with two distinct market positionings.
K COFFEE, focused on value and convenience, and Lavazza, focused on authentic Italian coffee. To summarize, our innovations and hard work in the pandemic years have made our business fundamentally stronger. We are confident in our team's ability to find opportunities in adversity and unlock further potential in China. We will continue to execute our RGM, which stands for Resiliency, Growth, and Moat framework to strengthen our competitive position and capture long-term growth. With that, I will turn the call over to Andy. Andy?
Thank you, Joey, and hello, everyone. Let me now go through the Q3 performance in detail. We saw sequential improvement in the Q3 . System sales returned to growth year over year, and restaurant margin was highest since 2018, well above our expectations. We focused on driving sales through new products and compelling value. Same-store sales recover to the same level a year ago. From a timing perspective, the trend remains volatile, impacted by frequent COVID outbreaks. In July and August, we saw a sequential recovery in same-store sales, and August exceeding the prior years. This was mainly due to lapping the Delta variant outbreak in August 2021, which heavily impacted eastern China. However, in September, same-store sales declined mid-single digits% as COVID-related health measures tightened in many areas.
Around 900 stores were temporarily closed or provided limited services in September, compared to around 400 stores on average in July and August. On the margin side, we continue to identify cost-saving opportunities, drive labor productivity, and rebase our cost structure. Let me go through the financials and our cost control initiative. Unless noted otherwise, all percentage changes are before the effect of foreign exchange. Foreign exchange had a negative impact of approximately 6% in the quarter. Third quarter total revenues increased 5% year-over-year in reported currency to $2.68 billion due to the contribution of new units and the consolidation of Hangzhou KFC. This was partially offset by temporary store closure and foreign exchange translation. In constant currency, total revenue grew 11%. System sales grew 5%. Same-store sales were flat year-over-year.
By brand, KFC same-store sales were flat, with same-store traffic at 93% of prior year's level. Ticket average grew 8% due to the increase in delivery mix, which has a higher ticket average than dine-in. Abundant value campaigns like the Family Bucket and Buy More Save More also contributed to higher ticket. Pizza Hut same-store sales grew 2% year-over-year. Same-store traffic grew by 2%, while ticket average was flat. High delivery mix, which has a lower ticket average than dine-in, was offset by discount management. Restaurant margin was 18.8%, 660 basis points higher than last year. The year-over-year increase was mainly due to high productivity, temporary relief, and sales leveraging. These were partially offset by inflation in commodity, wage, and utility costs. Labor costs also increased due to high delivery volume.
Our team worked diligently to improve our cost structure. Let me next go through each expense line item and the actions we have taken. Cost of sales was 13.7%, 150 basis points lower than last year. We're focusing on the most effective campaign to drive traffic that allow us to be more cost efficient while ensuring great value for money. We also manage commodity price inflation to low single digits. Cost of labor was 23.5%, 210 basis points lower than last year. This was mainly due to improvement in labor productivity and relief recognized in the Q3 of $17 million. These were partially offset by increasing labor costs from higher delivery sales mix and wage inflation of 2%. We improved labor productivity by, one, optimizing staff scheduling and hiring. Two, sharing restaurant management teams across stores.
Three, leveraging Digital Two to automate processes such as digital ordering and inventory management. There was also a lapping impact due to higher staffing levels in 2021 caused by the southern Delta variant outbreak. Occupancy in others was 27%, 300 basis points lower than last year. This was mainly due to our cost-saving initiative and lower rental expense as a percentage of sales. In addition, we pulled back on marketing and advertising. Rental expenses were lower in the quarter due to, one, rental relief of $13 million. Two, smaller store format with lower upfront investment and better store economics. Three, negotiating more rental relief with variable components. G&A expenses increased 16% year-over-year, mainly due to increased compensation and benefit expenses, consolidation of Hangzhou KFC, and incremental expenses from emerging brands.
There were also one-time expenses associated with primary listing conversion in Hong Kong. Operating profit was $360 million, a 77% increase year-over-year. The net contribution from Hangzhou KFC consolidation was 6% of total operating profit in the quarter. It included amortization of intangible asset acquired, which was roughly $60 million per quarter. This will run through the end of this year. Below the operating line, we incur a $13 million mark-to-market net loss on our equity investment in Meituan in the quarter. It was lower than $32 million net loss in the same period last year. The effective tax rate was 29.9%, 160 basis points higher than last year due to Hangzhou KFC consolidation. Prior to consolidation, the equity income from JVs was not subject to tax, resulting in a lower tax rate.
We expect the full year effective tax rate to come in around low 30s%. Net income was $206 million, a 72% increase year-over-year. Diluted EPS was $0.49, more than double the prior year period. The mark-to-market loss in Meituan negatively impacted diluted EPS by $0.03. We have returned around $560 million to shareholder in cash dividends and share repurchases year-to-date. We temporarily slowed repurchases in the third quarter, prior to the dual primary conversion. Powered by our strong balance sheet, we will continue to execute our discipline and balanced capital allocation strategy. Our operating cash flow remains strong. In the third quarter, we generated free cash flow of $558 million. Let us take a look at the Q4 outlook. The external environment remains challenging.
COVID-related preventive health measures escalated in October. In October, around 1,400 of our stores on average were temporarily closed or offered limited services. Downward pressures on the economy, cautious consumer spending, and inflationary environment are also headwinds that we continue to face. Our same-store sales in the third quarter were below the pre-pandemic level. We expect a full recovery of same-store sales will take time, and the path to remain uneven and non-linear. I would also like to remind everyone that, one, Q4 is seasonally a lower quarter in terms of sales and profit. Sales volatilities could have a more pronounced impact on profitability. Two, there was around $30 million temporary relief in the third quarter, most of which is unlikely to repeat in the Q4 . Three, the appreciation of U.S. dollar against the yuan may negatively affect our reported numbers.
Four, we continue to dial back some austerity measures to balance cost reduction and service level. Now despite the headwinds, in the Q3 , we resumed the pace of store openings and opened 621 net new stores year to date. By relentlessly optimizing store economics with lower upfront investment, our new store performance continued to be strong. Store payback remained healthy at two years for KFC and three years for Pizza Hut. This gives us strong confidence for further expansion. We will continue to implement our disciplined and systematic store opening approach, opening new and profitable stores at a robust pace. As the Q4 is usually the peak season for store openings, we are confident in reaching the full year target of 1,000-1,200 net new stores. Lastly, let me touch on our primary listing conversion in Hong Kong.
It became effective on October 24th, along with our inclusion in the Southbound Stock Connect. We expect the new status will provide additional access to investors, broaden our shareholder base, and increase liquidity. To round up, we have learned to navigate through uncertainties and volatilities in the past two years. COVID conditions will continue to remain challenging, but we are adapting to the new normal. Our resilient business model and agility allow us to pivot quickly and effectively develop new strength. When the market is relatively calmer, we are able to capture the upside and deliver strong results. In the Q3 , we have once again demonstrated our transformed fundamentals, cost control and solid execution. We're confident in our ability to achieve long-term growth in China and generate sustainable returns to shareholders. With that, I will pass you back to Michelle to start the Q&A. Michelle?
Thank you, Andy. We'll now open the call for questions. In order to give more people the chance to ask questions, please limit your questions to one at a time. Ashley, please start the Q&A.
Thank you. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star two. If you're on a speakerphone, please pick up the handset to ask your question. Your first question comes from Chen Luo with Bank of America. Please go ahead.
Hi, Joey and Andy. Congratulations on the very strong Q3 result. Given the very fluid situation amid the COVID outbreak and restrictions in China, my question will focus on margins. We have seen very impressive margin expansion in Q3 result. Over the past three years, we also observe a pattern that usually during the first few quarters of a big COVID outbreak, such as the Wuhan or the Delta outbreak in Q3 last year and the Omicron outbreak early this year, we might see a few quarters of margin erosion. After our very agile and quick adaptation, in the following quarters, we actually would manage to achieve margins that could be even higher than the pre-pandemic level.
Let's assume that next year we are not going to see another big wave of outbreak that will lead to massive lockdowns in our core markets such as Eastern China. Is it fair to say that we can actually achieve a restaurant margin that is largely comparable to the pre-pandemic level, which is around mid-teens%? This is my question. Thank you.
Chen, thank you for your questions. You know, I obviously, you know, our team has done a fantastic job to deliver solid margins, you know, amid very difficult and challenging situation. Now, you know, our margin improvement, obviously, you know, some of these, you know, fundamental transformations that would last, you know, going forward. Some of this is, you know, more temporary, and some of it's also our steady measures, maybe dial back, you know, as things returning to what is normal. Now, you know, if you look at, you know, our margin improvement was largely constituted by high productivity, right? And also, you know, for the quarter, you know, some temporary relief and sales leveraging.
When we look at the initiatives that we have undertaken, you know, over the past couple of years, we have mentioned, you know, over the past two quarters, you know, we have taken initiatives to really rebase our cost structure and also, you know, to drive efficiency gains. You see a lot of new product innovations, you know, in terms of our COGS is how we manage, you know, the pricing and also the cost inflation in commodity prices. Our supply chain team continues to be, you know, our core strength in terms of managing supply and robustness of our supply chain.
You know, sort of mitigate partially, you know, some of those impacts from high commodity prices, and allow us to continue to innovate and quickly to roll out new products that meet the consumer demand. The other one is obviously you look at the labor productivity, for example, you know, we have deployed technologies. We have continued to invest in technologies to automate system processes to help improve labor productivity. As we have mentioned probably last quarter, we're beginning to roll out, you know, a management pool for our staff. You know, our management team for the staff can be used across multiple store.
If you look at our rental, for example, obviously we see some rental relief, but we also have over the past two years and especially over the past couple years to work very hard to restructure the rental cost structure with landlord. You know, not only seeing lower rental costs, but also you know, more favorable and flexible rent structure. Those are fundamental transformations we continue going forward. Same thing for our digital investment.
Over the past two years, we have continued to invest heavily in digital that allow us, you know, to, in, for example, through pandemic, have direct outreach to our consumer, roll out new products, new marketing campaign efficiently. You know, and also allow us to, you know, if you look at our membership program, continue to be a very strong foundation, you know, for our sales. Membership program now account for, you know, north of 60% of our sales. Those will continue to help us going forward to maintain, you know, efficiencies and operating efficiency. However, as we mentioned before, some of these are temporary. For example, you know, the rent relief, you know, some of the relief in, you know, labor costs, especially, you know, some of the government incentives or relief.
As well as, you know, the delay in wage increase in the market in the Q3 . Now usually we adjust wages, you know, in the Q3 for our market labor force. Because the pandemic impact this year, you know, many markets have delayed wage increase, so some of these may come back and also some of the auxiliary program. All in all, I think, you know, looking forward, I think, you know, you can expect, you know, some of these fundamental change will stay and then, you know, some of these temporary measures may subside over time.
I would like to just add some color in terms of our management team thinking and also the business model, why that helps protect the margin now and in the future. Well, you know, we do believe that this company and this team, this management team, is a antifragile company. Whatever stones thrown at us, we possibly could convert these stones into our stepping stones to go further and higher. That's what we believe, and that's our team keeps trying to do the right thing. In terms of business model, as I mentioned in my presentation earlier, it's very important to recognize that our off-premise business right now is 60%. What does that mean? Well, if we look at the by brand, KFC is actually 65% off-premise, and that is up from last year, which was 60%.
Pizza Hut tells an even more amazing story. Pizza Hut, the off-premise sales is 50%. 50. Before pandemic, it was only 30%. From 30% to 50. Our business, our off-premise business in Pizza Hut is much, much stronger and higher. Given the fluid pandemic situation, these are incredibly important numbers, because when we are in sort of a much tougher situation in terms of lockdown, that 60% will become higher because there will be naturally some sales transfer from dine-in to additional off-premise business. With the 60% as sort of the off-premise in fluid situation, that percent will go higher, that naturally protects our business, our sales, because it's very difficult to have a strong margin when the sales leverage is not there.
It's not only all the margin line that we protect, as Andy has comprehensively pointed out, but on the other side, the sales side, that we have also protect. That's a lot of hard work in the last three years, and the team has done a great job. Thank you, Chen Luo.
Thank you, Joey and Andy. Your margin management capability is really impressive. Congratulations again.
Thank you.
Thank you.
Your next question comes from Lillian Lou with Morgan Stanley. Please go ahead.
Thanks a lot, Joey and Andy, for your very detailed explanation. My question is also a follow-up question on margin management, but maybe from different angle, because Joey and Andy, you mentioned about the sales leverage and also the line items management on cost side. So maybe look at all the initiatives in the Q3 and also during the pandemic in these three years, you've been focusing on really kind of rejuvenate the menu and the new product launch and smaller stores, very effective promotional campaign. When you all design this, what's your thinking behind, especially trying to understand that with our new stores now incrementally higher portion of small stores, would that actually fundamentally change our margin profile going forward?
Also, especially this quarter, you have more promotional campaigns, but in return, actually it didn't suffer on margin. Instead, it's on the opposite side; it improved the margin. I want to try to understand a little bit further how you achieve that from these efforts. Thank you.
Thank you, Lillian. I think, you know, I think in terms of margins, I think I want to emphasize, you know, at least in the short term, because of the COVID situations, we see fluctuations in our sales, that's impacted in high correlation with the COVID situation. You know, the biggest lever of deleveraging impact when things come down is actually sales, right? The higher the store sales, you know, generally will drive, you know, higher restaurant margins. We can see that, you know, even without the pandemic. In a normal time, you'll see that, you know, margin fluctuate through the year. You know, during the Q1 and the Q3 was generally higher sales period for us, and we also see higher margin.
You know, Q2 and especially the Q4 , generally a lower sales season for us, and you also see lower margin. I want to emphasize, you know, echo what Joey had mentioned earlier, you know, sales is very important for us in terms of driving margins and operating leverage. Now, in terms of our store format, you know, our store format remain very healthy, so economics probably back in the recent years. This is not just come naturally, but a lot of hard work that have put into the store format design, operations, and then also the menu mix and et cetera to make it work.
Our store formats obviously right now are geared toward, you know, sort of two areas largely. One is, you know, on the greenfield, right? We still have a lot of cities and townships that we can serve, and then we have a format for that. We also have, you know, format for catering toward, you know, to our, you know, the urban area where we increasing density and cater to a high mix of delivery and takeaway business. They all have one thing in common is that our store formats in terms of upfront investment are generally lower. Compared to a few years ago, we're spending on average, CNY 2.5 million per store.
Now we're probably spending not less than, you know, $2 million, close to, like, you know, maybe coming down to, like, you know, $1.6-$1.7 million per store. That helps us, you know, sort of like be more agile, more nimble and reduce the upfront investment that allows us to continue to have very strong, you know, unit economics for the new stores that we open. Now, as I mentioned in our prepared remarks, you know, you look at our payback period for KFC, it's still very healthy at two years. Obviously, there may be some fluctuations depending on the pandemic. For Pizza Hut, it's three years.
If you look at the satellite store model, as we mentioned before, its performance is very close to what we can achieve with KFC already. With that's what gives us confidence in terms of robust store expansion. I don't think we're too concerned about at least in terms of the store economics that would have a material impact on our margin mix going forward. That's the store format and then also our store economics for new store. Joey, do you have anything to add to this?
Yeah. Let me add some color in terms of the relation between promotion and margin management. As we mentioned earlier, we consolidate our promotion mechanism, and we focus on fewer and more impactful, such as Crazy Thursday campaign, like Buy More Save More. That help drive our sales during weekend, which is quite effective. At the same time, we are very careful to manage our products. For example, you know, the whole chicken, right? I'll give you one example. You guys will get it. Sometimes it's more detail, we get it. We sell 80 million whole chicken so far this year. It's roast chicken. Why not fried chicken? Well, here's the reason why.
Oil this year is very expensive. If we do roast chicken, it has two benefit. One, it's healthier. Two, it costs less. Customer love it. We go through every little detail, make sure that it has both great product but at good cost. And that work for not only dine-in but at home consumption. Just small example to give you a sense. In terms of margin compression, I would like to share another belief which result in very good results. Back to Q2, it was very difficult quarter. We iterate our commitment to protect our staff job, no layoff. We look at every single way to manage our cost structure, our margin, except layoff. We want to protect our employees' jobs during the tough time. Everyone needs some sense of security during very fluid situation.
Our staff, our 400,000 strong team, they appreciate it. Everyone go for every single innovation that we can achieve to protect our company instead. I'll pause here. Let's move on to next question.
Your next question comes from Xiaopo Wei with Citi. Please go ahead.
Hi, good morning, Joey and Andy. I also ask question about the margin, but I will take another approach, maybe the bigger picture, what happened in the past two years. If we look at what happened in the past two years since COVID, we are seeing you open more stores. In the Q3 , it's the first time that we are seeing amazing, rational margin with some very short window of rebound about all the consumption, et cetera. I can see that you greatly capture that upside of the consumption rebound. Shall we say that actually the new store opening, which worth the investment for the future, starting working well in a situation looking forward when the COVID is phasing out, actually our new store contribution to our profitability actually be more pronounced than before?
Another question related with this is, if we look at the delivery sales contribution. The KFC hit 37%, which is amazing, very close to Pizza Hut. I still remember years ago when I first met Joey. I had the impression that this KFC would never be that high in terms of delivery sales contribution for Pizza Hut. Now we are seeing Pizza Hut and KFC are having a very close kind of delivery sales contribution. Shall we say that looking forward, KFC fundamentally has transformed, and we are expecting actually higher than expected delivery sales contribution looking forward, approaching 40%. Thank you.
Thanks, Xiaopo. Thank you. I think there's a lot of questions about margin today. Obviously, we're very pleased, you know, with our margin performance in the third quarter. As you mentioned, you know, the sales leveraging when the time comes, we're not only able to capture, you know, both, you know, the sales upside, but also able to regain the sales leveraging. We obviously, as you mentioned before, you know, there's a number of fundamental transformations that we have undergone rebasing our cost structure, you know, from initiatives. I think, you know, what you're asking about is about two things, right?
One is, you know, the new store margins and probably the other one is, you know, the delivery sales mix, you know, what's the potential going forward. Now, I think, you know, when we look at the new store economics, I think, one thing to remember is that for any new store, generally it take, you know, a couple year for it, you know, to ramp up sales and margins, to mature to the level. The other part is that obviously we're very pleased, as you mentioned, you know, when we look at, you know, our new store performance, they continue to be very robust, very strong.
You know, if we look at the margin front, you know, that I mentioned, you know, the ramp-up period, but you know, even for the store that we opened this year, you know, a large majority of them you know turn to restaurant breakeven or better within three months of time, which is you know tracking on par or slightly better than you know the Taco Bell level. I mean, there's couple things that is happening there, right? One is, as we mentioned, we have worked very hard to find the right format, not just reducing the size, the size is obviously important, but you know but also the operations you know the whole operating flow and product offering and the menu mix.
All these, you know, work in conjunction with that. We also, as we mentioned, have worked hard on, you know, changing our like restaurant management structure, have developed a management labor pool that can share with, you know, the store to make it productivity improvement. I think and then also if you look at the rental for new store, obviously, you know, we have worked very hard to lower the rental cost as a percent of sales, but more importantly to keep us resilient, we continue to, you know, work with landlord to give up a higher proportion of variable cost component. That allow us to be, you know, more resilient over time.
I think our approach to new store opening is very disciplined and systematic as I mentioned before. We'll continue to drive that discipline so that when we open new store, as we continue at a very fast pace and likely accelerate in the Q4, we'll continue to open not only new store but Taco Bell store. I think the portfolio contribution for new store is important also over time. I think the economics is on par. As we mentioned, payback period is two year for KFC, two year for Pizza Hut, which is pretty consistent. That's the new store margins and possibly.
In terms of delivery sales mix, obviously in the short term, you know, you're gonna be depending on, you know, COVID situations, tighter measures, you're gonna see high delivery mix shift. You'll sometimes see that things calmer and then dine-in traffic will come back. All in all, I think, you know, you can see, there's a big change in our business. Our delivery mix right now and off-premise right now account for, you know, a majority of our sales now. That's why like when we develop new store format, as we mentioned before, you know, for the smaller urban format, we tailor those more catering to our delivery and takeaway business. How high it goes, I think, we depend on consumer.
You know, if they want more, we'll deliver more. We have the format and system to help achieve that, especially with the digital side. You know, like we have our own app to drive traffic, reward our creator, so you know, the consumer can order delivery whenever they want, and we have the s-store to serve them. Thanks, Xiaopo.
Your next question comes from Michelle Cheng with Goldman Sachs. Please go ahead.
Hi, Joey and Andy. My question is about store expansion. Given this very strong profit margin, do you have any initial thoughts on the expansion plan into 2023? Any chance we could further accelerate expansion given we know all the smaller players are suffering? And also more specifically by brands. Aside from KFC, Pizza Hut maintaining a relatively stronger momentum on expansion, how do you think about other brands since we actually reshuffling other brands quite aggressively in the past few quarters? Thank you.
Hi, Michelle. Thank you for your question. About new store and, you know, as I mentioned, you know, our new store performance continue to be strong.
Also, you know, as I mentioned before, I mean, we each year set a target thing what is reasonable, but ultimately is what the market and the fundamentals that would drive, you know, how many stores that would be open, and then also sometimes got impacted by COVID. We'll continue maintaining that discipline and systematic approach. You know, when unit economics are good, we'll, you know, the system will, you'll see some acceleration because more store we propose and more store we approve. You know, obviously when, you know, the market or like the unit economics are more moderate impacted, then you will see some deceleration of medical because, you know, it's due into the model and assumption itself. We refresh that, you know, very regularly.
We will maintain that very disciplined approach. Obviously, we continue to see very strong fundamentals for store opening. We see, you know, as I mentioned before, you know, at greenfield, we have more KFC. We're only in, you know, a little more than 1,700 cities. We see probably another, you know, 1,000 or so that potentially we can enter. If we look at Pizza Hut, you know, even, you know, like, almost 1,000 stores that KFC already in, we don't have a Pizza Hut store. There's a lot of greenfield opportunity. We still feel very good about, you know, store expansion, store network expansion and opportunity there. Now, in terms of, you know, the... Obviously, you know, we'll continue to work hard on the store format, right? The consumer dynamically could change.
You know, we see obvious opportunities right now. Our pipeline is very strong because, you know, we are viewed as very attractive tenants right now in the restaurant industry. After the two or three years of pandemic, we continue to be, you know, perform very well, pay our rent on time and everything. You know, we move from attractive to even more attractive tenants, so we have more opportunity. But our emphasis again is on discipline and systematic approach to make sure that we not only open new store, but open new and profitable store. That's important. Now, as you mentioned, we did some portfolio management on our brand.
As Joey mentioned earlier, we're winding down COFFii & JOY to focus our resources on the coffee side, on Lavazza, which we see, you know, very good opportunities, a lot of potential there. That's a different approach. We also, early part of this year, winding down the East Dawning business. East Dawning have been a homegrown brand for close to a decade now. Unfortunately, its market positioning is in the transportation and tourist location. Now, that business has been very challenging over the past three years, as you can imagine. Currently, we don't see the with the new normal improvement in any short time. We decided to wind that business down.
Again, you know, like back to, you know, that discipline and systematic approach, be it in store network expansion, be it in portfolio management, we are very disciplined about that. We'll continue that going forward, about the brand, development. Thank you, Michelle.
Michelle, I'll just add a few comments about the store expansion. First, we certainly are opening even more smaller stores. For Pizza Hut alone, 5% of the new store opened this year are either smaller or satellite store, and KFC is about half. These smaller stores work particularly well in lower tier cities, and that's where we will continue our store expansion. The result is pretty exciting, promising. That's comment number one. Comment number two is opening new the smaller stores also require focus on the product and operation side, and we are giving that support to the new smaller stores. For example, chicken breast burger, Ji Xiong Rou Bao. The price is very good. It's CNY 9.9 . It's brilliant.
It's amazing for the lower tier city new store as introduction to our business. There are other product like Yan Su Ji. We developed these products with lower price points specifically for lower tier cities and specifically for the introduction of new store. At the same time, we also continue to innovate in terms of operating process within the smaller stores. Well, one example, you know, smaller store, we only can accommodate fewer number of staff, which is a great news for shareholders. That also requires changes in terms of operating process. How to still make it work to protect our product quality, food safety, you name it. You know, not only just the cost of opening new stores, but also the product and the operating process that we are focusing on. Thank you, Michelle. Next question.
Your next question comes from Anne Ling with Jefferies. Please go ahead.
Hey, thank you. Thank you for giving me the opportunity for asking a question. Hi. Regarding the cost side, we look at, like, you know, we track the chicken price and which we saw a 20-odd% increase. Now, also at the same time, like, you know, flour cost also increased. I understand that management has a really great way in terms of, like, you know, making use of the whole chicken parts. Moving into, like, you know, year 2023, when we'll see that, you know, this increase in terms of the cost, the chicken cost or the other commodity costs are kicking into your P&L?
Maybe you can share with us, you know, what is your current agreement with your supplier? Thank you.
Hi, thank you for your question. Yeah. Joey, you want to.
Yes, go on. No. Go on.
Okay, thanks. So, when we look at, you know, our COGS, you know, obviously, I think we do have to, you know, comment on how fantastic job our product innovation team have done to help us manage that, you know, cost inflation. Commodity price inflation, as you mentioned, is very real. Is real globally and is true also in China as well. Obviously in China, we see more moderate inflationary pressure, but still, you know, we see food-related commodity price increase escalating over the past, you know, probably like a year. You know, we see a very favorable, you know, pricing last year, 2021.
We're beginning to see that, commodity pricing pressure building up, you know, and right now in China is probably at mid- to high-single-digit, you know, food commodity pricing increase. As you mentioned, we also see poultry price increase. As I mentioned before, you know, like this is gonna continue to be a headwind, and we'll continue to work hard to sort of mitigate it. The other one I wanna mention is that, as we have mentioned before, our supply chain generally will lock in most of the supply, you know, a quarter or two ahead of time. There will be some, you know, lagging impact on the inflationary side.
Obviously, you know, because, like, what you do in an inflationary environment, our supply chain also deploys long-term contracts, tries to, whenever it's possible, to lock in pricing a little bit longer. For example, coffee, they have done a fantastic job of locking in, you know, a longer term pricing contract. But, you know, some of the commodities you cannot lock in for such a longer time. So we will, we'll see some, you know, commodity pricing pressure building up in the coming quarter as well. Now, as you mentioned, you know, to deal with commodity pricing pressure besides the supply chain and the efficiency there, is also on product innovation, as Joey has mentioned.
You know, the team have done a fantastic job developing new products that utilize, you know, different part of, you know, the resources that we already have, chicken, beef. You know, for folks in the U.S., you know, like, when people talk about, you know, chicken sandwich or chicken burger, generally that would refer to chicken breast. As we have mentioned before, in, for Chinese consumer, generally, you know, they like dark meat more than, you know, white meat. Because, you know, dark meat tends to be more tender and more flavorful. This, for example, this quarter, as Joey mentioned, you know, we have developed, you know, a fantastic chicken sandwich, a chicken burger, that is very successful when we serve our consumer.
Now, like, that kind of product innovation both satisfy, you know, consumer demand and also help us to manage commodity prices will be very key for long-term managing that COGS. So that commodity pricing inflation, and then also obviously, you know, how do we manage our marketing campaign. How do we manage, you know, other costs, you know, waste, sanitation, all that, will be also important for us in the long term to manage that COGS. Now, for labor inflation, as we mentioned before, generally, you know, bad times, good times, we'll likely see labor costs increase. You know, sometimes we'll see delay, sometimes more moderate. In China, the long-term trend is, you know, mid- to high-single-digit %.
You know, in long term, we will continue to have to work hard to improve labor productivity, invest in technology, you know, IT, invest in infrastructure. As Joey mentioned, continue to innovate and need to improve our store operations so that you know, we can maintain, you know, labor efficiency that will be gained to offset that labor inflation. That's sort of like, you know, commodity pricing, labor inflation. Thank you. Thank you, Annie.
Annie, I'll just add one comment on that one. We do use every part of chicken except the chicken feather. I would also like to point out that we have our team, both the pricing team and then the product innovation team. We have been able to introduce and use different protein, beef, pork, fish, and duck. We are selling duck burger right now, as we speak right now, chicken and duck burger. We have a variety of protein in our pipeline that we can use and we can promote, depending also on the price. I mean, the thinking is rather simple. A good chef, they look at what is the best in terms of quality, not only price, quality and price available in the market. Then you turn these fantastic ingredient into great food.
Same for us, just at much, much bigger scale, I guess. We have both the flexibility and the scale to deliver amazing food to our customer at very good price and very good value. Thank you, Annie.
Your next question comes from Christine Peng with UBS. Please go ahead.
Thank you, management for taking my question. My question is on the product side. I spotted a very interesting, a new product, which Joey mentioned, which is this beef burger. I noticed that this product has been on the menu since May of 2021. Which means that this is likely to be long-standing product instead of a LTO. If that is the case, you know, Joey, can you share with us, you know, the thinking behind this product, you know, in terms of the rationale, the supply chain management and also future plan for this product going forward?
Because, you know, what I'm interested to understand is that, you know, will this beef burger, you know, potentially become a very important category, for KFC, going forward, and what's gonna be the structural, impact, on KFC in terms of competition, in terms of, you know, margin trends, et cetera. Anything you can share with us, that'll be very much appreciated. Thank you.
Thank you, Christine. Well, it's already a very important product in KFC portfolio. The speed and the support from the customer exceed our expectations. To quantify the sales of beef burger, I mean, it already contribute meaningful sales mix to our business. It's about 3%-4% of KFC sales mix, but that is a lot already, because for original recipe after all these years, it's about 6-7%. It's half of our original recipe chicken sales already. That's the numbers side. In terms of product side, for those who are in China, if you have a chance to try, I do strongly encourage you try it, then you can form the opinion yourself about the future of this product.
I know it's rather unusual for a company selling chicken to sell burger, beef burger, but this will. Once you try it, you will understand why it work. We have good choice, good range of product choice there, from entry price, burger, which tastes amazing still, beef burger, all the way to Wagyu beef burger, Angus beef burger. It, you know, as Andy mentioned, it's hard to imagine, but it tastes amazing. Wagyu beef, you know, you can't go wrong with Wagyu beef burger. So and the price is still very, you know, very good value. I won't say it's low price. I mean, it's, you know, the Wagyu beef burger, but it's fantastic value. So the choice of product is fantastic. Third is the flavor, the taste.
There are plenty of, you know, customer-made video comparing our burger versus other competitors. One thing very distinct about our beef burger is the burger is very juicy. This is our focus because while some traditional beef burger lover might love the barbecue flavor, for Chinese taste, they prefer the juicy burger. That has been our focus. We are uniquely positioned to do that because we have very high quality oven in our kitchen, each of our KFC kitchen, to produce the beef burger. The beef burger, the patty is cooked in oven, not on grill. I hope that give you some flavor of this amazing product that I love myself. Thank you.
Joey, let me add a little bit here because, you know, as I self-proclaimed number one fan of KFC, you know, I eat there very often and, you know, like, but still sometimes I do need variety besides of chicken, right, and rice. I think, you know, the beef burger is fantastic. You know, the beef burger is not only have one Wagyu burger, but now we have a range of, you know, beef burger that can, you know, appeal to different, you know, price point. I myself, you know, increase my frequency going to the store, you know, because I now have, you know, like, when I want to eat beef, I, you know, I have fantastic choice for the KFC beef burger.
From a customer standpoint, I think it's fantastic because it provide, you know, greater variety, like you mentioned, different protein, different choices. I love it. Anyway, thank you. Thank you, Joey. Thank you, Christine, for your patience.
Your next question comes from Veronica Song with Credit Suisse. Please go ahead.
Thank you management for taking my question, and congratulations on the very strong set of results. I have a question regarding the coffee business. As Joey mentioned, we're gonna wind down the COFFii & JOY business and focus more on the K COFFEE and Lavazza. Could you share more color on the current situation or achievement of Lavazza, especially in terms of store expansion and any color on store economics? How can we adopt the valuable experience we learned from both COFFii & JOY and KFC to drive Lavazza's success? Thank you.
Thank you, Veronica. Yeah, you know, sorry, Joey, you wanna say something?
No.
No? Okay. I think, you know, first of all, I want to repeat it quickly, which is, you know, we start winding down the COFFii & JOY business so that we can focus more our resources on the coffee resources on, you know, Lavazza and give, you know, obviously the team a more laser focus, you know, on the market. As you mentioned, you know, currently our coffee shops, we have two key brands. One is K COFFEE, which is, you know, serve the value and convenience segment. For Lavazza, you know, we're focusing on offer authentic, you know, wonderful Italian coffee and experience. For obviously COFFii & JOY , you know, it's a homegrown brand.
Over the past couple years we learned a lot. You know, this is one thing that we have kept saying, we have healthy respect, you know, when we enter into a new business segment. You know, coffee business is very different, obviously from, you know, fried chickens and from, you know, pizza business. So there's a lot of learning there, and you know how to, you know, give our product, coffee, water, milk, the whole process, to make good coffee. In selection obviously is also very critical. And then, you know, obviously, for coffee too, the store format take time to figure out, you know, what the right format has different, you know, trade zone, and economics and whatnot.
In terms of the Chinese customer, you know, and coffee is still a relatively new market segment. You know, a lot of Chinese consumers are still, you know, very new to the coffee, the taste of coffee and what their preferences are, also need time for us to develop and learn and apply to, you know, our product development. A lot of this learning, I think, wonderful learning that we did with COFFii & JOY would help us to obviously apply to Lavazza as we grow out and expand its business.
For you know Lavazza you know is continuing to you know recover from obviously a very challenging time you know because a lot of stores in Shanghai early part this year and we see you know recently business has rebounded. I think you know in terms of you know the product the team you know they continue to be on the right track. I think you know I don't think we can say like we're there yet you know but building a new brand a new business it will take time. But they have done a great job in terms of you know putting the right you know organizing the right team putting you know continue to innovate in the product. You've seen a lot of new product innovations right?
With the buffalo milk latte and drinks. We also see, you know, the coconut latte and all that have been, you know, wonderful success, you know, with the consumer. That sort of like, you know, offer that Italian, you know, experience, but also, you know, flavor that's dear to a, you know, Chinese consumer. Then we continue to do more, I think, you know, like in terms of training and food innovation. Our store format is the same thing. You see that they continue to experiment and roll out. Overall, you know, you see the unit economics improve.
I think, you know, for them to reach, obviously, you know, their consumer awareness, the sales level, and also, you know, the profitability, you know, take some time. I think, you know, people have to be a bit more patient on that. They have also, you know, quite a bit of stores this year, almost double, like right now we have, you know, 78 stores, and continue to open more stores. They also continue to develop, you know, its capability. They continue to develop its digital and delivery capabilities. If you look at, you know, sales mix now, you can see that, you know, the membership program and also the delivery program continue to increase.
Delivery now almost like, you know, 40% of the sales mix now. That's a great improvement, and especially given the challenging environment with COVID. Now store development, as mentioned, you know, like, physical improvement increased from a year ago to 78 stores. There will be more, but you should know it's not like COVID obviously doesn't have some impact. I think last year we mentioned 1,000 stores, and we're very much committed to that. Obviously the timing of that is gonna be depending on some market conditions, especially with COVID. As we mentioned, we have a very systematic and disciplined approach, even with the new coffee brand named Lavazza.
I think we're pretty confident, you know, as the store economics improve, you will see more stores open. That's the store update on Lavazza. Thank you. Thank you, Veronica Song.
There are no further questions at this time. I will now hand back to Ms. Shen for closing remarks.
Thank you, Ashley. Thank you all for joining the call today. We look forward to speaking with you on the next earnings call. If you have further questions, please reach out through the contact information in our earnings release and on our IR website. Have a great day.
Thank you.
That does conclude our conference for today. Thank you for participating. You may now disconnect.