Are Yum!'s China Margins Sustainable?

From the Question-and-Answer portion of Yum! Brands' (YUM) latest quarterly earnings conference call (link to full transcript):

John Ivankoe - Analyst, JP Morgan

The question is actually on China. Obviously the returns for the overall market, and presumably new unit returns, are fairly exceptional, as driven by your sales to investment ratios and specifically the margins that we are seeing reported on your income statement.

I guess what I am looking for is, how do you feel about having a 23.7% margin? Is that the level we should be thinking about you making longer term? Is that, for whatever reason, kind of a peak-ish margin in the quarter? Will new units, do you think it would be higher or lower than that?

In kind of parenthetical view to that, does it make sense at any point to perhaps lower that margin to make your business even more attractive to more consumers as you expand throughout China?

Richard T. Carucci - Chief Financial Officer

Good question, John. First of all, the China margins in the third quarter are a bit normal than our full-year numbers, just because of seasonality. So seasonality did drive third quarter above normal, but our year-to-date margins are over 21%.

I personally believe that 20% margins are sustainable in China for a few reasons. First of all, as we go to these smaller cities, even though our average sales are below what we are getting in the bigger cities, our margins are actually higher, so those businesses are performing well and our returns are higher there as well. So we feel great about that development.

The second piece is our competitive position continues to improve in China. If you really look at it, we have been adding 400 restaurants for the division, but just on the KFC side, close to 300 restaurants the last couple of years, which is three-to-one our nearest competitor. So our power in the marketplace continues to improve and we have been able to leverage that on the cost side.

I feel that our margins there are sustainable and, as income grows there, we are already becoming more and more affordable to people. We are expanding our reach as much as we want to, really, because of the income level rising as opposed towards to needing to discount our products.

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