What's the idea?
The consumer food service market in China is huge and estimated to equal about US$650 billion. Despite slowing growth rates, witnessed over the last couple of years, the market is highly fragmented and Yum China can increase its market share. Yum China plans to expand its restaurant network from current 15,000 to 20,000 units by 2026. It will allocate from $2.3 to $3.0 billion of capital expenditure to reach this goal. Moreover, the company will continue to experiment with menu items and store formats to drive net sales.
Development of the digital ecosystem is another pillar of the company's strategy. Yum China constantly improves its technologies to increase operational efficiency of supply chains and inventory management as well as boost digital orders, which positively impacts both margins and revenue. Yum China is a growth company so its current cash returns to shareholders are relatively modest. However, the management demonstrates commitment to return excess cash to shareholders, increasing returns in the future, which is a positive signal for long-term investors.
Buying a combination of stock and stock options gives an investor an opportunity to boost potential returns without equally high potential risks. We recommend buying CALL options on YUMC stock with a strike price of $35.00 and an expiration date of 17/01/2025. The option will cost about $2.74, while one contract will cost around $270.0, since option deals are concluded for 100 shares.
About Company
Yum China Holdings Inc. (YUMC) engages in franchising and owning restaurants. Its restaurant network consists of flagship KFC and Pizza Hut brands, as well as emerging brands such as Taco Bell, Lavazza, Little Sheep and Huang Ji Huang. Yum China is one of the largest restaurant companies in China in terms of sales, with over 15,000 restaurants covering approximately 1,800 cities in China. The company was founded in 1987 and is headquartered in Shanghai, China.
Why do we like CALL OPTION YUMC.US @35?
Yum China Holdings Inc. (YUMC) is one of the largest restaurant operators in China, with over 15,400 restaurants as of June 30, 2024, including brands such as KFC, Pizza Hut, and emerging names like Taco Bell and Lavazza. The company holds exclusive rights to operate KFC and Pizza Hut in China and is working toward expanding Taco Bell. KFC is the dominant brand, contributing 75.4% to the company's revenue in 2022, while Pizza Hut accounted for 20.5%. Despite challenges in China’s economy, the company’s share of the massive food service market is around 1.5%, giving it a strong foothold among western and local competitors.
YUMC is focused on significant growth, aiming to increase its store count to 20,000 by 2026, expanding in underpenetrated regions of China. The company plans to invest between $3.5 billion and $5.0 billion from 2024 to 2026, primarily in expanding its store network. Its strategy also includes improving store-level performance, diversifying revenue sources, and enhancing digital capabilities. Franchise operations, while still a small part of YUMC's overall structure, are also expected to grow, particularly in lower-tier cities where company-owned stores may not yet be established.
In Q2 2024, YUMC delivered strong operating and financial results. The company opened 401 net new stores during the quarter, contributing to a 4% year-over-year (YoY) growth in total system sales, despite a challenging comparison with the previous year's high base. While same-store sales decreased by 4% YoY, same-store transactions grew by 4%, reflecting continued customer engagement. Total revenues reached a record high of $2.68 billion, marking a 1% YoY increase. Excluding foreign currency impacts, revenues would have been $85 million higher, translating to a 4% YoY growth. Digital sales continued to thrive, reaching $2.2 billion, with 90% of total sales coming from digital ordering.
The company also demonstrated its commitment to shareholder returns, distributing $249 million in Q2 2024 through share repurchases and cash dividends. For the year to date, the company has returned nearly $1 billion to shareholders, surpassing its full-year 2023 returns. The share repurchase plan for 2024 stands at $1.25 billion, representing approximately 9.3% of YUMC's market capitalization, highlighting its robust financial health and focus on delivering value to shareholders.
We believe that buying long-term CALL options on YUMC stock could provide an attractive investment opportunity in the current environment.
We recommend buying the stock options with the following parameters:
- Option type: CALL
- Strike: $35.00
- Expiration date: 17/01/2025
- Option cost: $2.74
- Target price: $5.00
- Potential yield: 82.48%
- Breakeven point: $37.70
- From current share price to breakeven point: +8.0%
- Maximum possible loss: $270.0
Why is investing in stock options sometimes more effective than investing in stocks? You don't need to have a lot of capital to start trading stock options. For example, at the current YUMC stock price of $34.90 per share, 100 shares would cost more than $3,490, while buying an option contract would cost only $270.0.
Moreover, stock options provide significant leverage, i.e. if the stock price rises sharply, an option position would yield a significantly higher return than a similar stock position. For example, a 20% increase in the YUMC stock price by the expiration date of 17/01/2025 would result in a 156% increase in the stock option value.
The table below summarizes the yields of various investment strategies using YUMC shares and stock options depending on the stock price performance on the expiration date.
In order not to take too high risks, you can use a strategy of simultaneous purchase of shares and stock options on the same asset in a certain proportion. As you can see from the table above, this investment strategy allows an investor to get a higher return compared to buying only shares, while keeping risks lower than when buying only options.
How to use the idea
We recommend buying long-term CALL options on YUMC stock with a strike price of $35.00 and an expiration date of 17/01/2025. The option will cost about $2.70, while one contract will cost around $270.0, as option deals are concluded for 100 shares.
The investor will profit if the underlying asset’s price is above the breakeven point** of $37.70 on the expiration date. The higher the YUMC stock price rises above this point, the greater the profit will be. We recommend closing the position when the option price reaches $5.00. In this case, the profit will be more than 85%.
The investor will incur a loss on the option if the YUMC stock price falls below the breakeven point by the expiration date. The maximum possible loss, i.e. 100% of the option contract value, will occur if the stock price falls below the strike price, or $35.00 in our case.
The chart below shows the distribution of profits and losses from the option position depending on the YUMC stock price on the expiration date.
If the stock price rises with increased volatility, the options would show significant growth in a shorter period of time before the expiration date.
Important note
Options must be purchased with a limit order. Buying an option contract with a market order can result in extremely unfavorable prices.
This is a speculative investment idea which carries increased risks. Investing in options can provide a 50%, 100%, 200%, and in some cases even higher returns, but also can lead to a complete loss of the amount invested! In cases where volatility is low, profit or loss can vary between 20% and 30%.
A prudent approach to implementing option ideas is to invest a small portion of the portfolio in many such cases. In this way, losses from unsuccessful ideas will be compensated by high returns on successful investments.
Key risks
There is a possibility that some negative corporate news could lead to a decline in the YUMC stock price. In this case, the CALL options would become devalued. Excessively low volatility in YUMC stock may result in the options becoming devalued by the expiration date.