Trade Update W/ New Trade YUM: Taco Bell in a China Shop

by Dan October 9, 2012 2:06 pm • Commentary

Trade Update Oct 9th, 2012:  Two Months ago on Aug 10th, when I started to leg into the YUM Oct 62.50/55 Put Spread, my thought was that by this time, if my thesis was correct, the stock would be closer to my break-even point in the low 60s prior to tonight’s earnings report.  Well the stock is basically exactly where it was 2 months ago, and the Spread that I paid 1.12 for (stock ref 66.66) can be sold today at .45 (stock ref 66.40).  So with earnings just hours away, and my break-even down at 61.38, or 7.5% lower, the chances for success are becoming increasingly thin with less than 2 weeks to expiration.

The way I see it I have 3 options at the moment:

1. Sell the Spread for a loss and wait for the news to come out and then make a decision about how to express the bearish view if the news confirms the thesis (albeit at lower levels).

2. Sell the spread and roll to higher strikes and possibly even out to Nov in an effort to stay in the game.

3. Leave the position on and play for an out sized move post earnings.

At this point, I feel that disappointing results and less than stellar guidance, specifically as it relates to China could easily cause the stock to decline in line with the implied move of about 4.25%, or about $2.80 (stock ref 66.36).

Another way to think of it though would be that since Aug 10th, the SPX is up about 2.8%, and YUM is actually down a bit less than 1%, so investors appear to be bracing for disappointing results.

This excerpt from my original post on Aug 10th shows my slight reluctance at the time:

Conviction Level:  As I said above, timing will be everything, and if the stock rallies straight to 70 in the next couple weeks it will be hard to make money on this trade, so I am going to stick my toe in the water right here and initiate about 1/3 of a position. SO while I really like the idea, and it fits into my generally bearish world view, I would be foolish to suggest that this is a “slam dunk” entry point.

But at this point I am going to opt to close Oct and roll up and out in Nov and give myself a better chance of success and more time.  I given the commentary we have seen of late from U.S. multinationals (NKE & FDX) regarding sales in China, and given YUM’s almost 45% revenue exposure to the region, I would be very surprised if the company were able to offer decent guidance given the macro backdrop.  And finally, I guess the litmus test would be this, If I was just short the stock, not long premium for the last 2 months, and heading into tonight’s print, would I stay short the stock at the same level I sold it, or cover??  And my answer is fairly simple, stay short.

Action: Sell to Close YUM ($66.40)  Oct 62.50/55 Put Spread at .47 for a .65 loss.


New Trade: Bought the YUM ($66.40) Nov 65/60 Put Spread for 1.25

-Bought 1 Nov 65 Put for 1.83

-Sold 1 Nov 60 Put at .58

Break-Even on Nov Expiration:

-Profits btwn 63.75 and 60, make up to 3.75, max gain of 3.75 at 60 or below.

-Losses of up to 1.25 btwn 63.75 and 65, max loss of 1.25 65 or higher


Bloomberg Earnings Preview:

● 3Q adj. EPS est. 97c (range 91c-$1.05)
● 3Q rev. est. $3.66b (range $3.50b-$3.78b)
● 3Q comp. sales ests. (Consensus Metrix avg. of 18):
● Systemwide est. up 4.25%
● U.S. est. up 4.42%; Taco Bell est. up 6.78%, KFC est. up 1.17%, Pizza Hut est. up 3.56%
● Intl est. up 2.81%
● China est. up 6.03%
● India est. up 6.20%

● YUM probably will comment on previously given 2012 adj. EPS forecast (up >12% given July 18), provide initial 2013 EPS view
● 2012 adj. EPS growth est. up 14% to $3.26, 2013 growth est. 14% to $3.73: Bloomberg consensus data
● With ~50% of co.’s profits coming from China (where it owns 100% of store base), “material slowdown” in Chinese consumer spending may have “disproportionate impact” on YUM’s EPS: Raymond James (market perform)


Original Post Aug 10th, 2012: New Trade YUM: Likely to Succumb to Weak China Nums

Earlier this spring/summer we were fairly well focused on shorting U.S. multi-nationals with a good deal of revenue exposure to Europe, which proved to be a profitable endeavor.  At this point in the cycle we are getting pretty close to a sort of “put up or shut up” situation for European political leaders and central bankers.  Clearly they have reassured investors that they will do what it takes to avoid runs on risk assets, but without sustained and measured policy response, this new found “honeymoon” period they bought since the “Draghi Bottom” is likely to end soon in tears.

For the last few weeks the financial press has been looking at U.S. corporate earnings through rose colored glasses and has almost all but forgotten the risks to the re-emergence of the European fears.

One Country that has not been given a “pass” this summer is China, and the major equity index, the Shanghai Composite, mirrors the downbeat economic data that seems to be ever so slightly accelerating to the downside.

On a week that saw MCD report July same store sales that missed estimates badly, and were actually down in all 3 major regions for the first time since 2004, we would be remiss not to try to extrapolate this weakness to other U.S. multi-nationals.

YUM sticks out to us like a sort thumb as they got 43% of their sales from China alone in 2011, compared to only 30% in the U.S.   Much of YUM’s growth lies in faster growing emerging markets such as China, which is one of the main reasons the stock trades at almost 18x next years earnings that are expected to grow at 14% and sales growth expected to be 9% vs MCD at about 14x 2013.  

Interestingly, while MCD is struggling overseas, and CMG’s growth decelerates domestically, YUM’s sales appear to be tracking OK if you listen to their “award winning CEO” (Bloomberg interview last week here, as an aside, Enis and I wanted to puke listening to all this guy’s generally useless management speak and talk of products instead of financial substance).

Our View: Obviously this is a stock we want to take a shot on the short side, the slightest headlines of continued slowdown in China should see stocks like this re-test the June lows and likely make new ones.  The big risk to the trade is that the stock is basically 10% from the 52 week highs and about 9% off of the recent lows, so the stock is in no man’s land on a near term basis.  Timing is of the utmost imporatnce for a trade like this.

The Shanghai Composite is one of the worst performing major market indices down 1.4% ytd and trading at 3 yr lows, the market is clearly anticipating bad news in the months to come.  China has been easing fairly aggressively of late, so any continued easing and stimulus measures could cause a fairly decent squeeze, as names levered to China are likely to trade up with it.

Conviction Level:  As I said above, timing will be everything, and if the stock rallies straight to 70 in the next couple weeks it will be hard to make money on this trade, so I am going to stick my toe in the water right here and initiate about 1/3 of a position. SO while I really like the idea, and it fits into my generally bearish world view, I would be foolish to suggest that this is a “slam dunk” entry point.

TRADE: YUM ($66.66) Bought Oct 62.50 / 55 Put Spread for 1.12

-Bought 1 Oct 62.50 Put for 1.51

-Sold 1 Oct 55 Put at .39

Break-Even On Oct Expiration:

Profits btwn 61.38 and 55 make up to 6.38, max gain of 6.38 at 55 or below.

-Losses of up to 1.12 btwn 61.38 and 62.50 and max loss of 1.12 at 62.50 or higher.