MorningWord 10/10/12: YUM Bucking Multiple Trends

by Dan October 10, 2012 9:01 am • Commentary

MorningWord 10/10/12:  Last night YUM reported Q3 earnings that were better than expected, while revs were a tad light, but slightly raised FY2012 eps growth forecast from at least 12% to at least 13%.  As it relates to China, where they will see much of their future growth and receive about 45% of their current revenues, the company reported comp store sales in line with consensus and suggested they will open 750 stores in China this year, up from previous target of 700.  I guess the most interesting take-away from the report, is that while most investors were focused on China being the cause for concern (me included), many had expected the U.S. to be weak after seeing disappointing results this summer in the U.S. from MCD and CMG.  U.S. comp sales were actually better than expected, up 6% vs the estimate of up 4.4%.  Could YUM’s U.S. performance be a result of one of the main tenets of hedge fund manager David Einhorn’s short thesis on CMG that he laid out nearly 2 weeks ago at the Value Investing Congress?  His view on CMG (he declined to offer and investment opinion on YUM) is that Taco Bell’s New Upscale Menu in the U.S. may eat CMG’s lunch so to speak.  Some guys are just really good at this.

The stock is up about 4.5% in the pre-market in line with the implied move, as investors’ worries about slowing sales in China are allayed for now and the U.S. is outperforming.  This is one fast food chain that appears to be bucking the trend.

Yesterday prior to the close,  I adjusted a bearish position in YUM that I have had on for 2 months, and rolled up and out a bit, my new position as of yesterday’s close is long the Nov 65/60 Put Spread after taking a loss on the Oct 62.5/55 Put Spread.  In the post I outlined 3 options for my Oct trade and how I was thinking about going forward, and they were:

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.

In hindsight, number one was the right option, but here is the thing, if I am going to trade earnings, which I do frequently, I have to go with what I feel my best trade ideas are, knowing that I will not always be right.  The prudent thing to do would have been to take a step back after 2 months in the trade, and wait for the news to come out and make my next move with the knowledge of the results.  At this point, I am just wrong on the story, or maybe my timing is wrong, but now I have had 2 losing trades in the course of 2 months in the name, and it is likely time to bail and move on.  I will officially update this trade this morning, after I see how the stock trades.

On another note, Enis nailed CMI with a Bearish play into their Q3 earnings and will get paid early after last night’s negative pre-announcement.  Whats interesting about CMI is that their exposure to China is obviously one of the main drags on the company.  Also last night, AA once again cut their demand forecast for Aluminum due to weakness in China.  Both China related warnings come on the heals of FDX and NKE’s results in the last month that also both signaled to weakness in China.