MorningWord 1/09/13: $YUM Finally Succumbed to Weak China Nums

by Dan January 9, 2013 9:16 am • Commentary

MorningWord 1/09/13:  At RiskReversal, we pride ourselves in giving our readers the straight talk, in fact one of the reasons for the existence of this site is our disdain for the financial double talk that exists in the media, by brokerage firms and none other than the very companies whose stocks we invest in and trade.  Since August we have been sounding alarm bells (8/10/12: “YUM: Likely to Succumb to Weak China Nums“) on the potential slowdown of sales in China for YUM (they get about 45% from China alone), as we just didn’t understand how large U.S. multinationals like MCD and SBUX could be feeling the affects of a slowing Chinese economy, and the owner of KFC and Taco Bell was not.

Well Yesterday, for the second time in less than 2 months, YUM has lowered their guidance for Q4 same store sales.  So they’ve gone from their original +2.5% reading in mid Oct, to their -4% warning in late Nov, to the now likely accurate estimate of -6%.  As you can imagine, I was not all that happy to see my bearish positions in the stock expire worthless after Oct & Nov expirations.   At the time of the first pre-announcement (Nov 30, 2012) I had the following mini-rant in this space:

last night’s press release from YUM in front of their Dec 6th analyst day, reiterating their 2012 EPS growth forecast of at least 13% and put forward guidance of at least 10% EPS growth in 2013.  Here is the hitch, consensus growth forecast has been ~14% for both 2012 and 2013.  What investors will be most concerned with is YUM’s Q4 China comp guidance of -4%, well below consensus and their previous guidance given in early Oct of plus 2.5%.

This is total crap in my opinion, these guys either lied outright 2 months ago when they gave Q4 guidance – a full month into Q4 – or they suck at forecasting sales in a region that accounts for 45% of their sales.  We’ve expected Chinese weakness for a while, because every other company, regardless of sector, has mentioned Chinese slowing over the past 6 months.  Low and behold, YUM might actually be joining the world of actual facts and figures, instead of the fantasy world they seemed to have created in their own results.

There are already some who are saying that it’s simply a case of conservative guidance in the case of YUM.  But the stock has already more than tripled in the past 3.5 years.  At these levels, it only takes one or two missteps, and a 10% pullback becomes a 30% pullback.  At 22x, this stock is too rich for my blood, but the company has pulled the wool over the eyes of investors many times in the last year.  Maybe investors will finally wake up from YUM’s fantasy world.

While that might have been a tad harsh, the stock had just made a new all time high largely predicated on the results and the guidance that the company had just given.  Something fishy is going on here in my opinion.  The company has offered a handful of excuses, suggesting the sales slowdown is the result of investigations into their suppliers and will not become a trend, but that seems a tad optimistic given the circumstances.  Regardless of the fundamentals, the technical picture is a bit broken after the stock’s nearly 250% rise from the 2009 lows, culminating in new all-time highs just 2 months ago.  The chart appears to have made the mother of all double tops.  The stock is now sitting on, or has partially breached, the uptrend that has been in place since the 2009 lows.  If the fundamentals don’t firm up a tad, YUM will likely be sporting a 5 handle in the very near future.

YUM 5 yr chart from Bloomberg
YUM 5 yr chart from Bloomberg


This story is a good example of why we are skeptics when it comes to taking companies (or analysts, or policymakers, etc, etc) at their word.  Vested interests have strong incentives to sway opinion in their favor.  We view it as our duty to call things how we see them, and some of our most profitable trading opportunities have been a result of calling BS when it was warranted.

But there is one more lesson here.  If you have high conviction, persistence often pays.  I didn’t have the staying power on my short YUM idea that I should have had, and I’m slightly pissed about it.  Regardless, this is a broken story, and I’ll look to get involved again on any rallies, especially those accompanied by more corporate BS.





MorningWord 1/08/13: Much like Vegas Bookies do their best to handicap the outcome of ballgames, options traders spend a good bit of their time four times a year (earnings season) focused on making wagers around the market’s perceived implied move for individual names into their earnings reports.   At RiskReversal, we sincerely hope we do a better job than those who forecasted Alabama to beat Notre Dame by only ~10 points in the BCS Championship last night.   As traders looking for arbitrage opportunities, we are often drawn to names that have a tendency to move on earnings, but past performance is never indicative of future returns, so to speak.

Yesterday, Bespoke Investment Group, posted a chart detailing the most volatile stocks from the Russell 3000 index over the last 16 quarters following earnings.  Since many of the names you are not likely to recognize, these are not stocks that we will spend a good bit of time on as we approach our trading in the next couple of weeks, but it is interesting to keep and eye on some none the less to get a sense for how accurate the options market handicaps the moves.

[caption id="attachment_21258" align="aligncenter" width="443"]Bespoke- Most Volatile Stocks on Earnings Days Bespoke- Most Volatile Stocks on Earnings Days[/caption]


We have created our own Implied Move Calculator that should help readers as they assess individual stock’s expectations.  Kristen’s post in Apr 2012 explains the rationale behind the calculator.  During the next few weeks, we will walk readers through our process that will also include Qualitative Inputs coupled with those Quantitative ones that help us arrive at our trading decisions.  Stay tuned for an Earnings Preview in AA prior to tonight Q4 report, and possibly a corresponding trade.


MorningWord 1/07/13:  AAPL is trading down 1% in the pre-market as Barclays is the latest bulge bracket brokerage firm to lower out quarter estimates and their price target on AAPL despite slightly raising their Dec quarter which they feel is getting fairly washed out from a sentiment standpoint.  Here is a quick excerpt from Barcap analyst Ben Reitzes note to clients this morning:

While we are raising our December quarter estimates, we are lowering our long-term estimates given mix (new iPhones, iPad mini). For fiscal 1Q13, we now estimate EPS of $13.38 (was $13.00) based on 17% y/y revenue growth to $54.0 billion (was $52.4 billion). We now estimate FY13 EPS of $49.00 (was $50.92) based on 25% y/y revenue growth to $194.8 billion (was $196.1 billion).

Given lower estimates, our new price target for Apple is $740 as we believe that Apple can continue to be a leader in disruptive mobility and shares are attractive at current levels. This target applies a market multiple of about 13.0x to our new FY14 EPS estimate of $57.45.  

Reitzes goes on to suggest:

Apple is in a rare situation in CY13. Expectations are actually low and getting lower. We believe that many investors fear iPhone sales will be relatively flat this year and that there will be no move into TV that moves the needle. Consensus estimates have moved down steadily in recent months – and we believe that the buyside is finally in
equilibrium with the average sellside figures in aggregate. We do believe it is prudent to temper C1H13 expectations as Apple readies new products and services to be launched in the Spring and through mid-year.

Something else that could be weighing on AAPL shares this week is the plethora of competitive products that will be launched at the Consumer Electronics Show (CES) in Las Vegas from almost every other hardware and software company in the WORLD, except from AAPL.  While this may be very short lived from a sentiment standpoint, AAPL watchers are left to look back at the last few months refresh of almost every major product line and face the realization that the next really new product may not arrive until late 2013.

I would agree with Reitzes that expectations for AAPL’s fiscal Q1 to be reported are getting a bit dour, currently suggesting a year over year decline of 4%, which would mark the first time earnings actually declined in the all important Q1 (which includes holiday sales) since 2003.

Horace Dediu, who writes the very popular blog among AAPL watchers, Asymco, addresses his difficulty in forecasting fiscal Q1 in a post this morning (here):

Management gave very low guidance for the quarter’s earnings and sales. Normally this should not be a concern since the long-term pattern has been for them to “sandbag” significantly.

Management also launched a large number of new products. This normally leads to a surge in sales. The broad roll-out implies a steeper ramp in production and thus more volumes. This would also contradict the lowered expectations from the CFO.

Production was constrained. It was quite a long time before waiting times decreased for the iPhone–longer than what we saw last year.

Margins are complicated. Launch quarters have lower margins typically and this is well understood.

There was a vast increase in CapEx in the prior quarter. Normally CapEx spending “leads” production and is in proportion to it.

He Concludes:

All these currents make this quarter doubly difficult to forecast. And it does not help that it comes on the back of two weak quarters which were argued away as exhibiting transition effects.

So I’m very uncomfortable with my forecast and find it hard to defend this quarter. I considered not publishing one at all because it gives too much confidence when none is warranted.

My conclusion, this is getting very interesting, at least from a sentiment standpoint, where reliable forecasters with good track records are having a difficult time in front of a quarter that should be a slam dunk.   The set up into the Q1 print on Jan 23rd, after the stock’s 25% decline from its all time highs, and after the stock’s apparent inability to rally with the broad market ytd (down 2% vs Nasdaq up 2.7%) and implied volatility maintaining unusually high levels for an extended period of time as broader market volatility has been crushed in the last week may make for a very interesting trade into their earnings. For the time being the stock continues to act like it wants to break the $500 level which it has held  3 times since mid November. But where it is going into their earnings announcement will make all the difference in the world due to sentiment.


MorningWord 1/04/13: The all important and much anticipated December Jobs report is out and……its basically in line to expectations and the unemployment rate remains unchanged, phewwww.  The S&P futures don’t really know what to do (down 3 pts then up 3 pts) after the parabolic move earlier this week, but with the SPX less than 1.5% from the multi-year highs,  I would be surprised if this data alone would be enough to cause a breakout today. I am still in the camp that we will need to see a bit of consolidation above 1450 before we will see a sustainable break-out, but for the moment, the path of least resistance appears to be higher.  Today’s data is a continued sign of the “less bad” economic data that we have been witnessing for the last couple months, but we will quickly get a sense in the coming weeks if corporate earnings and forward guidance reflect some of this economic optimism despite the side show that was the “fiscal cliff”.

On the single stock front, with the Nasdaq Composite up 2.68% out of the gates in 2013, it is hard to find too many large cap tech stocks that are actually down on the year.   EMC’s weak performance ytd (down 3.68%) is in fairly stark contrast to IBM, ORCL, MSFT & CSCO’s gains of anywhere btwn 2% & 4%.  One cause for the under-performance is likely the result of a couple cautious analyst calls on the storage supplier suggesting that the company will miss Q4 estimates as a result of “fiscal uncertainty” and that 2013 guidance could be in jeopardy.  What I find so interesting about the weak price action is that EMC is a stock that is fairly well loved among Wall Street analysts with 39 Buy ratings, only 6 Holds and NO Sells, and there appears to be a fairly large disconnect btwn the analyst community and that of investors with the stock only about 12%   off of the 52 week lows from last January.

EMC has been on my short list of large cap tech stocks that trade with a PEG (PE to expected Growth Rate) of about 1 or lower (EMC has a forward PE of ~12.7 and expected earnings growth of 13% in 2013).  I don’t use this metric to soley make investment/trading decisions but merely as an input, and a way to identify quality companies that may screen as cheap on other metrics.  It is hard to come by too many stocks in large cap tech that have expected eps growth of 10% plus that trade at that multiple (which also happens to be at a market multiple ~13x for 2013), IBM is also one of them but IBM is only expected to grow sales at about 2% a year for the next 2 years, while analysts expect EMC to grow sales at 9% and 12% respectively   The company has about $2.5b of cash per share on its balance sheet, but does not pay a dividend, could this be a catalyst for the stock or will they continue to buy back stock and use the cash for acquisitions?  EMC’s large stake in faster-growing VMW is also looked at as an under appreciated asset, but both companies are highly susceptible to slowdowns in enterprise tech spending…..currently it appears that EMC investors are expecting a continued slowdown.  We will be doing more work on the name as we head into their Q4 report on Jan 29th.





MorningWord 1/03/13:  Just as most traders earlier in the week were eyeing the 1400 level in the SPX and the 200 day moving average on the downside at ~1390 as support, the market catapulted nearly 5% in a straight-line to ~1460  which has served as some fairly healthy resistance since the Sept multi-year highs.  While the move was largely predicated on investors positioning in front of the fiscal cliff deadline, and the resulting compromise, seasonal factors were also likely in play. Remember that the first trading day of the year in 2012 saw the SPX rally ~1.5%.   Just as we had been discussing mutual fund rebalancing since late Oct (out of winners and into some losers), some of this action continues into the new year as investors look for laggards.

Take the price action AAPL yesterday, while the stock was up 3.17%, largely in line with the Nasdaq Comp, the gains were eclipsed by the likes of FB (+5.19%), HPQ (+5.40%) & DELL (+5.28%).  I think there are very few folks on the planet that would argue that the fundamentals of FB, HPQ & DELL are remotely in the same stratosphere as AAPL, but maybe given AAPL’s long term out-performance and its recent fall from grace this signals better investment opportunities elsewhere.

Another name that caught my eye as an under-performer on yesterday’s massive rally was JPM, which was up only 1.57%, vs the XLF which was up nearly 3%.  Again this could have been investors favoring recent under-performers, or beta in the case of C and BAC respectively.

I am not going to make the same mistake that I made last year, by fading the strong equity performance right out of the gate, but I will look for opportunities to get short exposure where I feel the fundamentals don’t match the price action, and where I can identify catalysts.  My short biased trade in XLY yesterday is just one of these ideas where I think we will start to see some kinks in the consumer discretionary armor as we get into the meat of Q4 earnings later this month.  I would also argue that while the VIX move above 22 was likely a near term overshoot earlier the week, yesterday’s close below 15 might have been the same on the downside.  Given the potential for uncertainty around corporate earnings in the weeks to come, a trade similar to the one that we detailed on December 19th (here) could make sense at current depressed levels.

At this point in the rally, as most major equity indices approach long term resistance I would lean a tad cautious, especially as it relates to chasing longs here, the healthiest thing for the market to do here would be to consolidate some of the recent gains near highs and gather some steam for a break-out.




MorningWord 1/02/13:  The shenanigans in Washington over the last few months remind me a bit of my second semester senior year in college that started off with me doing a whole lot of nothing (good that is) the last couple months.  When the eventual year end deadline was looming, and not until the realization that to get my degree on time there would either need to be a “grand bargain” with my French teacher (who barely knew me) to get a “Proficiency” stamp to graduate, meaning I had to learn a foreign language to the standards of an Ivy League institution in a matter of weeks. Well, let’s just say my professor was less than impressed with my politicking and the compromise was between me and my desire to partake in senior week.  I passed my proficiency exam with hours to spare prior to graduation, although it wasn’t pretty, and I can still barely make out the items on French menu and I certainly can’t order them aloud!  

Our elected officials had to bite the bullet and forgo most of their Holiday break and do what their constituents elected them to do.  We have been squarely in the camp that a compromise would get done, but one that would more likely cause further deadlines on some of the most pressing issues, which this one does.  This likely means continued volatility in equities, due to continued uncertainty as a result of further self imposed deadlines.  Maybe investors have become accustomed to this sort of price action since the 2011 Debt Ceiling debacle to the most recent. I doubt it though. But I would suggest that the post election sell-off in Nov, and last week’s were both fairly orderly, and it wasn’t until volumes got very light last week that the VIX actually breached 20 on the upside.  My sense is that investors were not all that bothered, and very few expected the “worst case” scenario, as Enis so aptly discussed in his MacroWrap this morning.

Just as it so happens, investors who have been “cliff dwelling” and had moved to the sidelines are quickly trying to play a little catch-up in the last few days.  I can’t blame them, especially with the new year upon us, but very quickly the conversation will turn to corporate earnings and what sectors will see a drag from increased tax rates on close to 80% of Americans.

We are clearly a bit more cautious than most in the near term, and will be very inclined to get fairly short above 1450 prior to Q3 earnings.  But as we have also been saying, the Q4 earnings set up may be a bit dicey as we expect to hear the words Fiscal Cliff and Hurricane Sandy as frequently as we hear the words cautiously optimistic.

As we get back in the saddle for 2013, we will be most focused on single stock stories in the near term attempting to separate the forrest from the trees, that’s where we think we can add the most value to our readers, not forecasting fiscal outcomes in Washington.

We wish all of our readers a healthy, happy and prosperous 2013, and we thank you for your interest in RiskReversal and your continued support.