$YUM Q4 Earnings Preview

by Dan February 4, 2013 12:17 pm • Commentary

Event:  YUM reports their Q4 earnings tonight after the close, the options market is implying about a 5.5% move, vs the 4 qtr and 8 qtr avgs of ~2.75%.

Sentiment:  Wall Street analysts remain fairly mixed on the stock with 16 Buys, 12 Holds and 1 Sell, with an avg 12 month price target of ~$73.  Short interest sits at ~2% f the float. 

Sanford Bernstein last week downgraded the stock from Buy to Hold and lower their 2013 EPS estimates to $3.40 vs current consensus estimates of $3.58.   While the firm believes the stock should trade at a premium multiple too its peers due to its 45% revenue exposure and growth prospects in China, the company sees a meaningful sales comp hit in 2013, as they grapple with Chinese investigations into their chicken suppliers.

Open Interest:  The largest open interest in the name lies int he Feb 60, 62.50 and 65 Puts where there is 15k of the 60 and 65s and 21k of the 62.50s.  On the call side there is about 5k of the Feb 65 and 67.50s and 5k of the April 67.50s open.  The ratio of put to calls is near even at 55% to 45% with no meaningful changes in the last week.

Price Action / Technicals:  The stock has under-performed (-1.75%) the broad market (SPX up 5.36%) and its peers ytd (MCD up 7.68%), as YUM’s Q4 warning on investigation to chicken suppliers is weighing on shares.

The 2 year chart below shows the double top that occurred last year, both instances as the stock tried to make new all time highs.  The stock currently sits below the uptrend that has been in place since the 2011 lows and straddling crucial 1 year support.  $70 should serve as fairly solid resistance in the near term.

[caption id="attachment_22289" align="aligncenter" width="589"]YUM 2 yr chart from Bloomberg YUM 2 yr chart from Bloomberg[/caption]


Valuation / Fundamentals: YUM trades at 18x expected 2013 earnings which are expected to grow 10%, which could be a tad aggressive if the situation in China worsens, and they see some of the softening in the U.S. that CMG has recently warned about.  Also, when you have officials in China claiming that your products have “excessive levels of chemical residue”  then you have problems.  It appears from reports that the Shanghai Municipal Food Safety Commission Office is now moving on to YUM’s chicken suppliers, but the situation remains uncertain.   Much of the  premium U.S. investors have been willing to pay for YUM over MCD (16x 2013 estimates) is for the expected growth in their China division.

Vol Snapshot:  Implied vol is pretty high going into earnings with February and March at 47 and 31 respectively. Historically this is about as high as you’ll see volatility in YUM:

[caption id="attachment_22292" align="aligncenter" width="471"]YUM 1 yr 30 day Implied Vol vs 30 day Realized from Bloomberg YUM 1 yr 30 day Implied Vol vs 30 day Realized from Bloomberg[/caption]

Volatility tends to go to the low 20’s following their reports. So March will lose about 25% at least.

My View: With the Q4 pre-announcement out of the way, the stock will trade solely on forward guidance and any commentary regarding the status of China-Chicken-Gate.  Both of these are obviously fairly well tied together, but any acknowledgement of weakening trends in the U.S. could help the stock establish a new range below $65.  From a technical perspective the chart appears to be broken, but China obviously the wild card, if the company is able to quantify the sales slowdown and speak to re-acceleration and growth in the region shorts would likely cover, but $70 should serve as hefty resistance.    As stated above, even with part of the news out of the way, implied vol remains elevated into the print, and the implied move is more than double the 8 qtr avg, we are looking at ways to take advantage of this spread of expectations vs historical movement.  We will be sure to post anything that looks interesting.