New Trade – $YUM: Gap Fill of Hollow

by Dan February 11, 2013 1:30 pm • Commentary

Since last summer we have posted our share of cautious comments (below) on YUM Brands given their heavy exposure to China, and what appeared to be weakening trends for fast service restaurants in the U.S. and Western Europe by some of their peers.  It would appear based on the Jan pre-announcement of their Q4 (the second in 2 months), and the Q1 guidance that was below consensus that reality has caught up a bit to what was once an overly enthusiastic investment community.  So let’s look at it more in depth:

Since last week’s earnings announcement the stock has staged a fairly impressive comeback (up nearly 9%, first chart) after making fresh 52 week lows that almost sent the stock into bear market territory (20% off of the 52 week highs made in late Nov, second chart).

[caption id="attachment_22549" align="aligncenter" width="490"]10 day chart of YUM from Bloomberg 10 day chart of YUM from Bloomberg[/caption]


[caption id="attachment_22550" align="aligncenter" width="490"]1 yr YUM chart from Bloomberg 1 yr YUM chart from Bloomberg[/caption]


The price action in the last week is nothing short of impressive but my sense is this story is anything short but over.  The recent rally presents an opportunity for bears on the China growth story to average in, or look to establish positions for a retest of the long term support level of $60.  But bulls on the stock could point to the fact that a lot of the bad news is in the stock as evidenced by the fact that lowered earnings expectations and supplier scandal has yet to implode the stock and its multiple (trades 20x 2013 estimates that are expected to decline 3% and 17x 2014 that are expected to rebound up 19% yoy).

My biggest fear about pressing the stock on the short side would be the price action in competitor CMG.  While CMG is entirely exposed to North America, so not an exact comparison, sales started decelerating with many thinking the reason was menu moves at Taco Bell (YUM owns them), and the stock saw 3 consecutive gaps lower on disappointing results    The chart below shows 3 gaps, the latest being on their Q4 pre-announcement in mid Jan, but the stock quickly filled in the gap and is now making 5 month highs that sit 22% of the mid Jan lows.

[caption id="attachment_22551" align="aligncenter" width="490"]CMG 1 y chart from Bloomberg CMG 1 y chart from Bloomberg[/caption]


While the price action in CMG gives me a little pause to play for a pull back in YUM, they are 2 very different stories given where both’s growth is expected to come from.  As many readers know, I expect the market to pull back shortly, and I would expect a stock like YUM to retrace a bit of this recent move. Because the CMG chart gives me pause, I chose a structure that had low premium and good risk reward in the case the stock continues higher following its gap fill.


Trade: YUM ($64.75) Bought the March 65/62.50/60 Put Fly for .45

-Bought 1 March 65 Put for 1.85

-Sold 2 March 62.50 Puts at .90 (total of 1.80)

-Bought 1 March 60 Put for .40

Break-Even on March Expiration:

-Profits of up to 2.05 btwn 64.55 and 60.45, with max gain of 2.05 at 62.50.

-Losses of up t0 .45 btw 64.55 and 65, and btwn 60 and 60.45 and max loss of .45 below 60 and above 65

Trade Rationale:  I want to make a low premium play that the stock drifts in a bit over the next few weeks in a period that I think there is a very strong liklihood that the broad market comes in during that time period.  I am not expecting any company specific news during this time period, although an earnings pre-announcement could always happen.  The company’s chicken suppliers in China are being investigated by their version of the FDA, and then have recently suggested that this is more of a supplier issue than a YUM issue, despite pr issues and lost sales.

This is not a table pounder, but my sense is that the stock could come back in a tad over the next few weeks and I am not risking a ton of premium considering the high strike I own is already .25 in the money.




 Comments on YUM from last month:

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.