Event: YUM reports its fiscal Q3 earnings on Tuesday, Oct. 8th after the close. The options market is implying about a 3.25% one day move, which is below the 4 qtr avg of about 4.5%, but in line with the 8 qtr avg of about 3.25%.
Sentiment: Wall Street analysts are mixed on the stock, with 11 Buys, 16 Holds and 1 Sell, with an average 12 month price target of around $78. The stock is flat in the past year, a dramatic underperformance of the broader market.
Options Open Interest: Open interest is evenly split between calls and puts. The bulk of the open interest is in Oct and Jan14, with the 65 strike puts having a large amount of open interest in both expiries. The Oct 75 calls also have significant open interest. The stock’s high for the year is $75.13, and its low is $59.68.
Price Action / Technicals: YUM’s weekly chart shows the 1.5 years of consolidation that has taken place in the 59-75 range during that period:
The chart’s been a mess throughout 2013, chopping back and forth. You could perhaps watch the 68-69 area for near-term support, and the 74 area for near-term resistance, but those long-term levels are of far more importance.
Fundamentals: YUM was on a roll from 2003 to 2012, increasing earnings by 10-20% in every single year but one (2005). The fast-food franchiser (75% of KFC, Pizza Hut, and Taco Bell outlets are owned by franchisees) also was a first mover in China, developing a strong and important foothold in the most populous country in the world. That consistency of execution and strategic foresight led to a move from near $10 to over $70 from 2003 to 2012, with a brief selloff in 2008 the only real major correction for the stock in that entire period.
So long-time YUM investors have likely been surprised by the lackluster performance of the stock in the last year. Earnings have actually declined about 5% in 2013 vs. 2012, with the Chinese business (about 45% of revenues) the main culprit. In management’s own words, from its most recent 10-Q:
In late December 2012 our KFC China sales began to be negatively impacted by intense media attention surrounding the poultry supply incident in China, as further described in our 2012 Form 10-K. As a result our KFC China same-store sales in the quarter ended March 23, 2013 (January and February for the China Division) declined 24%. KFC China sales were further negatively impacted beginning in April by the intense media surrounding Avian Flu in China. The combination of the intense media surrounding Avian Flu and the residual effect of the December poultry supply incident resulted in our second quarter (March through May for the China Division) KFC China same-store sales declining 26%.
The company finally expects positive same-store sales in China in the fourth quarter. Investors have largely taken the company at its word, as the stock has not really declined despite the poor earnings in 2013. That’s because the stock does look quite cheap vs. its peers if 2013 does prove to be the trough for the Chinese business, and it re-accelerates in 2014 and 2015.
Analysts expect around 20% earnings growth over the next 2 years for YUM, with some help from low comparables after this year’s weakness. But this is a 22.5 P/E stock, cheaper than other fast growers like SBUX (37 P/E, 21% expected growth) and CMG (45 P/E, 22% expected growth), and better value than slow growers like MCD (17 P/E, 10% expected growth) or DRI (16 P/E, 10% expected growth).
That’s what makes the next couple earnings reports crucial. If YUM can show that its Chinese business is back on the fast track, this stock is cheap vs. peers and likely going higher.
Volatility: YUM has been rangebound all year, but the stock has been especially quiet in the last month. Realized volatility is at a 1 year low:
Not surprisingly, implied volatility ahead of earnings is lower than usual as a result of the low realized. It is likely to move into the high teens after earnings.
Trades: This is one of the better-valued stocks in the restaurant space. If YUM shows progress on the Chinese turnaround, then we see the potential for a breakout to new all-time highs in the next few months. We might look for a way to participate that does not leave us exposed to decay.