We have written about YUM on several occasions in the past few months, starting with our earnings preview in early October. In that post, I noted that YUM was quite cheap on a fundamental basis vs. other restaurant peers:
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).
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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.
YUM ended up missing on both revenues and earnings on that October report, and sold off hard initially. But that cheap relative valuation attracted buyers, with many also likely making the bet that the worst news out of China was now in the rear view mirror.
The stock made a new all-time high above $75 in late November, quite a surprise after its October earnings miss. However, I pointed out that the breakout quickly failed in my CotD post in December:
We missed a good opportunity to get long YUM after the earnings selloff, though we debated the right entry point and structure amongst ourselves when the stock was trading in the mid-60′s. The stock’s long-term failed breakout has made us a bit less enthusiastic about playing for a significant future upside move. YUM’s favorable valuation and consistent long-term business execution does keep us of the view that the downside is relatively limited, though. We might be on the prowl for yield capture strategies with a slight bullish bias in future situations where the stock gets oversold.
Since then, YUM made a push above $75 once again to start 2014, but YUM’s China comp sales release on Monday threw cold water on that rally. KFC comp sales were up 5% vs. 6% expected, while Pizza Hut was down 3% vs. +5.7% expected. The concerning aspect of those figures is that just as KFC seems to be rebuilding its brand image in China after a hit to business over avian flu fears last year, the Pizza Hut franchise drops the ball. Chinese local competition could also be a factor that YUM management simply attributed to macro fears last year instead.
The drop this week took YUM stock below the 50 day ma for the first time since early November:
[caption id="attachment_34793" align="alignnone" width="600"]
YUM daily, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg[/caption]
A messy chart that still indicates rangebound price action.
For all of YUM’s China missteps, the relative valuation story still looks interesting, particularly in a broader market environment where earnings growth at a reasonable valuation is almost non-existent. YUM’s 2014 earnings are still expected to grow more than 20% after low 2013 comparables due to last year’s weakness. The stock is in the same place it was 20 months ago, with better potential earnings prospects.
BUT, and this is a big but, if YUM does not deliver on its 20%+ earnings expectations for 2014 (which management reiterated in December), investors are liable to quickly lose faith in management.
Monday’s miss lowers the bar for early February’s earnings announcement. Given the technical range, and the push/pull of recent business weakness vs. attractive valuation, we have our eye on this range trade ahead of earnings in a few weeks:
Name That Trade: YUM ($73.20) Buy the Feb 77.5/72.5/67.5 put butterfly for $1.50
*We have not yet executed this trade, but might look to buy it if the premium gets to 1.50 or below on the structure.
Trade Rationale:
This trade structure targets the 69.10 to 75.90 range, which is the technical area that I expect to hold the stock at greater than normal probability over the next month. The $75 level is likely resistance on the upside after the second failed breakout, while the 200 day moving average around $71 is near-term support. Implied volatility in YUM is likely to inch higher into earnings, so we might pull the trigger if 30 day IV reaches the high 20’s:
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30 day implied vol in YUM, Courtesy of LiveVolPro[/caption]