MorningWord 2/3/14: Bull in a China Shop? $YUM

by Dan February 3, 2014 9:25 am • Commentary

Tonight, after the close, YUM will report their fourth quarter earnings. The options market is implying about a 5% one day move which is above the 8 qtr average move of about 4%.  The high implied move is largely a function of elevated implied vol throughout the broad market, which has not been helped by the stock’s dramatic under performance (down 11% year to date) and continued fears of a slowdown in economic activity in China, a region where the company gets more than 50% of their sales and much of their expected growth.

While I love my self a Mexi-Melt from Taco Bell every so often, investors have been most concerned with sales trends of KFC and Pizza Hut (2 chains I wouldn’t be caught dead in) in China.  The company released China December sales a few weeks back on Jan 13th where overall sales were up 2%, below analysts’ consensus of up 6%.  It was a bit of a ying and yang, as KFC was better than feared, and Pizza Hut was worse than expected.  While Q4 is likely to not be that material to how the stock trades, forward guidance will be the key.  Given the plethora of “one off” incidents in the last 18 months as it relates to China (bird flu issues, pork scare, beef issues in US), the outlook may remain a tad murky.

Last year will mark YUM’s first year over year earnings decline in more than 10 years, and its first sales decline since 2009, but analysts are fairly optimistic about a rebound in 2014, with consensus earnings growth of 23%.  On a PE basis, that sort of growth would place the stock at a fairly dramatic discount to expected growth and to peers like CMG.  My friend Stephanie Link, who is the co-portfolio manager of Jim Cramer’s Charitable Trust and runs their Action Alerts Plus product, suggested in a note on Friday:

“China will again be key to its fourth-quarter results, but we see an uncommanding consensus expectation with sales of $4.3 billion and earnings per share of $0.80. We’re also expecting management to reiterate its 2014 goals of 20% earnings growth and 100 to 300 basis points of margin improvement in China.”

It is our sense that the current stock price could reflect the disappointing comp sales of the last few months and any signs of improvement, or increased confidence in a turnaround in China, could cause a bit of a short squeeze.  I would also add that there are few U.S. based multi-nationals that have such disproportionate revenue exposure as YUM does to any one emerging market.  As a result, the stock has likely been used as a proxy for investors looking to reflect a dim trading view in China, which might just be painting with too broad of a brush.

One last point, this past Wednesday there was some interesting options activity in the stock where a trader bought 10,000 of the Feb 70 calls for 77 cents, with 16,000 trading on the day.  Here was my take on CNBC’s Fast Money that day: