In the last few months we have placed two bearish trades in YUM, one for a gain back in December in front of what I expected to be lowered Q4 guidance (here) and one for a loss earlier this month in which I expected to see lowered full year guidance (here). What aggravated me about the last trade (aside from being a loser) was the guidance that the company did give for 2015 was very much back-end loaded, and demonstrated in my mind the lack of visibility they have in their largest growth market, China. My explanation from Feb 5th:
The company expects China weakness to continue and the “pace of the recovery is slower than expected”. The company said they are “committed to 10% eps growth in 2015″. This seems hopeful for a company that has not achieved this goal for the last two years. The company suggests that a rebound in China in the second half of 2015 will be the impetus for double digit eps growth. I view this guidance as squishy at best. I am shocked the stock is up. It is my view that management has a massive credibility problem and after listening to the Q&A on the conference call the company is doing their best to put lipstick on a pig.
Last week when the February put spread expired worthless I wanted to roll the bearish view, but took pause as a couple traders were looking for a sharp rise by the end of this week, and possibly another by March expiration:
When the stock was $76.39 there was a buyer of 3,000 Feb 27th next week 77.50 calls for .47 to open and a buyer of 5,000 March 82.,50/85 call spreads for .15 to open.
I generally don’t base trading decisions on unusual options activity, but in this case seeing the directional commitment in the short dated calls was helpful, this guy got it right as the weekly calls are a nice winner, and the March call spread has appreciated, but has a long way to go.
The stock has made new 7 month highs, taking out the December high, and is now up 8% on the year:
MY VIEW: The guidance seems to be a tad sanguine, and the company seems to have a never-ending issue with food suppliers in China of which they get more than half their sales. Q4 marked a 16% same store sales decline, its worst quarterly decline in a year and half. On the bright side they had less sales in China able to be negatively impacted by the strength of the dollar. So there’s that.
My bearish thesis may take some time to play out as investors at the moment are giving YUM’s new CEO the benefit of the doubt, but I suspect it will only take one more hiccup in China in the coming months to have investors realize the stock’s premium earnings multiple (23x expected 2015 earnings growth of only 12%) is a tad rich for a company who has pinned its growth hopes on such a volatile region while facing increasing competition at home (Chipotle vs Taco Bell for instance, Domino’s vs Pizza Hut).
Despite options prices down significantly from the recent 52 week highs, implied vol remains elevated reflecting some trepidation from investors. This creates the potential to sell short dated puts to help finance the purchase of longer dated puts:
At this point there is little overhead resistance on the chart to the somewhere near the low strike of that call spread detailed above, so I am going to continue to ponder the entry. But gun to my head here this is my trade:
Hypothetical Trade: YUM ($79) Bought to Open April / July 75 Put spread for 1.75
-Sell to open 1 April 75 put at .95
-Buy to open 1 July 75 put for 2.70
Break-Even on April Expiration:
Max profit at 75,
Max risk of 1.75 with a sharp move above or below the 75 strike.
Ideal scenario is that the stock grinds lower to 75 and the April 75 puts expire worthless or I cover them for far less than I paid and look to to turn July puts into a vertical.
Rationale: The next earnings report are expected in late April, likely to fall in May expiration, but May is not listed yet, but that is the next real catalyst, so July expiration will have to do for now.