Name That Trade – $YUM: Third Point Attempt

by Dan May 1, 2015 10:41 am • Commentary

Over the last year my trading in Yum Brands (YUM) has been both right and wrong, with most recent being wrong. Since February there has been some fairly consistent build up in call open interest, in a manner that has been clearly directional and aggressive. That has kept me on the sidelines from expressing a short term bearish thesis.

YUM shares are up 4.5% this morning, trading at new all time highs as a result of the revelation that hedge fund Third Point has taken a “significant” stake in the company (per their Q1 investor letter here).  Dan Loeb who runs Third Point is a legend when it comes to activist investing, he was the guy who agitated for change at YHOO when the stock was below $15, yeah that guy.

That’s all fine and good, but trying to ride his coattails with the stock up 24% on the year, and up 30% from the 2015 lows seems a bit of a Muppet play.  I think it is a safe assumption that Third Point’s average price is below $80 as the stock has just recently broken out above that level and spent most of the first quarter at an avg price of about $76. Reading through Third Point’s letter it is clear that the investment view is not based on short term fundamentals but a longer term improvement in China where the company gets more than half its sales and much of its future growth. Also Loeb has at times been very aggressive in his agitation of his target company’s and who knows what his intentions are.

In the near term though, the stock’s performance has likely been a function of rumor of activist investor involvement. It has certainly kept my bearish leaning views at bay, and I have not traded it since early Feb as I have not wanted to get caught up in this sort of squeeze higher.

As I stated (below) back in February, the guidance for China was squishy at best, and I suspect that another leg lower in same store sales and this stock could re-trace a bit of the recent move back to the low to mid $80s.  Here is the thing, you’d have to be a fool to opposed Loeb’s fundamental view, given the fact that they have committed serious resources to his bullish thesis, and they were not buying the $70s to sell in the $90s. So I would expect to see more noise from Third Point, which should continue to buoy the stock.

Simply put, while this move from $80 to $90 is likely the result of some piggybacking on Loeb’s latest pick to click, it may not exactly be indicative of the current fundamentals and the potential for sales in China to remain poor. For those of you who like to chase this sort of activity I would say wait for a pullback to the mid $80s, and for those (like me from time to time) who like to fade mini-manias, I think there are probably better shorts in the market, near term without a broad market meltdown the likelihood of seeing this stock with a 7 handle aint great.

I wanted to merely update my thoughts from earlier in the year, if I were looking to fade I would consider put calendars, selling short dated puts that have seen spikes in vol terms to finance owning July that will catch Q2 earnings. With the stock at $90, the June / July 85 put calendar is about $1, that’s probably what I’d do, but frankly not that compelled.




Previous Post February 26th, 2015:  Name That Trade $YUM: Kept This One in the Chamber While I Was Ponderin’

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:

YUM 1yr chart from Bloomberg
YUM 1yr chart from Bloomberg

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:

YUM 1yr chart of 30 day at the money IV from Bloomberg
YUM 1yr chart of 30 day at the money IV from Bloomberg

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.

Stay Tuned.