Name That Trade – $YUM: Colonel Tso

by Dan July 14, 2015 12:31 pm • Commentary

Event: YUM reports Q2 results tonight after the close.  The options market is implying about a 6.5% one day move which is rich to the 4 qtr avg of 3.6% and the 8 qtr avg of about 4%.

Sentiment: Wall Street analysts are fairly mixed on the stock with 10 Buy ratings, 14 Holds and 3 Sell ratings with a 12 month price target of $92.39, just a tad above where it is currently trading.  Short interest is just 2% of the float.

Price Action / Technicals:  YUM is up 26% ytd, and down about 3% from the all time highs made in late May.

The stock’s breakout to new all time highs in the spring was a buildup in front of the eventual announcement of activists taking large holdings in the stock.

Excluding last week’s dip to $85, the stock held the uptrend that has been in place since last October.  I suspect the prior highs, and the breakout level should serve as a range the stock should consolidate in between until we get some color from the activists’ intentions.

[caption id="attachment_55299" align="aligncenter" width="600"]YUM since Jan 2014 from Bloomberg YUM since Jan 2014 from Bloomberg[/caption]

Fundamentals / Valuation:  YUM trades 26x expected 2015 eps growth of 13%, and 22.5x next year’s expected eps growth of 17%, on sales growth of 6 and 9% respectively.  The stock’s earning’s multiple on a trailing and forward basis is nearing 10 year highs:

[caption id="attachment_55300" align="aligncenter" width="541"]YUM P/E forward and trailing eps from Bloomberg YUM P/E forward and trailing eps from Bloomberg[/caption]

Back in February after the company reported Q1 results, I had the following to say on YUM’s forward guidance:

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.

As for that second half earnings recovery.  Analysts expect a massive uptick year over year, with 26% and 59% eps growth respectively in Q3 and Q4 after an 8% decline in Q1 and an expected 14% in the quarter just ended.

My View:  I would be very surprised if YUM is able to provide a material guide up given the uncertainty around China’s economic growth, a country the company gets a little more than 50% of their total sales.  The company stopped issuing monthly comps, so the quarter just ended is a bit more opaque than usual. But I suspect a Q2 miss will be overshadowed by either a guide up, or merely thrown on the heap of a guide down.  Given the new-found presence of activists investors like Third Point, I suspect the stock find support in the mid $80s.

Prior to numerous activists taking stakes, it was my guess that YUM would have been ground zero for U.S. multi-nationals who do a lot of biz in China on the slightest confirmation of decelerating growth. That has clearly been wrong.

So the question you have to ask you self is whether or not YUM deserves to join the DIS, FB, NKE, SBUX club??

Potential Trade:

If that’s the case you may want to fade the event itself near the previous highs in order to own the follow trough over the next month. One trade that looks interesting from a vol perspective is the July/Aug 95 call calendar. This costs about 1.20 and is selling July vol in the 80’s (albeit expiration week vol so not totally apples to apples) and buying August vol at about 34.

When you see a vol difference like that it typically means a wide range of profitability. If the stock went nowhere you’d be even or up a little money tomorrow, if the stock went higher you make money, with 95 being really profitable but even above that for a few dollars. The only losing scenarios are a move downward or a really big move higher. August vol is high and would likely come in 30% or so but with all the volatility in China it’s unlikely to go back as far as recent lows.