Event: YUM reports Q3 results tonight after the close. The options market is implying about a 5% one day move, which is rich to its 4 qtr average one day post earnings move of about 2.75%.
Price Action / Technicals: The stock is up 13% on the year, up 25% from its 52 week lows in October 2014, and down about 14% from the 52 week and all time highs made in May after it was announced that activist investor Dan Loeb of Third Point took a large stake.
The one year chart shows the stock’s recent bounce off of technical support last week at $75, but stalling this week at its converging 50 and 200 day moving averages, with the 50 crossing below the 200, which some technicians call a “death cross”:
Valuation: YUM trades 23.5x expected 2015 earnings, near a five year high, and 28x trailing earnings, very near a 10 year, vs MCD at about 21x trailing and current, a company who has faced some of the same issues as it relates to overseas exposure and headwinds from the strength of the dollar.
Fundamentals: China is obviously the wild card here but the stock is also the focus of activists, as some would like to see them unlock some value by spinning off their China division. In 2014 YUM got 53% of their sales from China alone, and much of their future growth. The company has previously committed to 10% eps growth, despite Q1 and Q2 declines. The second half of this year is expected to make up for that given what should be easy compares following last year’s chicken supplier scandal that saw Q4 eps decline 29%. It’s expected to jump 56% this year. Also despite China same store sales declines of 10% for the last few qtrs, Taco Bell, predominantly in the U.S. has seen an uptick, which has offset the dollar strength overseas and China weakness, per WSJ.com:
So there seems to be a little controversy here. A little push and pull between China improving, the countries devaluation of their currency in August, potential for continued improvement here in the U.S. and the potential for a spin out of their Chinese division.
Our Take: If China comps don’t improve, management’s goal of 10% eps growth for the year will be nearly impossible. Interest in spinning off their China division will be less interesting to investors as their domestic businesses serve as cover as they work through issues in China. If that is the case I suspect the stock trades back to $75. If the company demonstrates a beat and is reiterates their prior full year guidance and opens the door for unlocking shareholder value then the stock likely sees the mid to high $80s.
I also suspect that currency noise in the quarter hurt China sales for YUM as sales converted back to dollars will be less than previously expected.
So what’s the trade?
Options prices are high as evidenced by the implied move vs the realized over the last 4 qtrs. The five year chart of 30 day at the money implied vol in YUM shows options prices above the 4 year range, which is a combination of heightened overall market volatility, but also specifically as it relates to a company like YUM’s exposure to one of the most controversial trouble spots on the globe.
For those looking to pick a direction, the at the money weekly options are probably your best bet despite having very little margin for error. For instance with the stock at $82.75 the Oct 9th 82.50 puts that expire on Friday are offered at $2.20, if you bought those you would need a move to $80.30, down 2.6%. If the company were to miss and guide down that should be a fairly easy feat. But if they don’t that is basically in line with the avg move over the last 4 qtrs. But here is the big thing, you NEED to get direction right or you are dead in the water with just three trading days to expiration.
So If i were inclined to make a bearish bet I would probably NOT play for the big move on earnings and look to sell weekly out of the money puts, possibly in the form of a calendar. With the stock at $82.75 the Oct 9th weekly / November 80 put calendar is offered at about $2. If the stock is above $80 you own the Nov 80 puts for $2 and then can look to spread to further reduce premium at risk.
The corresponding bullish calendar also makes sense. Selling the weekly 85 calls and buying Nov 85 calls. That costs about 1.50.
Estimates & Forecasts from Bloomberg:
- 3Q adj EPS est. $1.06 (range 98c-$1.11)
- 3Q rev. est. $3.66b (range $3.5b-$3.85b)
- 3Q total comp. sales est. +3.8% (Consensus Metrix avg of 18)
- KFC comps. est. +2.7%
- Pizza Hut comps. est. +0.2%
- Taco Bell comps. est. +4.3%
- China comps. est. +9.6%; co. said Aug. 18,comp. sales “have turned significantly positive”
- India comps. est. -5.4%
- 2015 adj EPS est. up 14% to $3.51 (range $3.38-$3.65); co. reaffirmed EPS growth of at least 10% (July 14)