YUM: Built To Last

Yum! Brands (YUM) is selling off strong today after worse-than-expected preannounced China comps spooked analysts and investors last night.  Several downgrades from the Street today have added to the fear, creating what we have seen time and again in this stock: the China scare buying opportunity. 


YUM is geographically diverse from an operating income perspective  (first chart, below) but not so much from a sentiment perspective.  The perception among many investors is that this is a “China stock”.  While China is important for YUM, we would highlight that previous sequential decelerations in China’s Real GDP Growth and YUM’s China comps have not resulted in corresponding deceleration in earnings growth (second chart, below).  EPS growth has been remarkably consistent over the past number of years with economic growth rates in China and other markets varying over time.


YUM: Built To Last - YUM1


With today’s sell off, a spate of downgrades, and what seems to be a full baking in of worse China growth expectations, we believe that YUM represents a very attractive opportunity on the long side. 


YUM: Built To Last - YUM2

Energy and Volatility

We’ve already discussed the importance of the CBOE Volatility Index (VIX) hitting 14 and how it affects stocks, but what about other markets like energy? With volume and volatility moving lower, risk increases. Energy is a high beta sector, meaning that when the broader market sells off, energy sells off further and faster (and vice versa). The Energy Select SPDR ETF (XLE) is heading lower and when the VIX hits 14, it’ll likely take a beating.


Energy and Volatility - xle vix

Watching The VIX


Hedgeye CEO Keith McCullough appeared on CNBC’s Fast Money earlier this week and discussed the markets and America’s debt ceiling issues. One topic that’s more important than ever today is volatility in the market. The CBOE Volatility Index (VIX) is the de facto measurement of market volatility and when the index is at 14 (it’s currently at 15), it becomes a clear indicator to sell stocks. Keith calls it one of the most “obvious, clean-cut sell signals” out there. We short the S&P 500 when the VIX hits the low 14s and will continue to do so when the VIX hits those levels.


Watch Keith's full take on the VIX and when to sell stocks in the video posted above.


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The Vix

Not to be confused with the ‘80s band The Fixx, the CBOE Volatility Index (VIX) is at 15 and fast approaching the key level of 14. When the VIX is at 14, it’s a clear level to sell stocks for us and the rest of the institutional crowd out there. As we head into the weekend, keep an eye in the index in today’s trading. Provided there are no blowout catalysts in today’s market, volatility should remain at current levels.

Turning Japanese

With politicians debating what to do about the Fiscal Cliff on a daily basis and less than a month left until we hit the debt ceiling, things aren’t looking cheery for the United states right now. We’re beginning to look like Japan in ways as population growth slows along with our GDP numbers. The Federal Reserve’s agenda of printing money to solve problems hasn’t fixed anything and has artificially inflated commodity prices and the stock market while devaluing our currency over the years. With the US dollar down two weeks in a row, dollar bulls can’t call the currency the Comeback Kid just yet.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

After a long downward slide, TCB has finally turned the corner. The margin has stabilized after the balance sheet restructuring. Loans are growing thanks to the equipment finance business. Non-interest income is more likely to go up than down going forward, a reversal from the past 18 months. Credit quality has a tailwind from a distressed housing recovery in TCB’s core markets: Minneapolis, Detroit and Chicago. On top of this, the CEO, Bill Cooper, is one of the oldest regional bank CEOs, which raises the probability that the bank will be sold. Expectations are bombed out at this point, so we think it’s time to move from bearish to bullish on TCB.


There is improving visibility on 20%+ EPS growth with P/E of only 11x with better content leading to market share gains. New orders from Canada and IL should be a catalyst. Additionally, many people in the investment community are out in Las Vegas at the annual slot show (G2E) and should hear upbeat presentations by management.


While political and reimbursement risk will remain near-term concerns, on the fundamental side we continue to expect accelerating outpatient growth alongside further strength in pricing as acuity improves thru 1Q13. Flu trends may provide an incremental benefit on the quarter and our expectation for a birth recovery should support patient surgery growth over the intermediate term. Supply costs should remain a source of topline & earnings upside going forward.

Three for the Road


“I wish one politician would call it what it is..taxes, not revenues” -@upsidetrader


“It is amazing what you can accomplish if you do not care who gets the credit.” -Harry Truman


Unemployment in the Eurozone hit a new high of 11.7% in October.


Takeaway: YUM headlines this morning are an overreaction to last night's release, in our view.

As we said on our Yum call yesterday the company has been, and continues to be, a stock that you buy on China scares. The sell off this morning, in the wake of yesterday’s release from the company, presents another opportunity to buy the best Large Cap restaurant stock.  With regard to China, same-restaurant sales is a critical metric but unit growth is more important, in our view, that allows the company to achieve its stated guidance. 


YUM stated that SRS in 4Q are expected to be +4% at YRI, +3% in the U.S., and -4% in China.  The China numbers are missing consensus by 600bps and represent a +8.5% on a two year basis.  Both YRI and the USA results are better that consensus and consistent with our thesis.


On the development front, international development is expected to be at least 1,850 new units for the year, including at least: 800 new units in China (upside surprise), 950 at Yum! Restaurants International (upside surprise), and 100 at Yum! Restaurants India.


YUM is also lapping a Q4 headwind due to an additional week in 2011 fiscal year which produced a combined $26M operating profit benefit to the U.S. and YRI.


The company reaffirmed its guidance for 4Q12 of “at least” $0.82, but the Street was ahead of the company at $0.85.  The reaffirmation of FY12 guidance highlights one of our points during yesterday’s call: the company’s geographically diverse business model allows it to achieve targets despite weakness in certain markets.  In this case, it is its most important business, China, that is seeing weakness but the company is still expecting to achieve its FY12 guidance. 


FY13 guidance contained no material surprises:

  • The company expects at least 10% in EPS growth (street modeling more)
  • At least 1,800 new international units, including at least: 700 new units in China, 950 at YRI, and 150 at Yum! Restaurants India (as per our theses we expect upside to these numbers)
  • Estimated tax rate of about 27% with quarterly fluctuation
  • Foreign currency translation expected to be flat
  • Global capital expenditures of over $1B
  • Interest expense expected to be flat
  • 2% reduction in average diluted shares outstanding as a result of share repurchases
  • Worldwide G&A increase of 3% due to continued growth in China

This morning, the stock was cut to Neutral vs Buy at UBS, Neutral vs Positive at Susquehanna, and Underperform vs Market Perform at UBS.  We would buy the stock on these downgrades.









Howard Penney

Managing Director


Rory Green




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