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YUM: TOO BEARISH OR TOO BULLISH?

Yum! Brands remains one of our favorite names for 2013, despite the China controversy in January which, given the nature of the event, took many people by surprise.  For people looking for a longer-term idea in consumer, we think they would be hard pressed to find a more attractive opportunity than YUM at these levels.  YUM reports 4Q12 EPS on 2/4.  


It’s only February 1st and, already, so much has happened in such a short period of time.  Since YUM hosted its analyst meeting on December 6th, the following sequence of events has transpired (annotated in chart below):

 

1. 12/18-12/20: A story emerges that a Chinese chicken supplier had “used excessive additives in chicken feed”.  We believe the stock has been punished three additional times for the same story being rehashed in the media news cycle since first emerging

2. 1/07: YUM guides down FY12 EPS and warns that, as a result of negative media exposure, KFC China significantly impact during last two weeks of the year

3. 1/10: YUM CEO issues online apology

4. 1/17: Argus downgrades to Hold.  Xinhua publishes article stating that KFC supplier didn’t process sick chickens

5. 1/18: Shanghai vows “severe” punishment on KFC “violation”, according to the China Daily

6. 1/25: Bronstein, Gewirtz, & Grossman LLP announces a class action lawsuit against Yum! Brand.  Xinhua says, “Shanghai finds excessive animal drugs in Yum Chicken”.

7. 1/30: Yum! Brands shares cut to market perform versus outperform at Bernstein

 

YUM: TOO BEARISH OR TOO BULLISH? - yum media cycle

 

 

It is worth noting that, between the Analyst Meeting on December 6th and today, there has been a significant swing in consensus expectations for 4Q12, 1Q13, and FY13 EPS:

  • 4Q consensus EPS on 12/6 was looking for $0.84 or 12% y/y growth.  Now expectations are for $0.82 (9% growth)
  • 1Q13 consensus EPS on 12/6 was looking for $0.84 or 6% y/y growth.  Now expectations are for $0.80 (1% growth)
  • FY13 consensus EPS on 12/6 was looking for $3.67 or 13% y/y growth.  Now expectations are for $3.57 (10% growth)

 

Sentiment Swing

 

Sell-side sentiment on YUM has changed drastically in the last six months.  The percentage of buy ratings among sell-side analysts covering the stock peaked at just over 70% in May (29% hold, 0% sell).  The latest reading is 55% buy, 41% hold and 3.5% sell. 

 

 

It’s Not All China

 

News flow on YUM is focused almost exclusively on China and none of it is positive.  The company needs to do its part to counteract the negative stories (often repetitive rehashes) to highlight the positive things that are happening within the company.  As we highlighted in December, Yum! Brands is a resilient company because of its diversification.  It is perceived to be a “China-stock”, and China is an important component of its future, but 42% of the company’s operating profits are derived from markets outside of China. Over time, this and other attributes have led to steady gains in its share price and consistent EPS growth while competitors such as SBUX have seen more volatility over the years. 

 

YUM: TOO BEARISH OR TOO BULLISH? - yum mcd sbux opinc

 

 

Reaction to Chinese News May Be Overdone

 

The company has resolved its issues with the Chinese government and, as concern over the food scandal gradually dissipates, the company should be able to spend a greater portion of its time focusing on continuing to grow the business.   We expect the management team to articulate a clear plan of action to reach out to the Chinese consumer, including the acceleration of new food introduction schedules in the market.  It would also not be surprising to hear of an increase in the China division’s advertising budget with a view to reassuring the Chinese consumer that KFC is a trustworthy brand.

 

 

US Business Transformation From Class Clown to Teacher’s Pet

 

The US business is now a bright spot in the company’s press release, after years of disappointment.  We expect Taco Bell, in particular, to be a positive with same-restaurant sales at roughly 6% versus consensus of 5.5%.  On a consolidated basis, operating margins are expected to improve by 87 bps to 13.8%, driven by the US and YRI, offset by China.  Seasonally, YUM’s business tends to produce its thinnest margins in the fourth quarter. 

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst

 

 

 

 


Beer Mergers and the DOJ - An Academic Perspective

While surfing for some light weekend reading, I stumbled across an interesting article that appeared in the Review of Industrial Organization back in 2005 (yes, yes, I need to get out more).  The title is “The Supreme Court and Beer Mergers: From Pabst/Blatz to the DOJ–FTC Merger Guidelines.”



At a minimum, it is an interesting retrospective on the history of the beer industry in the U.S., with mention of some venerable beer brands (Hamm’s, anyone?).



The paper argues, compellingly, I believe, that the review of mergers and associated antimerger rules needs to progress as “economic understanding” progresses.  Word of warning, the article is bone dry, so a cup of coffee next to your computer is very much in order.  On the plus side (for you), I had to read the whole thing (yay me?).  It was also written prior to the merger of Anheuser-Busch and InBev, but the findings are still very much relevant.  Let’s get started.



“The first antimerger action in the beer industry was taken by the Antitrust Division in 1958 against the industry’s leading firm, Anheuser-Busch.  Anheuser-Busch had purchased the Miami brewery of American Brewing Company. The government successfully argued that this merger would eliminate American Brewing as an independent brewer and end its rivalry with Anheuser-Busch in Florida.”



What’s interesting here is that the government appears to have a long history of thinking (and acting) locally when examining beer markets.  What is also interesting is that Anheuser-Busch completely abandoned acquisitions as a means to growth for over two decades subsequent to this unsuccessful deal.  Instead, Anheuser-Busch spent its time and capital building efficient brewing capacity across the country (Florida included).  Anheuser-Busch’s market share leadership has been undisputed since 1957.

 

“Bottom line: mergers have not made much of an imprint on the structure of the brewing industry, and have not resulted in market power for merging partners. The most active merging firms, Stroh and Heileman, eventually failed. Much of the increase in concentration in the past three decades was due to the growth of Anheuser-Busch, Miller and Coors, whose expansion has been largely internal.”

 

The DOJ has taken the beer industry before the United States Supreme Court twice - U.S. v. Pabst (1966) and U.S. v. Falstaff (1973).  In both cases, the mergers were seen as anti-competitive, for different reasons in each case, but thinking that largely reflected the belief that mergers that took place in an industry with an existing trend toward industry concentration were anti-competitive.

 

“The mid-1970s saw the beginnings of a radical shift in antimerger enforcement doctrine – a major change in what Bork (Judge Robert H. Bork) called “the economic rules.”  In response to the work of Bork and others, the Chicago School of economics gained ground, and its focus on economic rigor in legal reasoning and an emphasis on consumer welfare as the goal of antitrust enforcement had a significant influence on antitrust law.”

 

This change in thinking ultimately led to the adoption of the DOJ-FTC Horizontal Merger Guidelines, where the focus shifted from simple concentration of market share to a discussion of “market power”.  Market power was defined as “the ability profitably to maintain prices above competitive levels for a significant period of time.”

 

“Contrary to the precepts of Pabst and Falstaff, under the Guidelines, ‘although large market shares and high concentration by themselves are an insufficient basis for challenging a merger, low market shares and concentration are a sufficient basis for not challenging a merger.”

 

The paper concludes with the following:

 

“Increases in concentration in brewing are neither the result nor the cause of market power. The reasons, rather, are benign: the exploitation of scale economies and the demise of suboptimal capacity; new or superior products; changes in packaging and marketing methods; poor management on the part of some firms; and the strategic use of product differentiation. As a consequence, Anheuser-Busch, Miller and Coors no longer face an array of robust domestic brewers. Brands like Schlitz, Pabst, Old Style, Stroh, Ballantine, Schaefer, Falstaff, Olympia, Rheingold, Ruppert, Blatz, Lucky Lager, Hamm’s, and the firms that produced them, are gone or are shadows of what they once were. But the big three domestic brewers now face significant import competition, in some cases from large brewers with operations in many countries, and significant competition from specialty brewers.”

 

We would add to that last point that brewers are also facing competition from wine and spirits makers, as beer continues to lose share of liver as a multi-year trend.  The DOJ gave little thought to the substitutability of these products.



Interesting stuff, and intuitively compelling.  As we pointed out in our prior note, we believe a critical and honest examination of the fact pattern in the proposed Anheuser-Busch InBev/Modelo transaction would support the notion that the transaction be allowed to proceed as contemplated.  The idea that Modelo’s 50% control (through Crown) of 6.5% of the U.S. market has been some mitigating factor on pricing across the rest of the 94.5% doesn’t exactly ring true to us, particularly in light of what has been an extraordinarily benign pricing algorithm throughout history.

 

Further, we don’t believe that the DOJ gave any credit to the indirect nature of the control that ABI will have over Crown, preferring to call it a façade.  We believe that the parties are talking, and will continue to talk.  Both STZ and BUD make sense when the deal gets done, with STZ seeing the greater upside potential in the near-term, but also more downside in the event of incremental negative news flow.

 

Enjoy your Sunday,

 

Rob

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

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P:

 

Matt Hedrick

Senior Analyst


TRADE OF THE DAY: WYNN

Today we shorted Wynn Resorts (WYNN) at $126.40 a share at 3:35 PM EDT in our Real-Time Alerts. For a trade, just managing the risk range of WYNN (its immediate-term TRADE overbought here). Hedgeye GLL Sector Head Todd Jordan is concerned about share losses in Macau (longer-term thesis).

 

TRADE OF THE DAY: WYNN - TOTD


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THE WEEK AHEAD

The Economic Data calendar for the week of the 4th of February through the 8th is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.

 

THE WEEK AHEAD - week


KMB - Still a Short

We have been vocal in our dislike for KMB at these levels given what we see as a deterioration in earnings quality - valuation is getting stretched and Keith is getting the signal to short.

 

KMB - Still a Short - KMB PE

 

Have a great weekend,

 

Rob


Berlusconi Buys Votes

To take you into the weekend I’ve copied a very good note below from the Irish Times on Berlusconi’s recent acquisition of star soccer player Mario Balotelli from Manchester City to his club AC Milan. It’s a move Berlusconi hopes will fuel not only balls in the back of the net but importantly more votes to get him another term in office.  With much uncertainty remaining on the structure of a coalition government in the February 24-5 Italian general election, especially following the scandal surrounding the government’s bailout of one of Italy’s oldest banks, Monte dei Paschi di Siena, we thought Berlusconi’s potential back-pocket influence was worth a call-out.

 

Matthew Hedrick

Senior Analyst

-------------

 

As well as goals, it looks as if Berlusconi bought Balotelli for votes

PADDY AGNEW in Rome

 

For a majority of Italian observers this week, the big question surrounding the much reported €20 million transfer of Mario Balotelli from Manchester City to AC Milan concerned votes, not goals. Could the purchase of this obviously explosive (in every sense) talent really win over 400,000 votes for the centre-right coalition led by the irrepressible, 76-year-old former prime minister Silvio Berlusconi, who, of course, just happens to be the owner of AC Milan?

 

In the short term, there is no doubt whatsoever that the Balotelli transfer has been a brilliant publicity coup, making the prime-time news bulletins and the newspaper front pages for three days in a row, right in the middle of a red-hot general election campaign. In football terms, this is clearly a huge moment for the Italian game, with populist sentiment ready to perceive this transfer as the return of a talented prodigal son, following two years of cultural misunderstanding in the land of the Anglo-Saxon.

 

Football professionals know that this is not quite the case. Those who have worked with Balotelli know all too well that, on occasions, he can make the Mad Hatter seem like an understated chartered accountant.

 

However, everybody knows that the “boy” can play and it is in that context that he been greeted like a returning hero.

 

Riot gear 

On Wednesday, Milan fans followed his every move back on Italian soil, greeting him when he arrived at the airport, when he then went to a nearby health clinic for his medical check and, finally, when he went to the Giannino restaurant in downtown Milan for dinner with AC Milan managing director Adriano Galliani and team coach Massimiliano Allegri. So enthusiastic was the 400 strong gathering of fans outside the restaurant that police had to don riot gear and restore some peace after “Balo” had slipped in by a side entrance.

 

By yesterday, sports daily Gazzetta Dello Sport was selling T-shirts reproducing Wednesday’s front page of the paper, totally dominated by a picture of Balotelli and bearing the headline “Balo Is Back”. Gazzetta even carried a picture of the “good luck”, AC Milan biro pen which Balotelli used to formally sign his new contract yesterday.

 

All of this might sound like just another big football transfer story. Yet for those of us who have monitored Mr Berlusconi’s 20-year long, complex intertwining of football and politics, this is clearly about more than football. Remember, Berlusconi is the politician who in 1994 “took to the field” of politics with a brand new party called “Forza Italia” (literally Up Italy), an expression that until then had only been used when cheering on national teams.

 

Political appeal 

The original Forza Italia deputies were referred to as “Azzurri”, a term that had previously only referred to national team players. Perhaps the most emphatic example of Berlusconi’s understanding of the role of football success in his political appeal came during that 1994 election campaign. In those far-off days of single seat constituencies, he taunted his centre-left rival in the Roma I constituency, the late distinguished economist, Luigi Spaventa, with the words: “Before running against me, go and win yourself two Champions Cups.”

 

As for Mario Balotelli, the narrative is very clear. After years when he appeared to pay little or no attention to his club, rarely attending either training or games, Berlusconi late last autumn suddenly got active again on the AC Milan front. Not only did he resurface for Serie A or Champions League games at the San Siro but he also began to make regular Saturday morning visits to the club’s Milanello training ground.

 

For Berlusconi, Milanello is not just an alma mater but it also represents a very loyal and safe political constituency. Nowhere else does he so clearly portray himself as a “winner”. Remember at his first meeting with Milan players back in 1986, just after he had bought the club, he told then that he was “not accustomed to finishing second”.

 

Thus given Milan’s current league standing of fifth, it was time to put some money back on the table, hire a big name and get the “winning” show back on the road. If that helps win matches, good. If it helps win votes, even better. In a week, too, when he had been bitterly attacked for pro-Mussolini comments made on Holocaust Memorial day, what better stroke than to hire a brilliant, black Italian. Who says I’m racist now?


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