This note was originally published March 12, 2013 at 11:40 in Consumer Staples
Last night, YUM reported Q1 (February) China comps of down 20%, with improvement in February versus the overall quarter. The stock is getting a well-deserved bounce today, and we mention it only because one of the names in our staples coverage has some leverage to restaurants in China - MKC. The big difference between YUM and MKC is that MKC has been bouncing hard for about a month now, on no news and with utter disregard for the direction of earnings estimates or the company's multiple.
MKC’s commentary relative to continued Q1 weakness (1/24):
“While the Asia Pacific region had a strong sales result for the Consumer business, demand from industrial customers, primarily quick service restaurants, was weak. This was largely an outcome of less new product and promotional activity versus the year-ago period. We expect this decline to extend into the first quarter of 2013, which has a tough year-ago comparison. If you recall, we grew base business industrial sales in the Asia Pacific region 22% in local currency in the first quarter of 2012.”
We get it – shorting mid-cap staples names is tough – the companies tend to have sticky shareholder bases, multiples tend to be elevated versus the large cap peer group (and seem to matter less) and the opportunity exists for relatively small deals to move the needle on EPS pretty dramatically. However, it isn't often that you see such a dramatic divergence between the direction of EPS estimates and the direction of the multiple in a non-cyclical name. Full-year 2013 consensus estimates have gone from $3.36 to $3.22 since the company reported back in January, and the multiple has expanded from 18.9x (immediately post EPS) to 21.7x.
Perhaps you can make the case the company sandbagged 2013 EPS guidance, but even an earnings base closer to $3.50 puts this name at 20.0x '13, and we are having a difficult time coming to either that earnings base or that multiple. It is our strong preference to deal in what is likely, and we think a more likely scenario is an EPS result for the full-year at or below current consensus.
Valuation is never a catalyst, but the combination of significant multiple expansion in the face of a declining EPS base confounds us, and we don't like being confounded. MKC is fast moving up our list of names whose current price we can't justify or explain, but are inclined to short.