Investors aren't exactly digging the fourth quarter earnings season, which has been a disappointment so far.
YUM remains on the Best Ideas list as a long.
- YUM’s balance sheet is significantly underleveraged, highlighted mostly recently by the WEN recapitalization.
- Management must de-risk the business from its significant exposure to China.
- YUM is significantly undervalued and has many levers to pull to enhance shareholder value.
YUM’s Underleveraged Balance Sheet
“We plan to take advantage of the current capital markets environment and low interest rates to recapitalize our balance sheet, targeting a leverage ratio of five to six times net debt to 2014 Adjusted EBITDA.”
–Wendy’s CEO, Emil Brolick
This morning, Wendy’s announced recapitalization and additional refranchising plans. Through a leveraged recapitalization, management plans to take net debt to 2014 adj. EBITDA up to 5-6x in order to raise money and, in turn, allow them to return substantial cash to shareholders through share repurchases and, to a lesser extent, dividends. Wendy’s shares are up more than 5% on the news.
In our view, this news exposes YUM’s underleveraged balance sheet in a very public manner. A leveraged recap was a critical component of the long thesis we laid out in December in a Black Book. The market is allowing restaurant companies to lever up to 5-6x “for free.” BKW (now QSR) levered up to 7-8x and was rewarded handsomely for it. In the case of YUM, all we are asking for is close to 5x, which would allow the company to repurchase ~40% of its equity value.
The stock has been flat for the better part of the past three years, making it an ideal time to announce a transaction of this nature. If management refuses to go this route, we find it highly likely that an outside force will step in to push for it.
Opportunity to De-Risk the China Business
“We expect that the net result will be a reduction in Company-operated restaurant ownership to approximately 5 percent of the total system by the middle of 2016. We believe this reduction in ownership will result in pretax cash proceeds of approximately $400 to $475 million and significantly reduce future capital expenditure requirements.”
-Wendy’s CEO, Emil Brolick
Wendy’s initiative to further evolve its system optimization initiative by reducing the percentage of company-operated restaurants from 15% to 5% is a stark reminder of the attractiveness of the franchise model.
In particular, it reminded us of the opportunity for YUM to refranchise aggressively in China in order to de-risk the business from the recent and, likely, ongoing volatility. Yum China represents a nasty mix for YUM – the business is under pressure and it is a significant part of the company’s overall financial performance.
Not only are global asset light models are trading at a premium to the group, but it’s also an ideal time to be a seller of restaurant assets. If you're sitting on the board, you must consider that now is the right time to pursue a transformational transaction of this nature.
SOTP Analysis Suggests Significant Upside
YUM is a great company, with great brands, that has dramatically underperformed its peers over the past one, three, and five years. We believe both the external (sales trends are positive, multiples are at peak levels, strong demand for restaurant assets, strong demand for global brands) and internal (management changes, structural changes, underleveraged balance sheet) environment make for a perfect time to affect change at YUM.
Despite significant global unit growth potential, high margins, significant FCF, and high returns, the company continues to trade at a significant discount to its intrinsic value – which may not last for long. Management has a number of levers at its disposal to enhance shareholder value and must pull them – before they no longer have a choice.
Wendy’s remains on the Investment Ideas list as a long.
Wendy’s reported 4Q14 results this morning, delivering a top line miss ($502mm vs $509 est.) and in-line EPS of $0.10. Comps were a little light (1.9% vs 2.4% est.), but that’s not the story here.
In the release, management announced recapitalization plans and its intent to sell ~500 additional company restaurants to franchisees by the mid-2016, effectively bringing down the company-owned mix from 15% to 5%. This extended system optimization is expected to raise $400-475 million in cash and considerably reduce future capital expenditures, while the leveraged recapitalization (up to 5-6x net debt/2014 adj. EBITDA) will allow the company to return substantial cash to shareholders primarily through share repurchases and, to a lesser extent, dividends.
In addition to the aforementioned, the company laid out 2020 goals for the system which include:
- 1,000 new restaurants (excluding closures)
- 20% restaurant margins
- $2.0 million AUVs
- 60% of restaurants reimaged
2020 is far out, but that's not the point. The company is heading the right direction by investing in the appropriate strategic initiatives while becoming a leaner, more shareholder friendly company. Asset-light models (PLKI, KKD, DIN, DNKN, etc.) are fetching premium valuations on the public market – and for good reason.
Given the growing, steady stream of royalty income, along with lower G&A and capital expenditure requirements, Wendy’s expects to generate at least $200 million of free cash flow in 2017 and $250 million in 2015. Considering the transformation underway, we believe Wendy’s presents one of the most attractive long-term investments in the restaurant.
Financial highlights from the quarter include:
- Company-operated same-store sales growth of +1.9%
- Franchise same-store sales growth of +1.6%
- N.A. company-operated margins of 16.8% (+50 bps y/y)
- G&A expenses of $60.1 million (-22% y/y)
- Adj. EBITDA of $107.1 million (+20.3% y/y)
- Operating profit of $51.7 million (+78% y/y)
- Net Income of $23.3 million, down from $33.1 million a year ago
- EPS of $0.10, down from $0.11 a year ago
More to follow.
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TICKERS: MGM, RCL, CCL
- Feb 3: WYNN 4Q CC
- ; pw: 57961245
- Feb 12: MPEL 4Q CC
- (1866) ; pw: MPEL
- Feb 17: MGM 4Q CC
- ; pw: 8870181
January Macau revenues - fell 17% YoY but hold was high. Junket volume fell 36%, VIP revenues dropped 17% (adjusted for premium mass reclass: -25%), and Mass revenues tumbled 18% (adjusted for premium mass reclass: -6%). Galaxy was the winner in January with GGR share of 22.5%, up 1.9% bps MoM while while SJM was the biggest loser with market share falling to 21.9%, its lowest share since Sept 2014.
Takeaway: The headline number was bad, but the details were even worse. Please see our detailed analysis in a separate note, MACAU JANUARY DETAIL.
MGM China - announced what it describes as a “discretionary bonus payout” for all non-management team members. The bonus, equivalent to one month’s salary and to be paid this month, was “in recognition of the Golden Lion Team’s steadfast efforts and success in the past year,” said the firm
Takeaway: MGM's 1st labor cost increase for 2015. Will there be more?
Paradise - said it had “successfully deployed” 78 of its Live Multi Game (LMG) terminals at SJM's Grand Lisboa casino-hotel in Macau.
Takeaway: ETGs was a rare growth spot in 2014 for Macau
RCL - Royal Caribbean's Grandeur of the Seas returned home to Baltimore a day early after a number of passengers became sick on the cruise with what is believed to be Norovirus. Royal Caribbean spokesperson Cynthia Martinez said 193 guests (9.91%) and nine crew members (1.15%) experienced the illness. The ship will undergo a ship-wide cleaning and disinfection after the guests disembark. The terminal will also be sanitized.
Takeaway: Well 2015 almost made it through Wave with Norovirus.
RCL – Cruise lines are starting to see declines from one of their most important revenue streams, shore excursions. That was one of the admissions made by newly named Royal Caribbean International President Michael Bayley at a forum for agents onboard the Freedom of the Seas.
Takeaway: Some agents blame low commissions on the shore excursions We think it's also due to more competition.
CCL - As part of Cunard’s, ‘Our birthday. Your present,’ celebrations surrounding the brand’s 175th anniversary year, passengers will receive additional complimentary on board spending money on selected sailings in 2015. Passengers who book a Cunard cruise before February 28, 2015 will receive between $120 and $1,595 complimentary on board spending money per person when booking with a Cunard Fare - double the amount originally offered when the offer started in December.
DC scratch-off- Washington DC will start selling scratch-off lottery tickets. A spokesman for the city’s CFO said Friday that the city has entered into new contracts with two of the three North American companies that print instant tickets. The first new tickets will go on sale on Wednesday.
Takeaway: SGMS was probably one of the two contractors.
China China broadened its graft probe into the financial sector today. Bank of Beijing Co Ltd board director Lu Haijun is under investigation for serious disciplinary violations, the bank said, the latest high-ranking banker to fall under scrutiny as China's anti-corruption drive turns to the finance sector. Chinese President Xi Jinping has warned that the problem of official graft is serious enough to threaten the Communist Party's legitimacy and has vowed to go after powerful "tigers" as well as lowly "flies".
Hedgeye Macro Team remains negative Europe, their bottom-up, qualitative analysis (Growth/Inflation/Policy framework) indicates that the Eurozone is setting up to enter the ugly Quad4 in Q4 (equating to growth decelerates and inflation decelerates) = Europe Slowing.
Takeaway: European pricing has been a tailwind for CCL and RCL but a negative pivot here looks increasingly likely in 2015.
Takeaway: January held high and VIP volumes remain depressed.
CALL TO ACTION
Macau gross gaming revenues (GGR) declined 17% YoY in January. While in line with our last forecast, January performed below our expectation at the beginning of the month. Gaming volumes deteriorated from Q4, seasonally adjusted. In other words, Macau trends worsened to start the year. Worse, extrapolating and seasonally adjusting the recent 3 month trend (October to December), February could be down 35% YoY and that would NOT be indicative of further deterioration of the underlying metrics. Optically, February will look very bad.
Please see our detailed note:
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