Third Point Joins the Party
Third Point revealed in its First Quarter 2015 Investor Letter this morning that it holds a significant stake in Yum! Brands. The fund initiated a position in the first quarter because they believe YUM is in the early innings of a recovery in its Chinese business:
“We believe this development should neutralize the largest overhang on the stock, set the stage for a dramatic profit recovery over the next 12-24 months, and change the public market narrative around long-term shareholder value-creation for the company.”
The Thesis Is Intact
The basic premise of our bullish thesis centered on the fact that YUM was trading at a significant discount to its intrinsic value. We thought there were two ways this value could ultimately be realized: 1) undertaking a variety of value enhancing initiatives or 2) spearheading a turnaround in the Chinese business. For this reason, we pegged YUM as an ideal long candidate for investors that offered substantial upside and multiple ways to achieve it.
The Story Is Stronger Than Before
Right now, it appears the momentum in the Chinese business is making the headlines, but we’d be remiss not to say that value enhancing initiatives are still a massive opportunity for the company. We believe management could unlock value through multiple channels, including aggressive refranchising, leveraging the balance sheet, and/or changing its ownership structure.
If China’s current pace of recovery continues and investors’ fears of structural issues in the region subside, YUM will realize significant operating profit and earnings growth driving a further re-rating of the stock higher. Any value enhancing initiatives outside of this would likely do the same. We previously pegged fair value for YUM in the $95-100 range, but note that a combination of the aforementioned scenarios could propel the stock significantly above this range.
Pushing Back the Pushback
One pushback we’ve heard is that the current recovery in China would likely keep activists away from the name. The truth is, some funds were afraid to get deeply involved with YUM due to fear of the China growth story unraveling. With a recovery on track and long-term growth story regaining credibility, we believe the company is even more attractive as an activist target. The value is there and it will continue to be unlocked – one way or another. Despite the recent run, YUM currently trades at 23.31x P/E (NTM), significantly below its QSR Peers at 28.81x.
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