YUM is on the Hedgeye Best Idea list as a LONG. We continue to believe that there is tremendous intrinsic value in YUM. There are a number of levers the company can pull to create shareholders value!
YUM is up 23% year-to-date, but down about 2% in the past month. The volatility in the Chinese market has not been good for YUM of late. On the margin, the market is going to need to digest an ugly quarter from YUM. Barring any big financial engineering event, making progress on the turnaround in China will be the focus of the current quarter. While things are getting better in China, the improvement will not be enough to convert bears into bulls. The wild card on this earnings call will be to see what if any impact the two activists are having on how management communicates with the street.
SAME STORE SALES
This is the last quarter of difficult comparisons for the China division. Current estimates have YUM China same-store sales at -8.1% for 2Q15E. This puts two-year same-store sale for china at +3.5%, a sequential improvement of 500bps quarter to quarter. 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.
Taco Bell is on track to have another great quarter with same-store sales of 3.4%. The sequential slowdown in the two year trend is consistent with industry dynamics. KFC is also on track to have another strong quarter, while Pizza Hut is a disaster and should be sold!
RESTAURANT LEVEL MARGINS
Given the poor sales performance in China, restaurant level margins will decline 335bps in 2Q15. This is only slightly better than the 451bps decline in 1Q15.
China’s operating margins performance will show a 370bps decline versus 554bps in 1Q15. Consistent with 1Q15, the management team in China continues to do a great job managing costs in a difficult environment.
Despite improving operating margin performance from Taco Bell and KFC, the gravitational pull from the China segment will bring consolidated margins down 177bps vs 187bps in 1Q15
Valuation is off the recent peak, but still at near all-time highs.
Short interest is approaching the highs seen during the peak of the last supplier scandal in China.
Sentiment still has the company as a show-me name with 65% as a hold or sell
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