Yesterday, YUM announced plans to de-risk the company from its China business by executing a major restructuring, including the spin-off of its China business (YUM CHINA). In addition, in a shift from their previous thought process, the company will lever-up its remaining predominately franchised business (YUM BRANDS).
We fully believe that this move will create significant shareholder value. The timing of the actual restructuring will be dependent on achieving final approvals and executing the necessary steps, but is expected to be completed by the end of 2016.
As more details become available, we believe the stock will trade higher over time. In the short run, holding things back will be the good bank/bad bank mentality.
Over the coming months, Yum! Brands (the good bank) is expected to execute a Leveraged recapitalization. In a complete shift from it’s current philosophy, YUM announced intentions for its franchised business to “become a non-investment grade credit rating with a balance sheet more consistent with highly-levered peers.” As a result, we believe that the new Yum! Brands will execute a $13-$15 per share leveraged recapitalization, bringing the new company to a debt-to-EBITDA ratio of 4.5x-5.0x. Upon this event we see the stock trading above $80 and the market capturing a majority of the leverage recap immediately.
Spin-off of Yum! China (bad bank for now) will likely be a better managed company as a stand-alone entity. It can also be argued that giving the public a direct way to play in the growth of KFC will boost consumer attachment to the brands - China KFC and Pizza Hut. While not specifically announced, we believe that YUM China will trade on the Hong Kong exchange, and will be the largest consumer company traded on that exchange. It also could be a must own equity for funds and indices in that region. We have long believed that the process of KFC China going public will act as a significant positive catalyst for the business as we have seen numerous times in the USA.
SHAK Chairman, Danny Meyer, said on CNBC last week that all the press about going public helped build brands awareness. KFC China will likely see that same benefit from months of substantial positive press. Lastly, looking at the Corvex plan the Yum! China business can also execute structural changes that can accelerate growth by selling stores and bringing in sub-franchisees.
Our new YUM model assumes that YUM China will pay YUM Brands a 4% royalty rate.
In the coming days we will be updating our sum-of–the-parts model for the combined entities.
Please call or e-mail with any questions.
Client Talking Points
86 of 500 companies have reported and this profit cycle recession we are entering is becoming broad based (i.e. not “ex-Energy”); Financials and Info Technology EPS -8% and -15%, respectively.
Oil is down another -1.5% this morning (after deflating -4.8% last week) and the most important callout here this morning is that the USD inverse correlation to everything WTI/Brent is burning off, i.e. not staying in the -0.7-0.9 zone anymore; this should confuse consensus.
There is nothing confusing about buying LT bonds on every bounce to the top-end of our UST 10YR Yield risk range of 1.98-2.09%; post the bounce to 2.08% yesterday, back down to 2.04% this am, so at least top-down GDP growth and bottom-up earnings slowing is getting Bond Bulls paid.
**Tune into The Macro Show with Hedgeye CEO Keith McCullough in the studio at 9:00AM ET - CLICK HERE.
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Top Long Ideas
McDonald’s reports 3Q15 earnings Thursday, October 22nd before the market opens, with a conference call at 11:00am ET. We are expecting strong sequential improvement in performance globally. We look forward to giving you an update on the company’s performance next week, but this week we wanted to focus on the ‘Looming Crash in Beef.'
On Thursday, October 15th, we held a thought-leader call regarding the declining price of beef and how long it will continue. Prices have sky rocketed in recent years and are now standing at more than two standard deviations above the 30 year average. We believe a 50% decline down to historical averages is well within the realm of possibilities. Declining beef prices will be a major tailwind for McDonald’s as they navigate their turnaround.
Restoration Hardware opened its new Full Line Design Gallery at the Cherry Creek Shopping Center in Denver this week. This is another anchor property -- using 53,000 feet of the 90,000 left vacant by Saks at Cherry Creek.
RH is taking up the size of its stores from an average of 8,000 square feet to about 40,000+ for its new stores – and productivity rates on these new assets are headed higher. In the old stores, RH could only show 10% of its assortment, while in the newer format stores, the company is showcasing better than 75%. Consumers can’t (and don’t) buy what they don’t see.
The #SlowerForLonger theme from Hedgeye Macro has been consistent and straightforward. Our pivot in advance of the most recent jobs report to get long of gold and stay out of the way short-side on commodities turned out to be a good position.
Growth expectations have been correctly revised, but there’s still a good amount of room between Hedgeye estimates and consensus. We are expecting GDP in a range of 0.1%-1.5% for Q3 and another 1-handle in Q4. If that proves accurate, flatter goes the Treasury curve (TLT, EDV), wider goes high yield spreads (bad for JNK), and down goes the USD (GLD).
Three for the Road
TWEET OF THE DAY
VIDEO (2mins) https://app.hedgeye.com/insights/47004-mccullough-short-euro-over-yen… via @hedgeye
QUOTE OF THE DAY
Life is like a dogsled team. If you aren’t the lead dog, the scenery never changes.
STAT OF THE DAY
97% of Tesla owners said they would definitely buy their car again despite Consumer Reports forecasts that the Tesla Model S will have worse-than-average reliability.
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Editor's Note: Below is brief excerpt and chart from today's Early Look written by Hedgeye CEO Keith McCullough.
Unarguably bullish... We're obviously kidding.
"...With Earning Season underway (86 S&P 500 companies have reported) sales “growth” is -3.6% and earnings “growth” is -7.9%, so the substitution on why everyone should be levered long stocks instead of Treasury Bonds is that “it’s all priced in.” #Cool
...But, if you “back out IBM” … and Industrials and Financials … and you don’t back out that Energy Stocks are the best performing S&P Sector Style to be long for Q4 (OCT) to-date at +11.2%, you should be making a ton of sense to your clients."
While that may be true for a regatta, that’s definitely not true for the Old Wall’s stock marketing game.
With Earning Season underway (86 S&P 500 companies have reported) sales “growth” is -3.6% and earnings “growth” is -7.9%, so the substitution on why everyone should be levered long stocks instead of Treasury Bonds is that “it’s all priced in.” #Cool
In other race to the bottom of 2015 “growth” thesis-drift news, Ferrari (not a new company) successfully priced its 17.2M share offering at the “high-end” of the $48-52/share range this morning. And yes, the ticker is RACE!
Back to the Global Macro Grind…
While there was a race for Morgan Stanley to print summer-time US equity strategy notes that explained how the US profit cycle was not peaking (if you look at it “ex-Energy”), here’s the fact of the matter so far in the Q3 US Earnings season:
- Energy – Sales -33%, Earnings -56%
- Materials – Sales -8%, Earnings -30%
- Industrials – Sales -10%, Earnings -6%
- Information Technology – Sales -6%, Earnings -15%
- Financials – Sales -3%, Earnings -8%
- Consumer Staples – Sales -3%, Earnings -1%
- Healthcare – Sales +14%, Earnings -1%
- Consumer Discretionary – Sales +2%, Earnings +5%
But, if you “back out IBM” … and Industrials and Financials … and you don’t back out that Energy Stocks are the best performing S&P Sector Style to be long for Q4 (OCT) to-date at +11.2%, you should be making a ton of sense to your clients.
How can you not laugh out loud at the thesis-drift that’s out there versus the prior “GDP is going to be +3-4%, Earnings +8-10%, and 10yr Bond Yield > 3%” in 2015?
Yesterday’s stock market (SP500) return was -0.14%, but if you looked a foot beneath the surface:
- Biotech Stocks (IBB) were -3.2% on the day
- Healthcare (XLV) was -1.6% on the day
- Capital Markets (IPO) were -0.7% on the day
Meanwhile Oil & Gas Stocks (XOP) tacked on another +0.8% as the US Dollar continued to drip in the face of both #SuperLateCycle GDP and EPS Season #GrowthSlowing.
Once the race started in Q4 (October 1st), remember that most couldn’t have been long this “reflation” trade in Energy and Basic Materials stocks (and short Healthcare) without having had a horrendous time for the year-to-date.
“So”, as Wall Street likes to say, this makes this macro market much more like what Blackrock’s Chief Fixed Income Strategist, Jeff Rosenberg, told me it was on Fox yesterday - “paranormal.”
By “paranormal” Rosenberg accurately explained that bad news is good (for Stock Market Bulls) and good news is bad (for Long Bond Bulls)… all the while, the credit & growth quality side of this setup continues to punish the companies that miss numbers.
That’s also explains why “active” managers who are selecting:
- Contrarian Macro Exposures (Long Duration Bonds, Munis, Utilities, Gold, etc.)
- Organic Growth Longs (GOOGL) vs. GDP Slowing Shorts (CAT, WMT, IBM, etc.)
- Fortress Balance Sheet Credits (long) vs. Credit Spread Blowups (short)
Are absolutely crushing the field in 2015 and haven’t been forced to substitute a new narrative every 3-6 weeks to their investors in order to explain why their performance boat is taking on water.
This is not to suggest that organic growth stories (companies who can show Sales #GrowthAccelerating during a Top-Down #GrowthSlowing phase) won’t slow. Last night, high-flying multiple Chipotle (CMG) talked about October sales being choppy.
As we head into the final leg of the 2015 performance race, the leadership (in US Equities) is narrowing. That makes high expectation stocks like Amazon (AMZN) reporting earnings big bottom-up macro events. And there will be no time-outs.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.98-2.09%
Oil (WTI) 44.64-47.49
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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