Last week, the restaurant sector came into focus, with several
major fast food chains reporting their quarterly results. Among
the list of companies reporting was Yum! Brands, which posted
better than expected earnings for its first quarter.
Yum! Brands is an interesting restaurant stock to watch
because it operates such a wide variety of restaurant chains,
which include Kentucky Fried Chicken, Pizza Hut, and Taco Bell.
Since Yum! Has three major chains under its roof, it provides a
much clearer picture of the overall sector than companies with
just one brand.
At first glance, the report looks great. First quarter earnings
of $0.87 per share came in higher than the $0.84 consensus
estimate, however the report was light on revenues. The company
had Q1 revenues of $2.72 billion, a bit shy of the $2.79 billion
As is the case with most restaurants, Yum! Brands has a lot
riding on growing its Chinese business, were it performed OK just
the quarter, but not as good as Wall Street forecast. China
accounts for around 50% of the company's total revenues, so it is
very important that operations move in the right direction in the
nation. Its same-store sales growth in China was 9%, which is
impressive, but under expectations for 9.2%. The company plans to
open 700 new locations in China this year alone.
The growth in China is encouraging, especially in light of the
poultry supply problems the company encountered last year, which
certainly factored into the company's 20% same store sales
decline during the same period last year. For now it appears as
though China is back on track for the company, but there could be
trouble on the horizon has Avian Flu broke out in early 2014 in
the country and could adversely impact sales in the upcoming
While growth in China remains pretty much on target, sales in
the U.S. are sluggish, and total worldwide sales were up just 4%
during the quarter. Kentucky Fried Chicken sales were up 3%
but were down 3%
in the America. Pizza Hut's international sales were up 8%, while
U.S. sales were down by 3%. Taco Bell fared a bit better in the
U.S., but still had sales drop 1% in the quarter.
Immediately after the company's earnings release the stock
jumped higher, but those gains were quickly erased, and the stock
actually closed down 0.9% on the day following the report. The
good news for investors is that the stock regained its footing,
and is still trading just a bit higher than where it was prior to
the earnings release.
I like the company, and believe that its growth in China is
going to help keep momentum in the stock. However, China plays
such a pivotal role to the company's total health that we have to
be worried about possible sales disruptions should more cases of
Avian Flu come to light. With multiple cases already reported
this year, it could spread at any time, and that would put
Kentucky Fried Chicken sales in serious jeopardy.
With the potential for another Avian Flu outbreak, I would
advise hedging any position on YUM at the current time. You can
use options to set up a hedged trade on the stock that has a nice
target return, but also provides a safe level of downside
protection should the stock head in the wrong direction.
A nice hedged trade on YUM would be the July 65/67.50 bull-put
credit spread. In order to set up this trade, you would sell the
July 67.50 put while buying the same number of July 65 puts for a
credit of 20 cents. This trade has a target return of 8.7%, which
is 37.3% on an annualized basis (for comparison purposes only).
YUM is currently trading at $77.53, so the trade has a
comfortable 12.7% downside protection. As long as the stock
trades higher, flat or loses less than 12.7% before expiration
you will book the total 8.7% return.