For markets in general and individual stocks in particular, market positioning and overall sentiment and mood are the most important factors in valuation. When things in general look good and buyers are plentiful, bad news is shrugged off. But when the general mood is gloomy, any hint of trouble can put a stock under massive pressure. I guess it would be fair to say that the last week or so has seen a negative outlook, so it is hardly surprising that companies that have issued bad news just before or during that time have seen their stock hammered.
Yum Brands (YUM) would certainly fit that description. By the middle of July, as the worries about slowing Chinese growth began to fade, YUM was flying, hitting a new all time high of $83.58 by the 15th, the day before earnings were released. Those earnings weren’t great, showing EPS of $0.73, just below the consensus estimate of $0.74.
As I said, not great, but hardly cause for the 11 percent selloff that took place over the ensuing week.
Yum! Brands (YUM)
There didn’t seem to be anything hidden in the numbers that would justify that either; revenues were a little light, maybe, and Pizza Hut sales were disappointing in the U.S., but overall the earnings release wasn’t too bad. What weighed on the stock was the worry about continuing problems with image in the important Chinese market after a couple of health scares hurt the brands there.
That worry seemed justified at the end of the month when Yum filed an SEC report indicating that the negative coverage surrounding one of its meat suppliers, Shanghai Husi Food Company, was having a “...significant, negative impact” on sales at both KFC and Pizza Hut. Shanghai Husi, which is owned by the Chicago based OSI Group, supplied some stores in the Shanghai area and was also a supplier to McDonalds (MCD) and Starbucks (SBUX) among others, but it was YUM stock that was hardest hit.
This may seem unfair given that Yum immediately severed all relationships with the local supplier and the parent company and that Shanghai Husi was not a truly significant supplier to either KFC or Pizza Hut on a national level, but for consumers, perception is reality. Following on previous food safety scares that affected KFC in particular, this one, it seems, was one scare too many.
So we had a situation where a stock that was already under some pressure and was coming off an all-time high was hit by bad news just as overall market sentiment turned sour; little wonder that the selloff turned into a rout. YUM closed Tuesday at $69.59, 17.64 percent lower than the July 15th high.
If you are a regular reader, you will know what I see here... opportunity. Yum Brands is a solid company with a 16.5 percent operating margin, $1.33 billion of levered free cash flow and a history of sustained growth, even in the under pressure fast food industry. Much emphasis has been placed on their Chinese operations as an engine of that growth in the future, so the reaction to the problem is understandable but if we step back from the immediate reaction, history tells us that “this too shall pass.” In that light, the current selloff looks hugely overdone.
The opportunity that YUM represents is made even more attractive by the proximity of the stock to an established support level at $65. This not only provides support, but also a logical stop loss level should it not hold, at say $64, which would limit losses to under 10 percent.
That stop loss would be wise, as these “scandals” seem to keep coming. It could be that pointing out the shortcomings of foreign companies is a politically expedient way of dealing with broader food safety issues in China, and if that is the case, there may be more to come. Even with that risk, though, YUM looks like a stock where an overreaction to problems has come because of a confluence of temporary bad news and negative sentiment. In my book that’s an opportunity.