Since Yum China (YUMC) reported worse-than-expected Q3 2023 results on Nov. 1, YUMC shares have been on a downward spiral, losing 26% of its value, and hitting a 52-week low on several occasions.
The first was Dec. 13 ($38.99), followed by a resurgence into the new year. Yesterday, it hit another 52-week low ($38.98), and as I write this early in Wednesday trading, it’s down to $38.09, setting another new low.
The Barchart.com Technical Opinion says YUMC is a 100% strong sell in the short term. All the short-term, medium-term, and long-term indicators say sell.
Here’s why I believe you ought to buy it. In addition, I’ll give you two ways to play Yum China without losing your shirt.
The Reason for YUMC Negativity
As StockStory reported on Nov. 1, YUMC stock lost nearly 12% of its value halfway through the day’s trading session on grim news about its growth in Q3 2023. It ultimately closed the day down more than 15%.
“[The] company reported third-quarter results with revenue, gross margin, and EPS all falling below Wall Street's estimates. These misses were driven by its lower-than-expected same-store sales growth, which is usually higher margin revenue than sales from new restaurants,” StockStory surmised.
On the top line, Yum China had revenue of $2.91 billion, $180 million shy of the analyst estimate for the quarter. On the bottom line, its adjusted EPS was 59 cents, three cents less than analyst expectations, with a 140 basis point reduction in its gross margin to 17.9%.
It opened 500 net new stores in the quarter, bringing its total count to 14,102. Should China’s economy ever get rolling, the numbers it will push out will be staggering. But clearly, we’re not there yet, as
Forgetting the analysts, its revenues were 15% higher year-over-year, excluding currency, with a 15% increase in system-wide sales for KFC and 13% for Pizza Hut. Its same-store sales rose 4% in the quarter thanks to a 4% increase from KFC and 2% from Pizza Hut.
As CFO Andy Yeung stated in its press release, the company’s 4% same-store sales growth was approximately 90% of its Q3 2019 results, suggesting its business isn’t nearly as gloomy as investor reaction might indicate.
It expects to open 1,500 net new stores in 2023 at the midpoint of its guidance, 300 more than its initial guidance earlier in the year.
With $870 million left on its share repurchase plan and its shares falling 26% in the last two months of 2023 and into 2024, I’d be shocked if it didn’t buy back at least half that amount in the fourth quarter.
It wasn’t perfect, but it wasn’t a disaster either.
Where to From Here?
The company’s primary goals are straightforward and achievable over the next three years.
1) It expects to have 20,000 stores open by the end of 2026.
2) It expects to grow system sales at a compound annual growth rate of 8-12% over the next three years with double-digit earnings per share growth.
3) It plans to return $3 billion to shareholders over the next three years through dividends and share repurchases.
Through the first nine months of 2023, it returned $442 million to shareholders (63% share repurchases / 37% dividends). It will return close to $1 billion to shareholders in 2023, with 72% for share repurchases and the rest for dividends.
It finished Q3 2023 with $3.13 billion in cash and short-term investments on its balance sheet, which works out to net cash of $1.09 billion. That doesn’t include $1.2 billion in long-term bank deposits and Treasury bills.
It’s got plenty to return to shareholders. We'll find out how much it allocates to share repurchases in February.
2 Ways to Play YUMC
There are no controlling shareholders of the company other than traditional institutional money managers so that any backdoor plays will be through ETFs or mutual funds.
The Invesco Golden Dragon China ETF (PGJ) invests in 70 U.S.-listed companies headquartered or incorporated in Mainland China. Yum China is the third-largest weighting at 7.94% of the fund’s $147 million net assets. The top 10 holdings account for 57% of the portfolio. I would suggest that many investors are familiar with most of the 10 names.
If you like the idea of owning YUMC, you believe China isn’t going to be down on its luck forever. The Golden Dragon will rise once more. Thanks to the China swoon over the past three years, PGJ has an annualized total return of -25%. If you believe in reversion to the mean, it’s an excellent bet.
The second way to indirectly invest in YUMC is to buy some calls or sell some puts. Which ones? I’ve looked at the unusual options activity, and nothing jumps out at me.
Therefore, let’s assume YUMC stock has a few more weeks of underperformance before moving higher. A reasonable timeframe would be 4-6 months out. I’m looking at the July 19 expiry for both calls and puts.
Let’s try to find something that requires only 5% down or less for the calls.
That suggests the $45 strike is appropriate. It has a current ask price of $1.80 and a 4% down payment. The delta is 0.32114, which means its share price has to increase by $5.61 for you to double your money on the calls by selling before they expire. They have to rise by $8.74 (23%) to consider exercising your right to buy.
Now, on to the puts.
If you sell the $45 strike -- it’s currently well in the money -- you’re looking at an annualized yield of nearly 38%. Based on the $7.50 bid, should you be required to buy the shares in 191 days, your net price would be $37.50, slightly below where it’s currently trading.
However, if it moves up to $44 by July, and they’re put to you, you’ll buy them at a 15% discount. If they move to $46, you probably won’t have to purchase the shares, and you’ll pocket $750 per contract.
Lastly, you could buy the shares right now, hold them for 3-5 years, and probably make a market beating return.
I like YUMC at these prices.
On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
