(Stocks in article: NYSE: BAC, NYSE: JPM, NYSE: GSK, NYSE: YUM, NYSE: GS, NYSE: AMR, NYSE: TXT, NYSE: UIC, NYSE: ABM, NYSE: BX, LSE: NRK.L, NYSE: BRK, NYSE: PTR, Nasdaq: UCBH, Nasdaq: BOBJ, NYSE: SAP, NYSE: PPC, NYSE: TSN)Stocks, as defined by the Dow, Nasdaq and S&P 500 Indices, are drifting modestly lower into the afternoon close, as investors start to contemplate what is forecast to be the worst corporate earnings quarter in five years. The Street.com currently has an
informative piece running on this topic. According to Thomson Financial, Q3 earnings growth is projected to measure just 1.4% for the financial sector heavy S&P 500 Index. We are sure that it is the combination of this gloomy forecast and concern about a Halloween shocker from the Fed, that has the market concerned.
As we outlined in "
The Greek's Week Ahead - Fed Follow Through Matters," we believe the equity market drunkenly ran up before and after the 50 basis point Fed cut in September, and completely disregarded the possibility that it could have been a
one and done type action. With Friday's revision to the August nonfarm payroll reading, this reality is likely to set in now. However, if the market does not adjust prior to Halloween, then we would go out on a limb and predict a frightful night in more than one respect.
INTERNATIONAL MARKETSChinese equities came back happy on Monday, after their week off. With mostly good news reaching wires during China's hiatus, there was no reason for a repeat of the February collapse that followed Chinese New Year holiday week. The CSI 300 Index rose 1.3% on the day while the Hang Seng slipped 0.22%. Japan and Canada are closed for various holidays. In Indonesia, the central bank kept its target rate unchanged at 8.25%, and the Jakarta Composite rose 0.92%.
Europe is modestly lower today, after the head of the IMF openly discussed his view that the dollar is undervalued. He also made a good argument for China to untie its renminbi from the dollar, as it manages the evolution of its own economy and domestic marketplace. At the same time, European Union finance ministers met in Belgium to discuss the risk to Europe tied to dollar softness against the euro. We believe this is a topic now of highest concern to European investors. European goods are losing cost competitiveness, not just in America, but in Asia as well. The group lowered its forecast for Eurozone economic growth to 2.5% this year, revised from 2.6% previously. The DJ Euro Stoxx 50 declined 0.44% today as a result, while the FTSE 100 has 0.83% at last check.
STOCK SPECIFIC NEWSWhile every publisher on the face of the earth is proclaiming Alcoa's (
NYSE: AA) earnings report tomorrow as the first of the season, Yum! Brands (
NYSE: YUM) really kicks off the week's schedule today when it reports after the close. In recent times, YUM has shown strong growth driven by its expansion into China. In Q2, YUM's China division grew sales 25%, on Mainland restaurant unit growth of 19%. The owner of KFC is not benefiting from chicken prices like it did last year, when bird flu fears had producers like Pilgrim's Pride (
NYSE: PPC) and Tyson Foods (
NYSE: TSN) scrambling to unload poultry. Instead, rising feed costs and bird flu recession have driven poultry prices higher.
Still, in its June quarter, the company earned $0.03 more than estimates. In fact, YUM has beaten estimates over at least the last four quarters. This quarter's consensus estimate, compiled by Thomson Financial at $0.45, has not changed at all over the last 90 days. Now, we're not saying that means YUM will beat its number, but a case is building for it.
We took a closer look at the company, to get an idea of how management felt about the September quarter back in July, when it last reported. What we found was, dare I say
yummy? YUM's management raised its own full-year forecast by three cents after reporting a three-cent beat in Q2. We suspect YUM is a serial UPOD (Under Promise Over Deliver) company, which Jim Cramer refers to regularly. It's truly a beautiful thing. YUM is not without risk though.
The company is growing its store base at a pace that would give Peter Lynch fits. YUM is planning to add a total of 375 stores in Mainland China alone this year, and 750 in its Yum! International Division, which excludes China. The risk of losing product and service consistency increases as you add octane to your growth. Even so, in such an unexploited market, that being China, Yum! is willing to take that risk.
Still, the machine is not without kinks, as you may recall YUM's multiple PR mishaps of recent times. For now, we expect YUM to pull another UPOD type quarter. However, at some point, we believe the company is going to have to get to work on efficiency improvement overseas, where its fast growth has likely created pockets of fat. Also, Kernel Sanders would certainly approve of some effort toward image restoration in the U.S.
Expectations this quarter are probably not tied to U.S. performance, since domestic operations have been less than stellar in ’07. U.S. division operating profit declined 7% through the first half of the year. So, YUM appears in a special position when compared to restaurant rivals, whose performance will be measured with an eye toward broader economic weakness. Since the market expects domestic performance to be weak at YUM, the stock should benefit from international growth, if execution is on target.
The stock has recovered ground lost in between quarters, and trades at 22X the ’07 consensus estimate of $1.64 and 19.5X ‘08’s $1.83. That puts YUM’s PEG ratio based on a 12% consensus 5-year growth forecast and the ’08 EPS estimate at 1.6. Now, EPS growth has been running a little hotter than this, at 15% in Q2. If we project a 15% long-term growth rate on the ’08 estimate (and we realize we are stretching a bit), we get a PEG ratio of 1.3. That kind of justifies YUM’s price. In other words, there seems to be an implication in YUM that growth will exceed the consensus figure. Still, with the stock running up into the report and the risk for some margin surprise from poultry prices, we would avoid a short-term long trade at this point.
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