When the stock market struggles, the tendency for most investors is to start looking for “safe haven” investments. That often means getting out of stocks and moving your money into less volatile options like bonds or very short-term, interest-bearing instruments like Treasury bills, money markets or Certificates of Deposit. Some investors will be a bit more daring by keeping their toes in the market, but by looking for stocks that they think should hold up reasonably well even if the economy begins to weaken or move into a recessionary period. There are always stocks that buck the broader market’s trend; these are the exceptions to the rule, but the simple fact of their rarity is something that makes them worth paying attention to.
The market’s drop since the beginning of October pushed every major market index to the brink of bear market territory before the Christmas holiday, something that has put every investor that is paying attention a bit on edge; a minor rally off of 52-week lows doesn’t minimize the importance of the market’s decline that is now pushing into an intermediate time frame and should, by any realistic measurement or evaluation, be considered a downward trend. That decline also translates to a performance for all of 2018 that as of Friday’s close was a little over -7%. A lot of stocks over the same period are down, 10, 20, or 30% over the same period, and in many cases the decline is even larger. That is creating a lot of opportunities for value-oriented investors to start finding stocks with good fundamental strength that are trading at very interesting valuations.
One stock that has bucked the broad market’s trend throughout the year is Yum! Brands Inc. (YUM). If you don’t recognize the company name right away, that’s all right; you most certainly will recognize the restaurant brands they operate. KFC, Pizza Hut and Taco Bell are their three major divisions, and these brands each operate all over the world. The company’s stock has soundly outperformed the entire stock market, increasing more than 12% throughout 2018 and a little over 20% since the beginning of August. And even as the stock market has accelerated its correction since the beginning of December by declining almost 10%, YUM has dropped less than 1%.
Considering the company’s niche in the fast-food industry, it isn’t unreasonable to suggest that even if the economy does falter and drop into a recessionary period, this is a company that should see relatively stable revenues. There are some interesting strengths that can be seen in the company’s fundamental profile; but there are also important weaknesses that I think the market has been overlooking, and that put the company at risk if in fact the economy does slip. From an investment standpoint, I think that makes the stock a risky position to consider, because if the market finds reasons to start focusing on the negative aspects of YUM’s fundamentals, the stock stands to take an above-average beating from its current price.
Fundamental and Value Profile
YUM! Brands, Inc. is engaged in restaurant business. As of December 31, 2016, the Company operated or franchised over 43,500 restaurants in more than 135 countries and territories operating under the KFC, Pizza Hut or Taco Bell (collectively the Concepts) brands. The Company operates through three segments: The KFC Division, which includes the operations of the KFC concept around the world; The Pizza Hut Division, which includes the operations of the Pizza Hut concept around the world, and The Taco Bell Division, which includes the operations of the Taco Bell concept around the world. KFC restaurants across the world offer fried and non-fried chicken products, such as sandwiches, chicken strips, chicken-on-the-bone and other chicken products. Pizza Hut is a restaurant chain specialized in the sale of ready-to-eat pizza products. Taco Bell specializes in Mexican-style food products, including various types of tacos, burritos, quesadillas, salads, nachos and other related items. YUM has a current market cap of about $28.6 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings increased almost 53%, while revenues decreased a little more -3%. In the last quarter, earnings increased nearly 27%, while sales increased about 2%. The company’s margin profile is an indication of strength for this company, as Net Income as a percentage of Revenues over the last twelve months was nearly 29%, and more than 32.5% in the last quarter.
- Free Cash Flow: YUM’s free cash flow has declined over the past year, but remains adequate, if minimal at about $871 million; that number translates to an uninspiring Free Cash Flow Yield of about 3%.
- Debt to Equity: YUM is very highly leverage, with more than $9.4 billion in long-term debt against on about $198 million in cash and liquid assets. Their impressive margin profile means that the company can comfortably service their debt from operating profits; but the minimal cash on their balance sheets means that they have poor liquidity; that is a risk, since any erosion in their operating profile could put them in danger of defaulting on their outstanding debt. Most analysts aren’t forecasting any such erosion within the next couple of years, but don’t ignore the possibility that a significant economic downturn could have a significant, negative impact on this stock’s bottom line.
- Dividend: YUM’s annual divided is $1.44 per share; that translates to a yield of 1.57% at the stock’s current price.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value. YUM has a Book Value of 0, which makes a practical valuation analysis based on Book Value impossible and should raise a red flag for any investor that wants to work with a long-term, fundamentally based perspective. The stock’s Price/Cash Flow ratio does provide a reference point to work from, but since the stock is currently trading 23% above that ratios’ historical average, the conclusion remains the same: this stock is overvalued, and its ability to defy the broader market’s trend throughout the year doesn’t imply a better opportunity in the year ahead.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: Since November, the stock has been hovering in a consolidation range at the top of its long-term trend, with support around $87 per share, and resistance at around $93. Technically speaking, that consolidation range means that the stock’s long-term upward trend has to be called into question, but cannot yet be expected to reverse. A break above $93 would mark a continuation of that longer upward trend, while a drop below $87 should be considered a strong indication that stock should drop into corrective territory, with a bearish trend reversal expected to follow.
- Near-term Keys: The stock’s peak at around $94 earlier this month marked an all-time high for the stock, which makes forecasting a new target price in the event of a new push above resistance difficult; but the fact that most previous resistance breaks were followed by new rallies of between 5% and 10% in price, it isn’t unreasonable to suggest that if the stock picks up a new wave of bullish momentum and sentiment, it should push above $100. The larger risk, however comes from a drop below support around $87; the next most likely support level is below $78 per share, or a little over 10% below that support line and about 15% below the stock’s current price. If you factor in the fact that the stock’s “fair price,” based on valuation measurements including the stock’s Price/Cash Flow ratio is only around $70.50 per share, you can see that this is a stock with far more downside right now than any kind of upside it can realistically offer.