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Yum drops 18% as earnings bad news hits market in worry hotspots

posted on October 8, 2015 at 11:13 pm

Yesterday I posted that Monsanto’s (MON) ugly earnings report provided important guidance for navigating earnings season. Wall Street analysts are projecting a 6.9% drop in third quarter earnings but that decline won’t be spread evenly across all market sectors. Energy stocks will, of course, see a big drop in earnings but, according to Standard & Poor’s, sectors such as telecommunications, technology, consumer discretionary, and health care will see growth of 10% or better.

Now we get a further bit of navigational advice from Yum! Brands (YUM). On Tuesday, after the market close, Yum! Brands reported earnings of $1 a share, 7 cents lower than Wall Street estimates, and revenue of $3.43 billion instead of the projected $3.67 billion.

But what is important for navigating this quarter’s earnings season was the market reaction to this miss.

Companies miss earnings projections by 7 cents or about 6.5% all the time. It’s never good news.

But seldom do stocks get taken out and shot for a 6.5% miss.

And that’d exactly what the market did to Yum! Brands. The shares closed at $83.42 on Tuesday before the earnings report and then plunged Wednesday after the open to $68.09 as of 10 a.m. New York time. That’s a drop of 18.5%.

Now there’s no doubt that Yum! Brands disappointed pretty much across the board. Same store sales in China, which accounts for about one-third of Yum’s operating profit, grew by just 2% instead of the projected 9%.

But Yum! Brands real offense was disappointing the market in some of the places where the market is most susceptible to fear.

Financial markets are worried about slowing growth in China? Yum’s results raised the possibility that growth in China had slowed so much that the company’s revenue would never completely bounce back from the food-safety scandals that had devastated sales. With growth in China slowing, what if Yum’s food safety scandals had destroyed the brand with Chinese consumers? Forever!

The other fear that hit Yum like a cold burger patty in the face was worry that growth in the fast food sector was over Forever! McDonald’s (MCD) revenue line has been essentially flat for four years. The sector is battling perceptions that its customers have moved on to better quality food and are looking for something other than gray burgers and overly salty chicken. What if the sector is never coming back?

Never is a long time and it’s a good bet that the fears about the future of Yum sales in China and about the death of the fast food sector are somewhat overblown. That’s what happens in a panic.

But the larger point for investors during this earnings season is that the markets are littered with land mines that are just ready to blow up on any company that steps on one. China growth slowdown is obviously one such land mine and Yum! Brands won’t be the last company to trip that mine this quarter. Falling commodity prices make up another mine—I’d look out, especially, for oil, copper and iron ore. The strong dollar is a third—look for exporters that live up to fears that a strong dollar will decimate sales. I’m sure there are others—falling prices in the drug sector as a result of political and regulatory scrutiny, for example. I’m sure you can make up your own list of land mines and the companies most likely to step on them.

Update MGM Resorts

posted on October 6, 2015 at 8:18 pm
chinese currency

Update October 6, 2015: With all the other excitement in the stock market over the last couple of weeks, there’s a good chance that you’ve missed the big bump in shares of MGM Resorts International (MGM.) The shares were up 15.1% from September 29 to the close on October 6.

Why? An announcement by Li Gang, director of the Chinese government’s liaison office, that Beijing will intervene to support Macau. Support for the hard-hit gambling destination could include granting more mainland cities the right to issue visas to Macau and the introduction of a new multi-visit visa that would make it easier for visitors to make multiple trips. In addition the local Macau government has said that it is looking for ways to boost tourism to Macau. That effort could be especially important since Beijing has been pressing Macau casino operators to move away from a focus on high-roller VIP gamblers in order to grow mass-market tourist traffic.

The government’s anti-corruption drive has done a good job scaring away those high rollers. Anything that smacks of conspicuous consumption can put an individual in the cross hairs of government investigators. The campaign has led to big declines in sales of luxury cars, Western brands of liquor, Prada and Louis Vuitton fashion goods—and VIP junkets to Macau. Gaming revenue in Macau has fallen about 33% on a year-to-year basis.

MGM is due to open a second Macau casino and resort complex in the city’s hot Cotai peninsula in late 2016. That has put MGM behind the earliest casino operators in the area but the timing looks fortuitous given the shift in the Macau market. That has let MGM fine tune its new casino/resort—about 1 million square feet larger than the company’s first Macau casino—to add more restaurants and more shopping as well as a nightclub, concert and ballroom venue. The VIP gambling rooms have been cut back in size in order to make room for more mass-market tourist attractions.

Macau in general and MGM Macau in particular certainly aren’t out of the woods yet. But the Chinese government has signaled that it’s aware that the anti-corruption campaign has damaged a critical local economy at a time when the national economy needs all the growth it can find.

As of October 6, I’m keeping MGM Resorts International in my Jubak’s Picks portfolio with a target of $25 a share by June 2016. I have a gain of 63.64% in this position since I added it to the portfolio in May 2012.

The numbers continue to point to slowing growth in China

posted on September 23, 2015 at 10:02 pm

The steady stream of bad news on China’s economy has led economists to predict that the Chinese government will lower its target for growth next year to 6.5% to 7% for 2016. The official target for 2015 was set last March at 7%. (The new official target won’t be set until March 2016.)

Today’s contribution to that stream of bad news came from the preliminary Purchasing Managers’ Index from Caixin Media and Markit Economics. That index dropped to 47.0 in September, below the median estimate of 47.5 in Bloomberg’s survey of economists. (In this index any reading below 50 indicates a contraction in the economy.) September’s reading was a drop from 47.3 in August. The index has been below 50 since March.

Financial markets around the world didn’t like the continued downward trend in the index because it points to lower growth in China and in the global economy next year. In Tokyo the Nikkei 225 fell by 1.92%. The Shanghai and Shenzhen markets declined by 2.19% and 0.83%, respectively. The Dow Industrials and the Standard & Poor’s 500 edged lower.

The economic bad news does suggest a possible future divergence between Chinese stocks and the Chinese economy. The People’s Bank of China has already lowered interest rates five times since November 2014 and reduced requirements for bank reserves. If the Chinese economy threatens to slow, as indicators are indicating, China’s central bank is likely to cut interest rates again. And that, on the historical record, would push up stock prices on mainland exchanges, at least temporarily.

The Chinese economy faces two major challenges over the next year. First, there’s a negative feedback loop in exports. As the global economy slows, so do China’s exports, and that in turn hurts global growth since a very large percentage of China’s exports depend on imports into China of raw materials and sub-assemblies from other countries. Second, falling profits at China’s huge state-controlled enterprise have emphasized the need for reform at these companies. That reform is necessary for China’s long-term economic growth but in the short term those reforms are likely to result in job cuts and a slow down in economic growth. That will be a tough haul since last week an index of manufacturing activity fell to the lowest level since the global financial crisis.

The short term worry in this data as we head into third quarter earnings season in early October is the degree to which large U.S. (and European) companies depend on the Chinese market for revenue growth. The place to look for a reflection of that problem is in corporate projections for the fourth quarter.

In the same Bloomberg poll economists cut their forecasts for third quarter and fourth quarter growth in the Chinese economy to 6.8% (for each quarter) from an earlier projection of 6.9%.

Market doubts grow about China’s ability to turn around growth trend

posted on September 22, 2015 at 11:35 pm
china real estate

One thing I would have been willing to bet on was that stocks trading on China’s mainland markets would climb today, September 22.

With Chinese President Xi Jinping starting a state visit to the United States, can you really imagine officials back in China letting Chinese markets go down? (You may have missed the start of President Xi’s trip in all the excitement over the Pope’s visit, which also started today.)

But it turns out that it was near thing. The Shanghai Composite index moved up just 0.92% on the day and the Shenzhen Composite closed ahead by 0.71%. It’s not that officials didn’t try. At 1:50 p.m. Shanghai time the index was at 3181, slightly above the open at 3161. And then, as has been the case recently, stocks started to move up strongly in the last hours of the session as money from government institutions and government-controlled (or government-commanded) entities from banks to brokerage companies started buying. By 2:20 the index was up to 3209. And then stocks in Shanghai stalled to finish the day at 3186 for gain of less than 1% for the day.

The failure of the Shanghai and Shenzhen indexes to put in a stronger day when President Xi’s prestige (in the opinion of the Chinese government and official media) was on the line didn’t do anything good for global stock markets. In fact, it looks like the lackluster day for Chinese markets served to draw attention to worries about slowing growth in the Chinese economy.

Investors and traders are increasing coming to see difference between the Chinese economy and the China stock markets. The Chinese government isn’t doing a great job of manipulating the Chinese equity markets but it’s doing a even less effective job in reversing the decline in the rate of economic growth.

For the day, sectors influenced by growth—or lack thereof—in the Chinese economy took it in the neck. Mr. Copper, a key indicator of economic growth, fell by 3.58% on Comex. U.S. crude benchmark West Texas Intermediate dropped by 1.8%. (Brent crude edged lower by 16 cents a barrel.)

Emerging market stocks continued their recent downtrend with the iShares MSCI Emerging Markets ETF (EEM) falling 1.87% on the day. Emerging market currencies fell hard too. The Brazilian real dropped to a record low, for example.

The best performing currency on the day was the Japanese yen. The safe haven currency of choice currently climbed on the day. (Which, of course, led to a decline in Japanese stocks with the Nikkei 225 falling 1.96%.)

And if the VIX, the so-called fear index, is to be believed, we’re looking at a return of volatility to the markets. The VIX rose 11.4% for the day to hit 22.44. That sent the volatility index up by 16.88% for the year to date. The high on the VIX for the last 52 weeks is 53.29 with a low of 10.88.

China “data week” starts off on negative note; look out tomorrow in New York

posted on September 7, 2015 at 3:29 pm

A big week for China news hasn’t started off well. And that says, “Watch out!” when U.S. stocks resume trading on Tuesday, September 8. In recent weeks global markets have followed the lead of China’s markets—generally lower—so even if you don’t own any Chinese or emerging market equities, a week of negative data wouldn’t be a positive development for your portfolio, and especially for any commodity positions.

Today’s news showed that China’s huge foreign exchange reserves got a bit less huge in August. China’s foreign-exchange reserves fell by a record last month as the People’s Bank sold dollars to support the yuan and prevent that currency from falling even further after the central bank’s surprise devaluation. China’s reserves fell by $94 billion to $3.56 trillion at the end of the month. (Economists surveyed by Bloomberg had expected a drop to $3.58 trillion.) Clearly, China still has plenty of cash to use in supporting the yuan, but the big drop in reserves, plus the cost of direct purchases of stocks to support the Shanghai market, does increase the pressure on the People’s Bank to limit its interventions in support of the markets. (Which thought doesn’t make Chinese markets happy.)

On Tuesday, tomorrow, the government will release trade figures for August with the fear among traders being that China’s exports will come in flat again—they’ve been flat for the first seven months of 2015—and that imports, down 15% in that period, will show another decline. On Wednesday, traders will see inflation numbers, which should show prices well under control. The week’s data dump ends on Saturday with news on industrial output, retail sales, and investment—all crucial numbers for anyone trying to figure out how fast China might be growing.

An impending death cross for the Shanghai Composite index hangs over all this and colors the reaction to these numbers. A “death cross,” according to technical analysis, is when the 50-day moving average falls below the 200-day moving average. It’s not a good thing, technicians say, since it indicates continued weakness in the price of a stock or, in this case, an index. Today, September 7, the Shanghai Composite was teetering on the edge of putting in this negative sign.

That wouldn’t do anything good for market sentiment.

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