Recent Sell (3)
Whenever I purchase a stake in a company my plan going in is always to hold for the long term. Essentially I want to treat my positions as if I owned the whole business and avoid the temptation to trade in and out of positions depending on Mr. Market's moods.
However, sometimes it seems right to make some sales. The reason for this sale, well position trim really, was three-fold. (1) I wanted to have some cash on the sidelines, (2) the valuation seems quite rich at the current price level and (3) I have concerns regarding some decisions made by management. Add those 3 together and you get a position that's ripe to be closed out.
In late July I trimmed my position in YUM Brands (YUM) and in that post mentioned that I was considering closing the position entirely. Well, a few weeks rolled by and I decided that I'd rather have the cash than the position, taxes be damned!
I first started purchasing shares of YUM Brands (YUM) back in 2014. Since then the position has done remarkably well for me with a 20.17% IRR. I'll detail my concerns later, but first let's look at the numbers. After 2 rounds of purchases and one dividend reinvestment I owned 42.099 shares of YUM Brands at an average cost basis of $2,163.15. I sold 11 shares in July and then closed the remainder in August.
On August 8th I sold the last 31.099 shares of YUM Brands for $118.34 per share including commission. The net proceeds from this sale amounted to $3,680.20.
The following table shows the date, cash flow and action for my investment in YUM Brands.
These shares produced a 133% return from price appreciation plus the dividends received over my hold period.
Overall I can't complain about YUM Brands and the returns that it's generated. A 20% IRR over roughly 5 1/4 years is pretty damn good. Keep in mind that doesn't include the shares in spinoff YUM China either which are currently valued around $1,900.
This position trim reduced my forward 12-month dividends by $52.25. The forward 12-month dividends for my FI Portfolio now stand at $7,235.71.
Reasons for the Trim
YUM Brands wasn't a major part of my portfolio so there wasn't a whole lot of "risk" should things turn south. However, as I mentioned earlier I wanted to raise some cash and YUM was a potential candidate due to what I believe is a pretty rich valuation as well as what I consider to be some questionable decisions by management.
At my sale price of $118.50 YUM's valuation seemed pretty expensive. The TTM P/E ratio stood at 28.3x with forward P/E's of 30.5x for fiscal year 2019 and 27.9x for FY 2020. To me that's a pretty high valuation, although it's not that bad within the context of 14.6% estimated annual earnings growth. That puts the forward PEG ratios at 2.1 and 1.9, respectively, which seems reasonable for a company that is actually growing.
While the P/E ratio doesn't seem terribly out of whack, there are other valuation metrics that don't look appealing. The EV/EBIT ratio is a very healthy 24.7x or a 4.0% EBIT yield. Likewise the EV/EBITDA ratio is 23.3x or a 4.3% EBITDA yield. Neither one of those inspire too much confidence in YUM being cheaply valued. Additionally the EV/FCF is 44.8x or a paltry 2.2% FCF/EV yield. Yikes!
The expensive EV ratios are due in large part to management's decision to increase debt substantially. YUM has carried a negative free cash flow after dividend and buyback every year starting in 2012. That means that management has been spending more cash than the business generates. To make matters worse the overspending has been financed with debt and has gone largely for share repurchases. I just don't understand the logic behind that move especially since YUM shares typically yield very little.
That massive overspending of free cash flow has led to a serious deterioration in YUM's balance sheet. YUM Brands was already a heavily indebted company from FY 2009 through FY 2015 and since the spin-off of YUM China during FY 2016 things have just gotten worse.
As of the end of FY 2018 YUM's balance sheet showed $10.1 B of debt compared to -$7.9 B of equity. In other words a net worth of -$2.1 B.
Over the TTM things don't look any better as debt has continued to climb although free cash flow has seen an improvement. The free cash flow interest coverage sits at 2.0x and it would take 9.9 years of the TTM free cash flow to pay down the debt entirely and 17.4 years of the TTM FCFaD to do the same.
In other words, the debt is likely here to stay barring a drastic increase to YUM's operations. In addition the risk to the business as well as the dividend has increased significantly. With the amount of leverage that YUM Brands now has they are very sensitive to the direction of interest rates. Should interest rates rise that's going to be a further drag on cash flow.
Plus going forward I don't expect share buybacks to be as big of a tailwind as they have in the past. At least not without further deterioration of the balance sheet.
While I didn't intend to sell my shares whenever I first purchased them, I decided that now was the time to do so. I very well might come to regret this decision, but what's done is done at this point.
The valuation looks quite expensive here, although should future growth pan out that will burn off some of the expensiveness. My bigger concern is the large overspending of cash flow and subsequently large increase in debt. As long as interest rates remain low then YUM will do just fine and has plenty of cash flow to service the debt although the debt doesn't appear like it will be extinguished. Due to the increase in debt I believe the risk profile for YUM Brands has increased. Given the paltry dividend yield and what I believe are better value opportunities, I decided to go close the position entirely.
Have you ever closed a position due to questions regarding management's decisions? Do you own shares of YUM Brands and do you have any concerns?
Let me know in the comments below.