Bears In The China Shop?

AnnaLisa is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Some notable Chinese related stocks have taken a big hit recently like Baidu (NASDAQ: BIDU), Yum! Brands (NYSE: YUM), and Coach (NYSE: COH) Is this just a tale of two or three stocks or is it something more pervasive to the China story?

The Yin and Yang of Yum!

Baidu and Yum! reported earnings on February 4 and both sold off, over 10% for Baidu and 2.66% for Yum!. Yum! barely beat on earnings but what really sunk their share price was a decline of 8% in same store KFC China sales, more than even they expected and the first such decline in four years. Lowering guidance as they say they need time to build their reputation back up in China was the straw that broke the panda's back.

Warren Buffett famously said, "It takes 20 years to build a reputation and five minutes to ruin it." KFC has been in China for 26 years and a chicken supplier scandal publicized on Chinese television in mid-December has hurt a quarter century's worth of goodwill earned by KFC and the venerated image of Col. Harlan Sanders.

James McGregor who wrote "One Billion Customers: Lessons From the Front Lines of Doing Business in China" told Bloomberg in 2011 that,"If Yum’s China business went south, it would kill the stock." Although Yum! has agreed to completely cooperate with the Chinese government investigation findings, the Chinese have endured several deadly food safety scandals in the last few years and are justifiably skittish.

US sales for KFC and Taco Bell were up mid-single digits. Yum! divested itself of Long John Silver's and A&W chains two years ago to allocate resources to Yum! China and it may have to divest itself of Pizza Hut (or at least it probably should). While Taco Bell in the US is benefiting from its artisan Mexican menu offering an inexpensive alternative to Chipotle Mexican Grill and KFC plods along Pizza Hut sales declined 1%.

 Despite weak US sales over the last few years Yum! had benefited enormously from its popularity in China. Before reporting Yum! was trading at an 18.80 P/E with a 2.00% yield and a 5 year PEG of 1.63.

Baidu: Down But Not Out

Baidu, the largest search engine in China, reported Q4 revenues that beat expectations but non-GAAP earnings just met analyst estimates.  The main cause of the sell off was that the formerly hot name's growth is slowing as it spends more on research and development to capture mobile revenues and guiding lower than expectations for Q1 2013.

Jonathan Ng of CIMB Forecast maintains an outperform on Baidu, likening its spend on R&D to Google's. The Maxim Group has a bearish call coming from Echo He who thinks competitors could snatch away Baidu's supremacy in desktop search as it focuses on mobile. He rates Baidu a sell and warns the stock could fall to $80.00, almost a 30% decline from the pre-ER price of $110.

Baidu still has a PEG under one at .65 but the years of stunning growth and share price soaring after earnings seems to be in the past. The stock has stubbornly stayed under its all-time high in the $160s for some time. While Google keeps rocketing higher Baidu, by no means saturating the Chinese market has many more strong competitors than Google with Sina Corporation, Sohu, and Qihoo 360 Technology which in August started its own search engine in direct competition with Baidu.

Baidu still made money, lots of money, in fact $1.01 billion for Q4 in revenue, above estimates and in line $1.28 EPS. Estimates had ratcheted out of Baidu's reach and margin compression caused the company to be hit with five downgrades after reporting from Raymond James, Stifel Nicolaus, Barclays, Jefferies, and Pacific Crest.

Coach Gets Tanned

Coach is one China related name that has been brutalized lately. If you've ever seen leather tanned, well, that's just what the market did to Coach. The maker of men's and women's higher-end accessories with a strong presence in China reported Q2 earnings on January 23 and the stock dropped back to 52 week lows on heavy volume just as it did at the end of July. Coach is now trading at a 13.43 P/E and sports a 2.40% yield, one of the most reliable in retail.

It wasn't China, however, that was the reason for the selloff but US sales. Some have posited that US factory outlet sales are hurting the brand's cachet. Their point being how can other woman know your status at a glance if you can get a pricey Coach bag at an outlet. This brand recognition has worked for Coach in China as expanding prosperity causes women (and men) to want to show off however they can in the People's Republic. Coach has 130 shop-in-shops, retail stores, and outlets in China, Singapore, Taiwan, Hong Kong, and Macau.

Coach has a return on equity of 53.18% and operating margin of 31.39%. As I've mentioned before, long-time CEO Lew Frankfort holds a huge position in Coach. The company most compared with Coach is of course, Michael Kors Holdings which has a larger ratio of debt, double the P/E, half the cash per share, a higher PEG, and most importantly no yield. Michael Kors is up 64% over 52 weeks and Coach down 32.76% in that same time frame and I leave it to you as to which one may be oversold.

Is China Still Intact?

Major retailers are seeking Mandarin proficiency for top jobs. When other companies announce a new presence in China their stocks go up. When pundits blather on endlessly about Apple, the mention of China is never far behind. China isn't going away as a profit driver.

These three stocks may have some further selloffs but Coach in particular should rebound. It may take more time than Yum! shareholders care to wait to restore Col. Sanders' shining reputation in China. As for Baidu the market is disillusioned with what was a growth machine but it will keep making money.

 

 


leglamp has no position in any stocks mentioned. The Motley Fool recommends Baidu and Coach. The Motley Fool owns shares of Baidu and Coach. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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