LENAR Reports Surprise Profit….Really? Opportunities in the XHB?

by Dan March 29, 2011 8:28 am • Commentary

In the wake of the past weeks dismal housing starts, new and existing home sales data, LEN this morning managed to report better than expected earnings and slightly higher revenues.  Upon further review the EPS beat isn’t that impressive when you consider what Citi cited in their first blush report this AM:

Headline EPS of $0.14 beat both our estimate of ($0.08) and the consensus estimate of ($0.06). However, we note that during 1Q11 LEN benefited from (1) a litigation settlement which we estimate was worth ~$0.15 per share

JPM’s first take was a bit more positive:

“given recently highlighted concerns regarding the unfolding of the Spring selling season, as orders were roughly in-line with our estimate and gross margins only modestly below, we believe on a net basis this represents a modest positive for the stock. Overall, we reiterate our Overweight rating on LEN amid our positive sector stance based on our view that the company’s relative valuation premium to its peers should continue to expand based on its solidly positive EPS, above average margins and accretive Rialto division.”

-STREET is fairly mixed on the name with 10 buys and 10 holds, no sells……LEN’s orders were down 12% yoy which was below the consensus estimate of up 2% and shouldn’t come as a huge surprise given the recent data we have seen.

-Company itself admits very little visibility as it relates to recent sales trends as they stated in this mornings release “it is unclear whether the spring selling season will gain momentum or continue its sluggish recovery.”

MY VIEW: I am certainly no economist or an expert on the housing market, but this sort of visibility (or lack thereof) can’t be bullish near-term, especially when you consider that the only way the company is beating estimates is on favorable tax rates and a one time litigation settlement.  In the next month or so we will see results from Pulte, Beazer and DR Horton, if these and others continue to see little visibility that things will improve and don’t have the benefit on one time gains you could see weakness in the XHB,  the SPDRs S&P Homebuilders ETF.  What I find interesting about this security is that only about 30% of the holdings are in actual homebuilders, while ~20% in retailers that sell home furnishings and ~20% in materials companies.

-believe it or not I want to look for a structure to capture near-term under-performance in this space and as most of these names will report after APR expiration, I am looking to May.

-This is not a high conviction idea as I have no idea what the housing data will continue to look like  and whether or not it is backward looking, but if LEN’s competitors echo the lack of visibility that they did we could see these stocks move lower as we head out of earnings season.

TRADE:   BUY the May 18/16 1×2 Ratio Put Spread for ~.35  (stock ref 18.14)

-Buy 1 May 18 put for .68 and

-Sell 2 May 16 puts for a total of .33 (~.17 each)

Break-Evens on May Expiration:

Upside: stock btwn 18 and 17.65 you can lose up to .35, above 18 you lose all .35 premium you paid.

Downside: Stock btwn 17.65 (down ~2.7%) and 16 (down ~12%) you can make up to 1.65 (or ~9% of the underlying).

-Btwn 16 and 14 (down ~23%) your pay off trails off dramatically but the absolute worst case scenario would be the stock closing below 14 on May expiration because you would essentially be put the stock at 16 and be out the .35 premium you paid and start suffering loses.  So you will have gotten the direction very right but the structure impaired your ability to make money and actually cost you money.

-Currently I am hesitant to suggest these strategies in single stock names as I see the potential for heightened volatility in the coming weeks around earnings, but in an ETF like this I think there are areas in which it is relatively safe to draw lines in the sand……I am willing to assign a very low probability that an index like this can be down 20% in a month and half and thus like the ratio structure.

-Couple other things to remember, being net short and extra put will cost you some margin, and if the stock has a sharp move lower you could actually be net long deltas on an interim basis rather that short and on a mark to market basis you could have losses until the options that you are short settle down and start decaying at a faster rate closer to expiration.

***For those who don’t like the Margin issues or Tail Risk I strongly Suggest turning this 1×2 Put Spread into a Put Butterfly by buying the wing, the May 14 put which is offered at  .08, will be increasing your premium outlay but defining your risk.

MAY 18/16/14 Put Butter Fly for .43

-Buy 1 May 18 Put for .68

-Sell 2 May 16 Puts for .33

-Buy 1 May 14 put for .08

In this scenario you have the same long stock as the trade above but are protected below 14 in the stock. Your losses below 14 would be capped at .43, in other words, the cost of the butterfly.