I initiated a range trade on STZ on January 8th ahead of its earnings report. I ended up with much more than I bargained for when I got into this position. Check out the 17 day chart of STZ since I initiated the position:
The stock initially rallied a bit on earnings, then sold back down near $35, but then had a strong move to new all-time highs, in large part in anticipation of the Dept of Justice approving the Budweiser / Modelo merger, and the Constellation / Crown Imports deal along with it.
The DoJ rejected the deal this morning, causing the massive drop. However, the deal is not dead yet, and the possibility for an eventual positive resolution has the stock back up to $32. Long story short, I’m happy to get out of this trade with a small win.
ACTION: Bought to Close STZ ($32.50) Feb 35 straddle for 3.35, sold the Feb 30/40 strangle at 0.35, paid net debit of $3.00 to close the structure, for a $0.40 gain
Original Trade Jan 8th, 2013:
I laid out my thoughts on STZ in my earnings preview earlier today (included below).
Given the high level of implied volatility, and my lack of directional bias, I basically just want to sell volatility ahead of the earnings event. The question we’ve debated amongst ourselves all day was the best way to do that. In the end, I decided on the following trade:
TRADE: STZ ($35.80) Sold Feb 35 straddle at $5.20, bought the Feb 30 / 40 strangle for $1.80, collected $3.40 net credit on the structure
-Sold 1 Feb 35 call at 3.05
-Sold 1 Feb 35 put at 2.15
-Bought 1 Feb 30 put at 1.00
-Bought 1 Feb 40 call at 0.80
Break-Even on FEB Expiration:
-Profits between 31.60 and 38.40, with max profit of $3.40 with stock at 35 on expiry
-Losses up to 1.60 between 30 and 31.60 and between 38.40 and 40, with max loss of $1.60 with stock below 30 or above 40 on expiry
Trade Rationale: My risk/reward on this trade is about 2 to 1 in my favor, and I am short volatility that I think is quite high under the circumstances, so I like my odds on this trade. The trade can’t be a huge winner tomorrow, but it will be a small winner in many scenarios, and should bleed in my favor over the course of the next month if STZ doesn’t make any drastic moves.
Original Earnings Preview:
Event: STZ reports its calendar Q4 earnings Wednesday before the open. The options market is implying about a 7% move post-earnings, which is slightly low relative to both the 4 qtr avg move of about 11%, and the 8 qtr avg move of about 8.5%. The historical moves are a bit deceiving because STZ announced its complete acquisition of Crown (U.S. importer of Corona) on the same day as earnings on June 29th, which sent the stock up 24%.
Sentiment: Wall Street analysts are fairly bullish on the stock with 8 Buys, 4 Holds and 1 Sell, and an average 12 month price target of around $41. Short interest has rarely risen above 3% over the past 3 years, and sits at 2.5% of float right now.
Fundamentals / Valuation: Constellation Brands sells wine and beer, primarily in the U.S. and Canada. It’s a simple business that has grown earnings around 10 percent per year on average for the past 10 years. The interesting aspect of this story is that the stock has doubled since the fall of 2011, while earnings have not grown much since then. Most of the increase in the stock price has been a result of multiple expansion. Here is the 10 year chart of the P/E multiple:
The multiple has gone from under 9 to around 16 today in less than 18 months. The main reason for that is the acquisition of Crown Imports. As a result, investors revalued the stock based on expectations for much better future earnings growth. Analysts are modeling in about 16% earnings growth in calendar year 2013, and 21% for 2014.
Price Action / Technicals: The stock broke out to all-time highs in the months following the announcement of the acquisition of the rest of Crown Imports. That acquisition was a definitive step into the beer market for Constellation, which many investors viewed as changing the underlying value proposition. The charts bear that out on the breakout. Here is the 20 year monthly chart:
STZ 20 yr chart from Bloomberg
The stock had big volume in the summer months of 2012 when it broke above the $30 area. Since then, the stock has been quite boring, trading between 32.5 and 37.5 since late August. Given the long-term nature of the breakout, I think 32.5 is very strong support, while 37.5 is current resistance, but not necessarily strong resistance.
Volatility: Implied vol is as high as this stock sees going into this earnings. Here’s a look at the past 2 years with the ramp up in IV (red) lately:
Implied vols will likely settle in the 20’s following earnings, so months like Feb and April will see a massive crush from their current vols at and above 50.
My View: STZ has had an impressive run in the past year, up 80% since Jan 2012. The stock has strong technical support in the low 30’s. It looks reasonably valued given analyst estimates, and the business has been relatively consistent. My only main concern comes from their most recent earnings release. Quoting management commentary from that release:
For the three months ended August 31, 2012 (“Second Quarter 2013”), the Company’s net sales increased 1% compared to the three months endedAugust 31, 2011 (“Second Quarter 2012”), primarily due to spirits volume growth, base branded wine (as defined below) volume growth and net sales of branded wine acquired in the acquisitions of Ruffino and Mark West (both as defined below), partially offset by higher promotional spend. Operating income decreased 10% over the comparable prior year period primarily due to the higher promotional spend and an increase in selling, general and administrative expenses.
The 1% sales growth on increased ad spending does not indicate a very strong end-market wine consumer. So while the Corona contribution is likely to be a nice bonus going forward, the underlying wine business seems weak.
In sum, I don’t think the stock has a ton of downside given the technical setup and the prospects for the beer segment, but I also don’t expect a rip-roaring breakout above the 37.5 level. I’m looking at potentially selling volatility overall as a result.