New Trade $PCLN – Naming My Own Price

by Enis April 16, 2013 3:09 pm • Commentary

Priceline.com has grown itself into one the top 100 largest companies in the U.S. by market cap.  The company was founded in 1998, and its 15 year growth story is the stuff of legend.  Only a few internet companies, all household names, are larger in market cap terms:  GOOG, AMZN, EBAY, and FB.  Quite impressive for an online travel site.

What’s even more impressive is PCLN’s recent earnings growth trends, despite the fact that only 30% of its revenues come from the U.S.  Given weak global growth, many internationally exposed companies have seen weak sales trends in the past couple years.  But not PCLN.  Here is the 5 year trend of GAAP earnings:  

[caption id="attachment_24802" align="alignnone" width="367"]Earnings by quarter, Courtesy of Bloomberg Earnings by quarter, Courtesy of Bloomberg[/caption]

The company has almost tripled earnings from 2009 to 2012.  Not too surprising then that the stock more than tripled in that period as well.  Here is the 5 year weekly chart:

[caption id="attachment_24803" align="alignnone" width="636"]5 year weekly chart of PCLN, Courtesy of Bloomberg 5 year weekly chart of PCLN, Courtesy of Bloomberg[/caption]

The stock has pretty much stalled over the last year, but contrary to most stocks that make such a big run, PCLN’s valuation actually looks reasonable.  The 5 year chart of the Trailing P/E shows that PCLN is near the low end of its historical range:

[caption id="attachment_24804" align="alignnone" width="506"]5 year chart of Trailing P/E, Courtesy of Bloomberg 5 year chart of Trailing P/E, Courtesy of Bloomberg[/caption]

Of course, the caveat is that expected growth going forward is going to become more subdued.  So 25x does not look as appealing when expected earnings growth is closer to 20% rather than 35%.  Moreover, the exposure to international sales could end up being a problem, despite PCLN’s resilience so far.

On a volatility basis, realized volatility (blue) has been quite low, but implied volatility (red) is starting to tick up ahead of the May 9th earnings event:

[caption id="attachment_24805" align="alignnone" width="637"]30 day IV (red) vs. 30 day RV (blue) in PCLN in last year, Courtesy of LiveVolPro 30 day IV (red) vs. 30 day RV (blue) in PCLN in last year, Courtesy of LiveVolPro[/caption]

Given that the low level of implied volatility has persisted for the past 5 months, implied volatility does look rich.  Moreover, from a technical standpoint, the stock’s breakout last week failed after yesterday’s selling:

[caption id="attachment_24806" align="alignnone" width="628"]1 year daily chart of PCLN, Courtesy of Bloomberg 1 year daily chart of PCLN, Courtesy of Bloomberg[/caption]

Going forward, I expect 730 (where I’ve drawn the red line) to act as likely resistance.  The important reference point on the downside is around 665, where I’ve drawn the February low in green.

Put it all together, and while PCLN looks reasonably valued, it also has international headwinds and a slowing growth rate as the company increases in size.  Its technical picture shows continued range bound action, and volatility looks a bit rich.  Here’s the trade putting those pieces together:

TRADE:  Buy the PCLN ($719) May 740/700/660 Put Fly for $8.00

-Bought 1 May 740 Put for $42.10

-Sold 2 May 700 Puts at $21.80

-Bought 1 May 660 Put for $9.50

Break-Even on May Expiration:

Profits: Make up to $32 btwn 668 and 732, with max gain of $32 at 700 on expiry.

Losses: Lose up to $8 btwn 660 and 668, and btwn 732 and 740, max loss of $8 at or below 660 and at or above 740

Trade Rationale:  This trade in the short-term is more of a short volatility trade than a purely directional trade.  Ideally, the stock drifts down towards 700, but it won’t make a huge difference to pricing until we get closer to expiry.  As for my strike selection, I detailed on the 1 year chart above, 730 to 665 seems to be the relevant range, and 700 has acted as a magnet on numerous occasions this year.  The fly would be profitable essentially inside of that range.

Risk Profile:

[caption id="attachment_24813" align="aligncenter" width="566"]Screen Shot 2013-04-16 at 1.19.03 PM from TradeMonster[/caption]