$HLF Q1 Earnings Preview

by Enis April 29, 2013 12:12 pm • Commentary

Event:  HLF reports Q1 earnings tonight after the close.  The options market is implying about a 8% move, which is just below the 4 qtr avg move of ~8.5% and the 8 qtr avg move of ~8.5%.

Sentiment:  This is not a widely followed name by Wall Street analysts, but the small contingent of analysts who do follow it are bullish – 7 Buys, 3 Holds and 0 Sells with an average 12 month price target of ~$55.  Short interest has been quite high ever since Ackman’s December presentation, and has been between 35-40% of float for most of 2013.  It is currently at 39%.

Open Interest:    The call to put open interest ratio is around 0.8, close to where it has been for the past month.  After a flurry of options activity in December and January, option traders have been quiet.

Price Action / Technicals:   The technical action in HLF indicates a stalemate in the hedge fund battle between Ackman and Icahn.  Ackman is short about 20% of the company, while Icahn is long around 16%.  The stock’s price action since Icahn’s December announcement has continued to respect the 30-49 range, shown by the two red lines:

HLF 2 year daily chart, Courtesy of Bloomberg
HLF 2 year daily chart, Courtesy of Bloomberg

I’ve included the volume bars on the lower panel to illustrate that the bulk of the trading activity over the past 2 years has taken place with the stock in that 30-49 range, so most long and short holders have a cost basis in that area as well.

I executed one range trade earlier this year in HLF with that range in mind, and in hindsight, I should have continued to hold on to it rather than take it off for a profit, as the $40 level has continued to act as a magnet for this name.

Fundamentals / Valuation:  I have rarely dwelled on the fundamental case for HLF, simply because two billionaires with myriad analysts and lawyers at their disposal probably have done many hours of research, and have come down on opposite sides of the same stock.  The company has been under increased media scrutiny for the past year (which is part of Ackman’s plan by going public in the first place).  Most of the attention does not cast the company in a favorable light, but most investors only care about the cash flows at the end of the day.  On that front, the company is still projected to grow earnings and cash flow 10-15% over the next 2 years.

However, one of the main risks outstanding is whether the government regulators eventually get involved.  So far, there has been little to suggest that they will, but that’s the tail risk that keeps implied volatility quite elevated.

Vol Snapshot: That tail risk I just mentioned is the main reason why implied volatility is priced so far above realized volatility:

6 month chart of 30 day IV (red) vs. 30 day RV (blue), Courtesy of LiveVolPro
6 month chart of 30 day IV (red) vs. 30 day RV (blue), Courtesy of LiveVolPro

The gap between implied and realized is essentially at its highest in the past 6 months.  The earnings event tonight is part of it, but that gap would be 15 points tighter if it wasn’t for the market’s fear of more headline risk, particularly on the regulatory front.  Regardless, the risk/reward continues to favor option sellers here, even though implied vol is a bit lower than it was a month ago.

MY VIEW:  With $40 the magnet, and the stock right there, I don’t have any view on direction in HLF from here.  I am most surprised by how high implied volatility has remained in further out maturities, and my inclination is to sell August options and sit on them, but a bit wary of the headline risk myself.  We will of course post any trades before 3:30 pm at the latest.