A bit earlier I previewed WFM’s Q3 earnings report expected after the close tomorrow night. With the stock just 2% from the all time highs made earlier this month, and up 22% on the year, I thought the set up reminded me very much of SBUX into their report last week. Heading into their print, SBUX (our preview here) had many similarities to WFM, given the market that they serve (despite WFM being a domestic play), premium valuation, price action, technicals and general investor sentiment. The larger point I want to make, just as I said WFM is priced for perfection, meaning the slightest hiccup and the stock tumbles (see COH today), I said the same about SBUX last week. Now just because SBUX gapped to new highs doesn’t mean that it wasn’t priced to perfection, it just means that for the time being, there are continued buyers on good news.
I wanted to quickly lay out a few ways, with defined risk through options one could play the earnings event as we continue to evaluate possible set ups into the print:
Play For New Highs Following the Print:
WFM ($55.84) Buy the Aug/Sept 60 call calendar for 0.35
Long premium trades are tough in this name as vol in August could come in about 50% and Sept about 30%. The calendar seems like the only responsible way to play for a move higher. What one would be doing here is selling 41 vol in Aug to buy 29 vol in September. This increases your chances of winning as a move nowhere is likely to be profitable and any move higher even more so. The risk on this trade is to the downside as those Sept 60’s would get destroyed.
Fade The Implied Earnings Move:
WFM ($55.84) Buy the Sept 57.5/52.5/47.5 put fly for 1.30
If WFM doesn’t do much it’s likely to settle in somewhere between its recent highs and its 50 day moving average of about 53. This structure is essentially selling just below the recent high and setting up for the stock to go sideways near its 50 day. Intrinsically you can think of this trade as getting short the stock at 56.20 and long it at 48.80 with your max profit at 52.50.
Play For A Retracement back to the Breakout Level:
WFM ($55.84) Buy the Aug/Sept 50 put calendar for 30c
Similarly to the Call calendar above, this is one of the only ways to play for a fairly healthy directional move without getting too far over your skis on high vol premium. This isolates 50 as the level the stock broke out from and would likely serve as support to the downside. The calendar will do well if the stock doesn’t do anything on earns and does really well down closer to 50. If the stock breaks out to the upside you’ve likely lost most of your 30c, but that’s a better situation than had you been short alot of deltas in the form of a put spread or outright put.
Original Post July 30, 2013: $WFM Fiscal Q3 Earnings Preview
Event: WFM report’s their fiscal Q3 earnings tomorrow after the close, the options market is implying about a 7% move following the results, which is shy to the 4 qtr avg of about 9.25% and basically inline with the 8 qtr avg of about 6.8%.
Sentiment: Wall Street analysts remain fairly mixed on the stock with 15 Buys, 13 Holds and 3 Sells, with an avg 12 month price target of ~$55.50, a touch below where the stock is currently trading. Short interest has recently risen to the highs of 2013 in lock step with the stock’s strong performance, but sits at a mere 2.35% of the float.
Options Open Interest: Calls outnumber Puts by a very small margin at 87k to 85k with the 5 single open line being in Aug expiration: 5700 of the Aug 57.5 puts, 5500 of the Aug 40 puts, 5400 of the Aug 43.75 calls, 5k of the Aug 55 put, and 4500 of the Aug 55 calls.
Volatility Snapshot: WFM implied vol is following its familar pattern, rising from the low 20’s to the high 30’s into the event:
The IV the last few cycles has turned out to be justified as there have been some gaps in the name on earnings. But vol quickly falls following the report and it’s not uncommon to see it get cut in half pretty quickly, meaning the direction of the move on long premium trades needs to be correct, and any ranges of short premium trades needs to account for the potential gap. Aug vol is about 44 and Sept about 30, so expect August to get cut in half and Sept to be in around 30% or more following the report.
Price Action / Technicals: WFM has been a very strong performer ytd, up 22%, and especially since its Q1 earnings mishap in Feb, that saw the stock make new 52 week lows over the ensuing months, at one point placing the stock down almost 11% on the year. The nearly 40% rally in the shares from the April lows now has the stock within 2% of the all time highs made early this month.
The 2 year chart below shows the stocks breakout above $50 on volume to new all time highs following last quarter’s earnings and guidance, this breakout level should serve as VERY healthy support on any disappointment.[caption id="attachment_28701" align="aligncenter" width="589"] WFM 2 year chart from Bloomberg[/caption]
Fundamentals / Valuation: Two weeks ago, GS raised their earnings estimates and price target on WFM based on what they perceive to be a strengthening high-end consumer, in large part due to firming of employment trends and rising home prices, particularly in California where WFM has 22% of their stores.
One of the fairly routine knocks against WFM by the naysayers is the fairly extreme valuation for a supermarket, the company trades at 39x trailing earnings and 32x expected 2014 earnings. While this seems aggressive in a market that trades below 15x, WFM is expected to grow earnings in the high teens % for the foreseeable future and sales in the mid-teens.
MY VIEW: Back in February the stock got punished as the company lowered their sales outlook, for what the time was a fairly common excuse, the uncertainty around payroll tax increases and whatever else we were worried about at the start of the year. As we head into the back half of 2013, most of the trends that affect the high end consumer appear to be improving on the surface, except one, $100 crude which this summer has translated to nearly $4 gas at the pump. While this does not have a huge impact on most existing customers (Prius drivers), it does affect the trade up crowd.
While this is not a stock that I could buy due to its price action and valuation, as I do think it is priced to perfection, it would be remiss not to mention the very similar set up in SBUX last week, where the company not only beat expectations, but the stock gapped to a new all time high on huge volume and has held the gains. If WFM were to put up a beat and raise would we see new highs? Most definitely, but for a stock that has a history of earnings gaps of late (both up and down) I think it is safe to say this is not a name you want to be complacent on. Look for a post where we will offer some ways to play.
Estimates from Bloomberg:
- 3Q adj. EPS. est. 37c (range 35c-38c)
- 3Q rev. est. $3.09b (range $3.05b-$3.13b)
- 3Q gross margin est. 36.0% vs 36.4% Q/q, 36.0% Y/y
- FY13 adj. EPS est. $1.45 vs co. forecast $1.43-$1.45