MorningWord 12/10/13: TOL reported fiscal Q4 results that were better than expected and offered a mixed tone about the existing environment in their earnings release:
“In our fourth quarter, the impact of those price increases, combined with uncertainty from the political discord in Washington and a sudden rise in interest rates, contributed to a leveling of demand. In our fourth quarter, contract growth was 6% in units, but was still up 23% in dollars, against strong growth comparisons: FY 2012’s fourth quarter contracts were up 70% and 75%, respectively, versus FY 2011’s fourth quarter.”
Despite the very strong performance this year in the “home improvement trade” in stocks like HD, LOW, BBBY, WHR & TPX, the actual homebuilders have sorely lagged as many investors remember all too well the ills of overcapacity in the sector when the housing bubble burst in 2007/2008.
TOL, which is considered best of breed and higher quality due to its reliance on higher end consumers, ytd performance (up about 4%) is fairly interesting. The year to date chart below shows how the stock topped out right before the FED hinted at the possibility of a Taper in May/June (circled):
As it expected in the face of rising interest rates the entire homebuilding space got nailed with TOL briefly entering serious correction/crash mode down 20% from the Spring highs. Until recently, the group has been flirting with new lows on the year but has since caught a second wind as stocks across many interest rate sectors have become a bit more comfortable with the idea of a higher interest rate environment going forward, as many investors believe that better than expected growth will off set rate headwinds.
If you are in the camp that thinks that the Q3 GDP print and the ever so slightly better jobs data will portend a much stronger economy in 2014, then one of the most obviously economically sensitive sectors that has essentially sat out this year’s party could be ripe for the picking.
TOL is expected to grow earnings and sales at about 40% in calendar year 2014. On the earnings front, the $1.50 a share they are expected to earn in calendar year 2014 equals about 30% of what they earned at their peak in calendar year 2005.
How to Play:
Playing for a breakout here above $34 on the news may be a bit of a press, and what is obvious from the chart above is that the $30 level has been the spot, and probably an appropriate stop no matter where you entry.
Implied volatility is fairly low on a longer term basis, but still relatively high to its historical and to its realized. The 5 year chart below shows IV (blue) that is in the mid 30s, while the realized vol approaches 5 year lows in the low 20s.
If I had to play from the long side, and I may on a bit of a pullback for a sort of “Dogs Of the Dow” play into the New Year, I would consider just buying a near the money call spread:
Potential Trade– On yesterday’s close of $33.58, the March 35/40 call spread would have cost about 1.30. That trade would break even on March expiration at $36.30, with a max potential gain of $3.70 or about 11%. That seems like a fairly reasonable defined risk way to play.
For those with slightly higher risk tolerances and have no problem selling naked puts:
Potential Trade- On yesterday’s close of $33.58, sell the March 30 Put at 1.00 and use the proceeds to buy the March 35/38 call spread for 1.00. That call spread risk reversal would cost no premium, with break-evens at $30 on the downside on March expiration with max gain of up to $3 btwn $35 and $38.
This is a name I am going to keep a close eye on and if the stock and the sector continue to hold in despite the markets comfort with higher rates this could be one of the few laggards from 2013 worth taking a shot on in the new year.