New Trade – $MAS: Construction Delays

by Dan July 28, 2014 2:22 pm • Commentary

Event: Tonight after the close, Masco (MAS) reports their Q2 results. The options market is implying about a 6% one day move, which is a bit higher than the 4 qtr avg of a little less than 5% and below last quarter’s 7.45% decline.

Sentiment: It’s fairly mixed on the stock with Wall Street analysts nearly split with 14 buys and 11 holds with an avg 12 month price target of $24.44 or about 21% above current levels.  Short interest is fairly low with just 3% of the float.

Price Action / Technicals: The stock has shown very poor relative strength to the broad market, down almost 11% ytd, and even the XHB (the S&P Homebuilders etf) of which it is a component, which is down about 7% ytd.

Technically the stock is at a fairly important spot, approaching a key support level at $20 (red line below).  I would also add that the April gap below the up trendline (green below) that has been in place since late 2011 is troubling and could be suggesting a meaningful top formation:

MAS 3yr chart from Bloomberg
MAS 3yr chart from Bloomberg

Options Open Interest:  about 30% of the total open interest lies in Jan15 expiration, with 14,700 of the Jan 20 puts and 12,800 of the Jan 21 calls, followed by 10,000 of the Aug 23 calls.  Calls outnumber puts by a ratio of about  1.4 to 1.  Only 400 options have traded today, well below the one month average of about 2800.

Volatility:  Despite what appears to be a relatively high implied move for the current quarter, the price of options have not reached implied vol levels that have been normal for just before earnings over the last couple years. That being said, the pre earnings bounce has come off of multi-year lows, and I would expect for them to settle back towards those levels on the heels of any move less than what is implied:

MAS 2yr chart of 30 day at the money IV from Bloomberg
MAS 2yr chart of 30 day at the money IV from Bloomberg

Fundamentals:  The news surrounding the homebuilding sector is poor, especially given the weak new home sales data, and some of the high profile earnings disappointments from suppliers like LL, TPX and WHR.

If you take analysts’ consensus estimates for MAS over the next few years, the valuation looks quite reasonable.  Analysts expect 25-30% EPS growth, while the trailing 12 month P/E is around 25.  The market’s valuation indicates that investors do not see that sort of EPS growth as the base case for the company.  A problem with earnings estimates for Masco is that the business is quite volatile, as indicated by historical results.

In the first quarter, management blamed the weather for the weaker-than-expected North American results (the stock was down 7.5% after the earnings miss).  That excuse won’t be available this quarter, so it’s important that MAS show better execution.  The bar is relatively high (0.28 expected, or 22% year-over-year EPS growth,  on 5% sales growth), but so are overall expectations over the next couple of years.

My View:  I do think there is another leg lower in Housing stocks, more likely closer to the end of the Fed’s Taper as opposed to now after a fairly sharp decline recently that could discount bad news in the short run.  In MAS, I want to sell the implied move, playing for a near term consolidation, and look to own some longer dated near the money puts.  Here is the trade:  

Trade: MAS ($20.38) Bought Aug/ Oct 20 Put Spread for .50

-Sold to Open Aug 20 Put at .475

-Buy to open Oct 20 Put for .975

Break-Even on Aug Expiration:

-Max profits with stock at $20 on Aug expiration.

-losses of up to .50 if stock is significantly higher or lower than $20 on Aug expiration.

Rationale:  Assessing the potential range of outcomes, it seems that a miss and guide down, while likely, could see a more muted move given the stock’s 10% decline from the highs earlier in the month.  On the flip side, the disappointments from many peers and the weak data suggest that a beat and raise is fairly unlikely. But the stock could see a bounce on an inline to slightly better report. I think the most likely outcome is under-performance of the implied move which leaves me inclined to sell it and finance the purchase of longer dated puts.  This is not a particularly high risk/ high reward trade, but it takes advantage of the elevated levels of implied vol and fits my thesis on the sector.