Name That Trade – $PCLN: Name Your Price

by Enis August 1, 2014 1:16 pm • Commentary

Priceline has been one of the bull market leaders of the past 5 years, which I detailed in a February earnings preview:

PCLN has gone up almost twenty-fold in the past 5 years, going from around a $4 billion market cap in early 2009 to a $67 billion market cap today.

The secular trend of the travel booking industry moving online has been much bigger than investors expected just 5 years ago.

Continued industry growth has investors excited for the sector’s bellwether – PCLN.  PCLN has grown earnings at more than 30% per year for the past 10 years, with no hiccups in the process!  That’s astounding earnings growth, and the stock has appreciated in tandem.

The stock is actually up more than 1% this week despite the weakness in the Nasdaq.  PCLN is flat today as EXPE’s strong earnings report last night has given PCLN a bit of a boost as well.

Expedia highlighted the growth in the hotel market in its press release last night, while air travel was only 7% of the company’s total revenues for the second quarter:

For the second quarter of 2014, revenue increased 24% (22% excluding foreign exchange) primarily driven by growth in hotel, advertising and media as well as air ticket revenue. Domestic revenue increased 19% and international revenue increased 30% (25% excluding foreign exchange). International revenue equaled $706 million, representing 47% of worldwide revenue versus 45% in the second quarter of 2013.

As a percentage of total worldwide revenue in the second quarter of 2014, hotel accounted for 71%, air accounted for 8%, advertising and media accounted for 8% and all other revenues accounted for the remaining 13%.

Air revenue increased 22% in the second quarter of 2014 due to a 28% increase in air tickets sold, partially offset by a 5% decrease in revenue per ticket.

So the online travel industry in the U.S. looks quite strong.  

But what caught my attention yesterday was when MA management on their conference call mentioned that Europeans were cutting back on travel this quarter after the downing of the flight in Ukraine and geopolitical concerns overall:

So Europeans, and the fact that was little bit even has changed when you look versus the year ago volume, Europeans are staying closer to home, both, it looks like from a pleasure point of view as well as from a business point of view.

It’s just really interesting if you look beyond this a little bit and to understand what’s going with the Europeans for example or other – if you look at all our data on which are the hottest travel places around the world, you’ve got London, you’ve got Bangkok, you’ve got Paris and cities like that. If you look at that data, tourism into Southeast Asia has been impacted over the last six, eight months because you’ve had some unrest in Thailand, you’ve got problems in Vietnam with the Chinese situation. You’ve got people canceling trips into that part of the world.

It’s similar inside Russia for all the obvious reasons that we’ve been talking about. So what’s happening also I think in this last quarter or two, is that people are staying closer to where they are comfortable, and the Europeans in particular are relatively intrepid travelers outside. They have been – and they travel frequently. They take a few holidays a year, in case you sort of look at how many holidays the Europeans do get in their course of the year, they have cut back as Martina is laughing at me. She is half German, half French. So they take the most holidays in the world.

But the fact is that if you sort of look at what’s going on there, there is a genuine difference right now in the way people are traveling.

Priceline is very exposed to Europe, where it gets more than half of its revenues.  A downtick in travel growth in the region in 2011 during the sovereign debt crisis hindered some of PCLN’s profit growth at the time.  Given the serious geopolitical risks in Ukraine, Russia, and the Middle East, a cutback in travel would not be surprising.

Having said all that, PCLN has generally executed very well, consistently beating consensus expectations and growing EPS at 30%+ per annum on sales growth of 20%+ per annum.  Yet, it seems logical that 20%+ sales growth for PCLN from its current base of $7 billion in annual revenues would be more difficult than 20%+ sales growth from its $3.5 billion base 3 years ago.  Add to that the MA warning, and the fact that the third quarter (July to September) is the most important from a seasonal perspective for PCLN, and the risks seem tilted to the downside for the early August earnings report.

Given Priceline’s propensity to beat on earnings over the past few years, and the stock’s decent looking technical setup about a month ago, Dan put on a call calendar in PCLN on July 1st.  However, he took that trade off for a very slight gain in mid-July after PCLN could not muster a new high despite broader strength in the Nasdaq.

Today, just as the fundamental backdrop has changed, the technical setup looks much different for both PCLN and the market as a whole.  While PCLN has held up better this week (partly thanks to EXPE’s strong number yesterday), the stock has still been unable to make a higher high since its all-time high in early March:

[caption id="attachment_43693" align="alignnone" width="600"]PCLN daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg PCLN daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg[/caption]

The one positive is that PCLN has held above its 200 day moving average for most of the past 3 months, holding the long-term uptrend.  However, the overall situation looks at risk of a breakdown, especially on a less-than-stellar earnings report.

The tough part of a trade in PCLN is choosing the correct structure given that 30 day implied volatility is approaching 40 ahead of earnings on August 11th:

[caption id="attachment_43699" align="alignnone" width="600"]30 day implied volatility in PCLN, Courtesy of Bloomberg 30 day implied volatility in PCLN, Courtesy of Bloomberg[/caption]

We looked at calendars and verticals, but none of them really looked attractive.  The one structure that I did like is the following (NOTE:  I did not execute this trade today):

Hypothetical Trade:  PCLN ($1238) Buy the Sept20th 1220/1120/1020 Put Butterfly for $19.75

-Buy 1 Sept20th 1220 Put for $50

-Sell 2 Sept20th 1120 Puts at $17.50 each, or $34 total

-Buy 1 Sept 20th 1020 Put for $3.75

Break-Even on Sept20th expiration:

Profits: between $1039.75 and $1200.25 make up to $80.25, with max gain of $80.25 at $1120

Losses: between $1000 and $1039.75 lose up to $19.75, between $1200.25 and $1220, lose up to $19.75, below $1000 and above $1220, lose full $19.75

Rationale:  The reason why I like this structure is that I view the likelihood of a break below 1020 as quite unlikely given the long-term breakout above $1000, which was the high from 1999.  As a result, the put fly is a cheaper way to get downside exposure than a vertical spread.  However, the main reason we are going to hold off on this trade for now is that we want to pick the best strikes to fit the technical situation ahead of the earnings event on August 11th, so we are going to wait until closer to the event.