$HD Q2 Earnings Cheat Sheet

by Enis August 18, 2014 12:57 pm • Commentary

Event:  HD reports its fiscal Q2 earnings tomorrow morning before the open.  The options market is implying about a 2.5% one day move, which is slightly above the 4 qtr avg of about 2%, but below the 8 qtr avg of about 3%.

Sentiment:  Wall Street analysts are somewhat positive on the stock, with 21 buys, 11 holds, and only 1 sell, and an average 12 month price target of around $89.50.  HD is only up 2% year-to-date, but the stock hit a new all-time high last week after a year of consolidation.  Short interest is negligible at around 1% of the float.

Options Open Interest:  Total open interest is almost evenly split between calls and puts, with slightly more calls than puts outstanding (ratio of 1.05 to 1) as a result of the heavier call volume over the past month.  Calls have traded about 1.25x the volume of puts in the past month.

For a $115 billion market cap stock, HD’s options volumes are quite tame.  The Sept 85 calls have over 8k of open interest, and then Nov 85 calls have over 10k of open interest, while the Sept and Jan15 75 puts both have over 5k of open interest.

Price Action / Technicals:  HD broke out to a new all-time high above $70 in early 2013, and the stock has held that breakout ever since:

[caption id="attachment_44366" align="aligncenter" width="600"]HD monthly chart, Courtesy of Bloomberg HD monthly chart, Courtesy of Bloomberg[/caption]

The daily chart since the start of 2013 shows HD’s rangebound price action between approximately $72.50 and $83.50 until last week’s breakout:

[caption id="attachment_44367" align="aligncenter" width="600"]HD daily chart, Courtesy of Bloomberg HD daily chart, Courtesy of Bloomberg[/caption]

The $82.50-$83.50 area is now crucial support for HD as traders watch to see whether the stock can hold its breakout to a new all-time high.  The difficulty for traders is whether there is a gap back below support as a result of earnings, though HD has not been a big mover on earnings over the past couple of years.

Volatility:  30 day implied volatility in HD is in the mid-teens, lower than where it normally has traded prior to earnings over the past 2 years:

[caption id="attachment_44368" align="aligncenter" width="600"]HD 30 day implied volatility (blue) vs. 30 day realized volatility (white), Courtesy of Bloomberg HD 30 day implied volatility (blue) vs. 30 day realized volatility (white), Courtesy of Bloomberg[/caption]

The main reason for that low level of implied volatility is that 30 day realized volatility has also been near a 2 year low over the past couple of months.  Even last week’s breakout did not occur with any one-day move greater than 1%, quite a surprise for a breakout above an 18 month range.  In other words, the recent move higher has failed to generate volatility, so options traders are not expecting much future volatility in HD.

Our View:  While the housing sector has been one of the main laggards in the past year, HD has remained a leader among housing-related stocks.  A big appeal of HD for investors is the company’s consistency, as sales have grown 2-7% in each of the past 4 years, and EPS has grown at a 15-25% annual pace in that period.  While HD stock stalled after its first touch of $80 in May 2013, the continuing growth of the business has made the valuation more reasonable today than it was for much of last year.  At a 21x P/E and continued expected EPS growth of 15-20%, the stock hardly looks expensive.

HD will have to continue to deliver consistent results to meet investor expectations.  Given that the company has performed well throughout the ups and downs in housing of the past 5 years, it’s hard to bet against HD management.  Having said that, a weak quarter that sends the stock back below $82.50 would put this stock back in the range trade, and likely indicate dead money for the rest of 2014.