Name That Trade – $HTZ So Good

by Dan January 12, 2015 12:21 pm • Commentary

Earlier in the MorningWord (Picking On Stock Pickers) I highlighted some of the recent commentary on those who look to gain out-sized returns by picking individual stocks. Activists investors very much fall in the category. For the better part of 2014, Carl Icahn built a stake in auto rental company Hertz (HTZ) while gaining three board seats.  As of his latest filing, Icahn owned 52 million shares, or about 11.5% of the shares outstanding and appears willing to play nice with management as they restructure and getting their accounting sorted.

Taking a quick look at the financials, this one is kind of tough to figure out.  Earnings and sales growth are expected to drop dramatically in 2015, Wall Street consensus calls for earnings to decline 50% year over year, while sales growth should drop from 19% in 2014 to only 4% in 2015.  The company has a ton of leverage, with a $10.7 billion market cap, they have only $423 million in cash, and $16.3 billion in debt.  The company better get earnings and sales going in the other direction, or this name could see future potholes in the road.

All that being said, far smarter investment peeps than myself see something completely different.  A quick look at the top holders reveals a who’s who of the “HedgeFund’erati” with Icahn, Jana, Glenview, Fir Tree, Tiger and Highfileds all in the top 10 holders. It seems like the fix could be in:

From Bloomberg
From Bloomberg

How could so many billionaires be so wrong?? …

For those playing at home, I think it is important to note that those holders above, especially Icahn with his board stake probably have a much longer time horizon than you. And do recognize that a work out of the growing leverage issue could take years to turn around.  Is this stock the sort of thing you want to get in and just buy on the hopes that the big dogs are gonna take you along for the ride?  Probably not.  But the options market could provide the potential to define risk in an effort to express a speculative bullish view.

Thirty day at the money implied vol at has come in hard from the more than 100% gains in Aug to Oct as the stock declined from 52 week highs to 52 week lows:

[caption id="attachment_49834" align="aligncenter" width="600"]HTZ 1yr chart of 30 day at the money IV from Bloomberg HTZ 1yr chart of 30 day at the money IV from Bloomberg[/caption]

From purely a technical standpoint, as the company gets its accounting in order the stock could be range bound between $20 and $26, with the stock currently near the mid point of that range:

[caption id="attachment_49835" align="aligncenter" width="600"]HTZ 1yr chart from Bloomberg HTZ 1yr chart from Bloomberg[/caption]

If I were inclined to ride some activist coat-tails, but concerned with entry and the potential for the stock to see lower lows as headlines could remain spotty for the first couple quarters of the year, I would consider the following trade structure to offer a fairly wide range of potential profitability to the upside, with some forgiveness on entry while offering time for the bullish thesis to play out:

Hypothetical Trade:  HTZ ($23.33) Sell Jan16 20 Put to Buy Jan16 25/35 call spread for 40 cents

-Sell to open 1 Jan16 20 put at 2.20

-Buy to open 1 Jan16 25 call for 3.40

-Sell to open 1 Jan16 35 call at .80

Break-Even on Jan16 Expiration:

Losses: between 20 and 25 lose 40 cents, lose one for one below 20, down 14% from current levels.

Profits: between 25.40 and 35 make up to 9.60, with max gain of 9.60 above $35 on Jan16 expiration.

Rationale:  This structure sells a put at the most recent lows with the thought that there’s a bit of a floor in the stock as long as these big dogs stick around. (The risk being they bail.) The upside participation is sizeable and takes you past recent highs. This is similar to buying stock but with a buffer in case the entry isn’t exactly correct.

We’re not stepping in her as we’d prefer to do a similar structure closer to those recent lows with a lower put strike… but we wanted to get our thoughts out there in the meantime.