Following Autonation’s (AN) fiscal Q3 results on November 2nd the stock gapped up nearly 15% to a new 52-week high on investor enthusiasm regarding their announcement of a multi-year service partnership with Alphabet’s autonomous driving unit Waymo. Since then the stock has been fairly volatile, immediately giving back half of its one-day post-earnings gains, then rallying 13% to a new high earlier this month, only to relinquish all of the gains and now trading back at the Nov 2nd opening gap lows:
While the press released offered little by way of specifics on the economics of the Waymo deal, I think it is safe to say that this sort of partnership might prove to be a long-term homerun for AN, which for now can be viewed as an effort to hedge against autonomous fleets being a massive headwind to AN’s core business of selling and servicing gas and people-powered cars and trucks. I think it is safe to say that autonomous vehicles and the potential for associated services around them will be a massive investment theme for years to come. At the time of the headline, I considered AN as a long but did not want to chase it, and the recent pullback might provide an opportunity for a long entry.
Another very important input for a long thesis has to be AN’s existing high tax rate of nearly 39% and the potential for earnings to increase meaningfully in 2018 under the new tax rules just passed in Congress with corporate rates of 21%. The Healthy Wealth Coach on SeekingAlpha.com estimates the potential for a 25% increase in earnings for AN in 2018 on this change alone:
For a stock like AN that trades 12.7x expected 2018 eps growth of 8%, a $1 bump to earnings will place the stock at 10x earnings, which might be viewed as way too cheap given the potential tailwind/optionality of the Waymo deal and cause investors to rerate the stock higher.
While the company has been buying back stock pretty aggressively ($400 million alone in fQ3 2017) the expected windfall from paying lower taxes in 2018 may provide the company the opportunity to pay down some of its $6.5 billion debt load which is 1.4x its equity value and makes its $53 million in cash look like a rounding error.
One last point on the technical set up, the Nov gap to new highs placed the stock handily above the downtrend that had been in place since the stock’s all-time highs in the first half of 2015. While a total gap fill might be possible back towards the high $40s, this might be a good spot to start picking at the stock on the long side:
The next identifiable catalyst for the stock will be their fQ4 earnings estimated to be February 2nd.
Short-dated options prices have picked up a bit this week, with 30 day at the money implied volatility up 2% points to 28 offering the opportunity to sell short-dated calls in Jan to help finance the purchase of Feb calls that will catch earnings.
So what’s the trade?
AN ($51.10) Buy Jan / Feb 52.50 call calendar for $1
-Sell to open 1 Jan 52.50 call at 65 cents
-Buy to open 1 Feb 52.50 call for 1.65
Break-even on Jan expiration:
The max risk of this trade is $1 in the event the stock were to trade meaningfully below current levels, or above the 52.50 strike. The ideal scenario is that the stock is very near the 52.50 strike on Jan expiration and the Jan 52.50 calls expire worthless or covered for pennies and then I will be left owning the Feb 52.50 calls for $1, which depending up how close to strike they are will have increased in value to adding deltas. At that point, I might consider selling a higher strike call in Feb creating a vertical put spread and further reducing my premium at risk.