Monday, July 30, 2012

LL: Big move, big mo', sad analysts

Sometimes I'll run across a stock whose chart and financials seem to glow with awesome goodness, but then I'll encounter, standing by the side of the chart, a group of market analysts, clothed in ashes and sack-cloth, weeping and wailing as they tell a tale of woe.

Such is the case with Lumber Liquidators Holdings Inc. (LL).

The company's web site shows its founder and chairman Tom Sullivan standing in front of a truck with the hand-written slogan, "Hard Wood, Soft Prices!". That's Sullivan's business model in a nutshell: Build hardwood floors for lower prices than the competition.

The chart story for LL is also simple: Big move, big momentum. The question is whether LL still has the speed to keeping sliding up the slope.

LL gapped up 12.2% last week after a 45.8% quarterly earnings surprise. After gapping, it kept on rising, hitting a high Friday of $44.73, up 37.3%  from the pre-earnings close.

Today the price pulled back a bit, although it stayed within Friday's range. It's the first very near term correction since the upside gap.

The Toano, Virginia company's stock has been rising, with corrections, since September 2011. The most recent leg up predates the earnings gap. It began Feb. 23 from $20.03.

So this a chart with momentum, a fact recognized (belatedly?) today by the stock analysis company Zacks, which on the public portion of its website named LL as Today's Momentum Stock.

I haven't read Zacks' analysis yet so that my own analysis will be independent. You can read it here.

Lumber Liquidators operates 266 stores in 46 states, and last year made its first foray into Canada. Size gives the company opportunities of economies of scale: Building hardwood floors in craftwork, to be sure, but Lumber Liquidators can buy the materials in bulk, allowing it to negotiate favorable prices with suppliers.

Sounds like a plan to me, but analysts are less than enamored with LL. Their enthusiasm index stands at a negative 60%, unchanged from a month earlier.

Perhaps its the bargain basement business model, which can be seen as a race to the bottom. Perhaps its the uncertain state of the economy; no one buys a new hardwood floor of they're uncertain they'll have a job come fall.

For whatever reason, LL's momentum is largely leaving analysts cold.

Certainly on the books Lumber Liquidators is a company to love. Return on equity is 17%, and there is no long term debt.

On the downside, annual profits per share  show no acceleration to the upside.

Earnings for the peak quarter, the 2nd, are unsteady: Up in 2010 with a downside surprise, down in 20111 with an upside surprise, and then way up in 2012 with another upside surprise. That pattern tells me that Lumber Liquidators is extraordinarily sensitive to fears about the economy.

Institutions own pretty much all of the shares, and the price isn't too far above parity: It takes $1.60 in shares to control a dollar in sales.

The stock is less liquid than I generally like, trading 1.2 million shares a day. But this supports a reasonable selection of option strike prices, with high open interest and not-too-horrible bid/ask spreads.

My main complaint with the options is that near-the-money strike intervals both in the front month and the out months are at $5, more than 10% of the stock price. That makes it hard to fine-tune the risk of an options position.

Implied volatility stands at 46%, about mid-way through the six-month range. Volatility has been on a roller coaster ride since early June, falling to around 33%, rising above 50%, heading sideways into late July, then spiking to 55% before dropping back to the present level.

The price may be sprinting to the upside, but volatility has been an inconstant beast.

Options are pricing in confidence that 68.2% of trades will fall between $37.33 and $48.87 for a potential gain or loss of 13%.

Option volume is running around three-quarters of its five-day average -- not surprising given the volume spike that accompanied the upside gap. Puts are running at 93% of average volume, at calls at 51%.

The stock is trading within today's fair-price zone, which runs from $42.99 to $43.64 and encompasses 68.2% of trades surrounding the most traded price, $43.18. The five-day zone surround $43.23 and runs from $38.82 to $44.55.

Lumber Liquidators next publishes earnings on Oct. 22.

Decision for my account: I would only play LL using stocks. The options are a problem because of the overly wide strike intervals. Also, by my rules we're too close to August expiration to trade spreads, and too far away from September expiration. I'll be open for vertical spreads again on Aug. 3.

The negative analyst enthusiasm is less of a problem. I suspect they're focusing on fears of another recession triggered by collapse of Greece and Spain, bringing down the euro, and on and on and on. I could be desperately wrong, but it would be political suicide for any government to let that happen. They know the problem. They know how to avoid it. They'll play brinksmanship for awhile in order to get a good deal, but they won't let the house of cards collapse. That's my opinion, at least.

A third aspect of the decision is the rapidity of the rise over the past three days. Big moves end with profit-taking and a correction. I want to see some of that correction before opening a position. I think going long now would amount to buying at the high.

Bottom line: I'm passing on LL for now. I'll look at it again next week.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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