Not Down for the Count

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Oct 24, 2014
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Floored, but far from out

We've seen this play before

Lumber Liquidators (LL, Financial) was a market darling one year ago. The stock had run from a 2011 low of $13.40 to a high of $120. Earnings were zooming higher, and the shares fetched north of a 43x multiple.

Three consecutive disappointing quarters have sent LL back down to $49.15. Management has guided 2014 EPS down to a range from $2.38-$2.52. That compared with previous expectations of about $2.75.

At the new 52-week low set on Oct. 23, 2014, LL is now trading for about 20.5x this year’s and 17.6 times 2015's newly reduced projection. While not cheap, this is a stock that has traditionally commanded premium valuations.

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The firm has some positive attributes. It is debt-free, has no defined benefit plan to deal with and holds a reasonable amount of cash.

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Lumber Liquidators has worked through down periods before. EPS declined from $0.97 in 2009 to $0.93 in 2010, then flattened at that level in 2011. Traders who gave up on LL as a growth vehicle missed the previously mentioned 795% 26-month run to $120.

Has the stock bottomed? Who knows?

I have not purchased any shares outright so far. I did use today's weakness to write (sell) some January 2016 puts at the $40 strike price. I received $5.40 per share when the stock was still hovering at $49.61. By the end of the day, with LL dipping a bit lower, somebody else got an even juicier $5.70 put premium.

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My trade's "if put" price drops all the way down to $34.60 ($40 strike price – $5.40 put premium). That provides a better than 30% margin of safety from the trade inception quote. The break-even price is dollars below any actual trading price for LL in more than two full years.

The implied P/E, if eventually exercised, falls to just 14.4x this year’s estimate, the exact multiple in place when Lumber Liquidators bottomed in 2011.

Maximum profit would be keeping 100% of all premiums collected. That will occur if LL merely holds above $40 through the option's Jan. 15, 2016, expiration date. The worst-case scenario is forced purchase of shares at a net cost of $34.60 per share.

That’s not a scary prospect. Lumber Liquidators peaked at $33.40 in 2010 when EPS were on pace to finish at $0.93 rather than $2.40 or so. Revenues have risen substantially since then and book value has more than doubled.

Disclosure: Short LL Jan. 2016, $40 puts