This Broker’s Downgrade Could Stop This Stock
Investors often have to sort through conflicting information. They might have a great earnings report, for example, followed by a broker’s downgrade. Then, they must sort through the market reaction and look for a trading opportunity.
That’s exactly what happened to Planet Fitness, Inc. (NYSE: PLNT) in recent days.
Planet Fitness is a franchiser and operator of fitness centers in the United States. The company reports having approximately 10.5 million members and 1,600 stores in 49 states, the District of Columbia, Puerto Rico, Canada and the Dominican Republic.
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The stock has been volatile recently.
A Solid Earnings Report Pushes the Price Up
The company recently announced its quarterly earnings and as Zacks reported,
“Total revenue increased from the prior year period by 31.0% to $140.6 million. System-wide same store sales increased 10.2%.
Net income was $30.4 million, compared to net income of $18.0 million in the prior year period.
Adjusted net income increased 53.3% to $33.2 million, or $0.34 per diluted share, compared to $21.7 million, or $0.22 per diluted share in the prior year period.”
Analysts had been expecting earnings per share of about $0.25 and the stock jumped on the news. The CEO discussed the news and highlighted the positives.
“Our second quarter results reaffirm that Planet Fitness is a high growth company,” stated Chris Rondeau. “Total revenue increased over 30% with all three operating segments up double-digits, system-wide same store sales grew 10% on top of a 9% gain a year ago, and we added 44 new franchise stores to the system to surpass 1,600 stores in total.
More importantly, our unique business model and recent tax reform allowed us to translate our exceptional top-line performance into an even stronger improvement in profitability. While we are very pleased with our many recent accomplishments, we believe the future is even brighter for our Company.
There are numerous expansion opportunities for our high value, low cost non-intimidating fitness concept in the U.S. and internationally, we are pursuing exciting ways to enhance the member experience, and our strong cash generation and recent debt refinancing provide us with a high level of flexibility to return capital to shareholders.
I am excited about our prospects for continued growth as I look ahead to the second half of 2018 and longer-term.”
Analysts Question the Bullish Outlook
But, not everyone agreed. According to MarketWatch,
J.P. Morgan analyst John Ivankoe downgraded the fitness center operator, citing concerns over valuation. Ivankoe cut his rating to neutral, after being at overweight since he started covering the company in August 2015, just weeks after it went public.
He slashed his stock price target to $38 from $50. Ivankoe said that while “fundamentals remain strong,” he doesn’t believe current valuation supports expectations of earnings per share growth in the coming years.
On Friday, the stock shot up 6.5% to close at a record $51.94 after the company reported second-quarter results. The company has beat the FactSet consensus for both earnings per share and revenue every quarter since it started reported results in September 2015.”
The analyst’s concerns come after a strong up trend in the stock. The chart below shows the trading history of the stock since it began trading.
The trend may have gone too far in one direction. Analysts expect the company to report earnings per share of about $1.15 this year and $1.30 next year. At the current level, the stock is trading with a price to earnings (P/E) ratio of about 38 based on next year’s expected earnings.
That could be considered expensive for the company and is about twice the expected earnings growth rate of 18.5%. While that growth is significant, and the expected growth exceeds the projected rate of growth for 73% of all publicly traded companies, the P/E ratio is higher than average.
This sets up the question of whether or not the stock can gain more. That seems possible, but unlikely. That means traders may want to consider strategies that benefit from price declines.
A Bear Call Spread in PLNT
For PLNT, we have a number of options available that could benefit from a decline in the price of the stock. These strategies would use short term options that have the added benefit of allowing us to trade frequently and potentially expand our account size quickly.
Some traders may argue that short term trades also reduce risk to some degree. That’s because there is less time for a news event to surprise traders. For this trade, a trader could consider a bearish call spread.
Specifically, for PLNT, we could sell a September 21 $50 call for about $2.65 and buy a September 21 $55 call for about $0.70. This trade generates an immediate credit of $1.95, which is the difference in the amount of premium for the call that is sold and the call.
Since each contract covers 100 shares, opening this position results in immediate income of $1.95. The credit received when the trade is opened, $1.95 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $305. The risk is found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($1.95).
This trade offers a potential return of about 63% of the amount risked for a holding period that is about five weeks. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if PLNT is below $50 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $305 for this trade in PLNT.
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