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This Retailer Could Deliver a 118% Gain

This Retailer Could Deliver a 118% Gain

Trade summary: A bull call spread in Tractor Supply Company (Nasdaq: TSCO) using the June 17 $105 call option which can be bought for about $2.65 and the June 17 $110 call could be sold for about $1.08. This trade would cost $1.57 to open, or $157 since each contract covers 100 shares of stock.

In this trade, the maximum loss would be equal to the amount spent to open the trade, or $1.57. The maximum gain is $343 per contract. That is a potential gain of about 118% based on the amount risked in the trade.

Now, let’s look at the details.

The company recently released earnings and the stock was up.

TSCO daily chart

The details of the were covered by GlobeNewswire,

TSCO, “the largest rural lifestyle retailer in the United States, … reported financial results for its first quarter ended March 28, 2020.

“Our year-to-date results underscore the importance of Tractor Supply as an essential, needs-based retailer.  Tractor Supply delivered solid results in the first quarter, and second quarter sales are off to a strong start,” said Hal Lawton, Tractor Supply’s President and Chief Executive Officer.

“I can’t thank the Tractor Supply team members enough for their dedication and support of each other and our customers.  During these unprecedented times, I am incredibly proud of how the team is responding.

The health and safety of our team members and customers will continue to be our highest priority.  Across our business, we have taken more than 100 actions in response to the COVID-19 crisis with a focus on being preemptive and proactive.  Tractor Supply has a strong and resilient business model, and we are confident we will emerge from the crisis even stronger.”

Lawton continued, “At this critical time, Tractor Supply is committed to supporting our customers’ ability to take care of their families, property and animals.  We are leveraging our strengths and pursuing opportunities as we adapt to our customers’ changing needs, as they rely on us to be the dependable supplier to support their lifestyle.”

Net sales for the first quarter 2020 increased 7.5% to $1.96 billion from $1.82 billion in the first quarter of 2019.

Comparable store sales increased 4.3% compared to an increase of 5.0% in the prior year’s first quarter.  The comparable store sales results included an increase in comparable average ticket of 5.4% and a decrease in comparable transaction count of 1.1%.

All geographic regions of the Company had positive comparable store sales growth.  The increase in comparable store sales was primarily driven by strength in consumable, usable and edible product categories, along with solid demand for spring seasonal categories.

This growth was partially offset by softness in sales of cold weather seasonal merchandise and discretionary categories such as clothing and footwear.

Net income increased 9.0% to $83.8 million in the first quarter of 2020 from $76.8 million in the prior year’s first quarter, and diluted earnings per share increased 12.7% to $0.71 from $0.63 in the first quarter of 2019.

The Company repurchased approximately 2.9 million shares of its common stock for $263.2 million and paid quarterly cash dividends totaling $40.9 million, returning $304.1 million of capital to shareholders in the first quarter of 2020.

As previously announced, the Company suspended its share repurchase program effective March 12, 2020.

The Company opened 20 new Tractor Supply stores and closed one Del’s store in the first quarter of 2020 compared to 10 new Tractor Supply store openings and one Petsense store opening in the prior year’s first quarter.

Given the uncertainty related to the COVID-19 pandemic, the Company withdrew its guidance for fiscal 2020 on April 7, 2020.

The uncertainties related to the COVID-19 pandemic include, but are not limited to: how macroeconomic factors evolve, including unemployment rates; the impact of the crisis on consumer shopping patterns; the timing of when consumer stimulus checks arrive; the duration and degree of quarantine measures, including additional measures that may still occur; uncertainty in the economy in the remainder of 2020; and the incremental costs of doing business as an essential, needs-based retailer in the current environment.  For the second quarter of 2020, the net incremental costs of doing business as an essential retailer are currently anticipated to be in the range of $30 million to $50 million.

Capital expenditures for fiscal 2020 are still expected to be in the range of $225 million to $275 million.  The Company is moving ahead with its new store opening program, but the timing of new store openings in some areas may be delayed as a result of the COVID-19 pandemic, including local and state orders.

Tractor Supply’s strong balance sheet, coupled with its robust operating cash flow, provide the Company with significant financial flexibility.  Preemptive actions to strengthen its liquidity and preserve cash while navigating the COVID-19 pandemic include:

  • Suspending its share repurchase program effective March 12, 2020,
  • Borrowing $200 million on March 12, 2020 under the accordion feature of the Company’s existing credit facility, and
  • Entering into an amendment to the Company’s credit facility on April 22, 2020, under which the Company borrowed an additional $350 million.

At this time, the Company does not expect to suspend or reduce its quarterly cash dividend.

COVID-19 Update

The stock is nearing an important breakout level on the chart and a move to new highs could unfold quickly.

TSCO weekly chart

However, there are risks to all retailers and a strategy that limits risk could be ideal in this environment.

A Specific Trade for TSCO

For TSCO, the June 17 options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.

A June 17 $105 call option can be bought for about $2.65 and the June 17 $110 call could be sold for about $1.08. This trade would cost $1.57 to open, or $157 since each contract covers 100 shares of stock.

The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.

In this trade, the maximum loss would be equal to the amount spent to open the trade, or $1.57.

The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.

For this trade in TSCO the maximum gain is $3.43 ($110- $105= $5; 5- $1.57 = $3.43). This represents $343 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $157 to open this trade.

That is a potential gain of about 118% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.

A Trade for Short Term Bulls

As with the ownership of any stock, buying TSCO could require a significant amount of capital and exposes the investor to standard risks of owning a stock.

To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.

Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.

To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.

This strategy is designed to profit from a gain in the underlying stock’s price but TSCO the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.

bull call spread

Source: The Options Industry Council

Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.

This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.