Trading Earnings With an Eye on the Risks
Earnings reports can be market moving. That’s true even when the initial announcement seems to be shrugged off as appears to be the case for Monro Muffler Brake, Inc. (Nasdaq: MNRO).
GlobeNewswire reported the company’s first quarter results:
“Sales for the first quarter of the fiscal year ending March 28, 2020 increased 7.2% to $317.1 million, as compared to $295.8 million for the first quarter of the fiscal year ended March 30, 2019.
The total sales increase for the first quarter of $21.3 million was driven by a comparable store sales increase of 0.8% and sales from new stores of $19.6 million, including sales from recent acquisitions of $16.6 million.
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Comparable store sales increased approximately 6% for brakes, 2% for alignments and 1% for tires, and decreased approximately 1% for front end/shocks and 2% for maintenance services.
Gross margin increased 80 basis points to 40.4% in the first quarter of fiscal 2020 from 39.6% in the prior year period, primarily due to benefits from the company’s initiatives to optimize its product and service offerings and store staffing model and from leverage from higher comparable store sales, partially offset by the impact of sales mix from the Free Service Tire acquisition.
Total operating expenses increased by $7.6 million to $91.8 million, or 28.9% of sales, as compared to $84.2 million, or 28.5% of sales in the prior year period. Operating expenses for the first quarter of fiscal 2020 included expenses from 87 net new stores compared to the prior year period.
Operating income for the first quarter of fiscal 2020 was $36.4 million, or 11.5% of sales, as compared to $33.1 million, or 11.2% of sales in the prior year period. Interest expense was $7.2 million for the first quarter of fiscal 2020 as compared to $6.6 million for the first quarter of fiscal 2019.
Net income for the first quarter of fiscal 2020 was $22.6 million, as compared to $20.6 million in the same period of the prior year.
Diluted earnings per share for the first quarter of fiscal 2020 were $.67, including $.01 per share of incremental costs related to increased acquisition activity in the first quarter of fiscal 2020 compared to the prior year period. T
his compares to diluted earnings per share of $.62 in the first quarter of fiscal 2019, which included $.02 per share in one-time costs related to Monro. Net income for the first quarter of fiscal 2020 reflects an effective tax rate of 23.1%, as compared to 22.7% in the prior year period.
During the first quarter of fiscal 2020, the company added 55 company-operated stores and closed one, ending the quarter with 1,251 company-operated stores and 98 franchised locations.”
The stock was little changed on all this news.
In the longer term, the stock could be positioned for an up side breakout.
A Trade for Short Term Bulls
As with the ownership of any stock, buying MNRO 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 has 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.
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.
A Specific Trade for MNRO
Every day, we scan the markets looking for trades with low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
For MNRO, the October 18 options allow a trader to gain exposure to the stock.
An October 18 $90 call option can be bought for about $2.80 and the October 18 $95 call could be sold for about $1.60. This trade would cost $1.20 to open, or $120 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 $120.
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 MNRO the maximum gain is $3.80 ($95 – $90= $5; $5 – $1.20 = $3.80). This represents $380 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $120 to open this trade.
That is a potential gain of about 216% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.