"AZO reported F1Q10 EPS of $2.82 versus consensus of $2.66 and our $2.60 estimate. The outperformance was broad based with better than expected top-line and gross margin. A lower than expected share count added $0.08 in EPS relative to our estimate while a lower tax rate served as a $0.02 benefit. Overall operating results reflect yet another strong, consistent quarter out of AZO with strong same store sales in both retail and commercial, gross margin expansion despite a modest negative impact from mix, along with the support from efficient capital allocation including $200 million of share repurchase during the quarter.
While we acknowledge that top-line trends will slow beginning in the current quarter (F2Q) due to much more difficult comparisons (SSS -1.5% in F1Q09 vs +6.0% in F2Q09), we believe AZO is well positioned to continue to
gain market share in both Retail and Commercial and expand gross margins. In addition, we expect the company to moderate SG&A spend to accommodate slower top-line growth due to the tougher comparisons. We believe the company is capable of earnings outperformance throughout F2010 based on continued strong secular tailwinds, market share gains, accelerating growth in commercial, and supported by another year of large share repurchase activity given significant free cash generation (8.5% yield).
We are raising our target price from $179 to $182 which is based on 13.5x and 12.0x our F2010 and F2011 EPS estimates. Shares of AZO currently trade at 11.3x our F2010 EPS estimate and 7.4x on an EV/EBITDA basis. We view current valuation as compelling given our expectation for low-to-mid teen’s EPS growth in 2010 fueled by modest top-line growth and supported by another year of significant share repurchase."
The implied volatility in March is slightly elevated to 26 compared to 21 in April. With shares trading near 52-week high, I think volatility is cheap and could be setting up for a big move. I like the following trade going into earnings:- Buy to open March 170/175 call spread for $1.35
- Buy to open March 165/160 put spread for $1.75
I just filled both orders at above prices. The stock will have to move either above $173.1 or below $161.9 by March expiration for the trade to turn a profit. That's about 4% to the upside or 2.5% to the downside. Currently, at-the-money straddle is going for $8.60. In other words option traders are expecting about 5.5% move in either direction.
The max profit on the trade is 61%. I like the odds.
Good luck!
