The market continued stronger on Wednesday on the back of what was viewed as positive commentary from Fed Chairman Ben Bernanke as well as solid economic data. Over the past two days, Bernanke has shown support for its QE program and does not look like the Fed is ready to take its foot off the pedal. As long as the Fed is pumping money into the economy, the market will likely continue to push forward. On top of that, the market got a number of helpful data points as well today. Pending home sales came in very strong, up over 10% year/year. Additionally, the increase of Great Britain's GDP by 0.3% versus 0.0% expectations was positive as well. On the other hand, durable orders came in weaker than expected. The market reversed Monday's losses over the past two days, but Thursday and Friday should bring sequester into focus. More on our outlook is at the end.
Stocks To Trade:
The first stock we like is Home Depot. Earnings from HD were very strong, and we believe that the report should help keep shares moving higher. The company benefited from rebuilding efforts in the East Coast as well as growth from "pro" customers as well. Further, HD believes that it's going to continue to see positive demand from Sandy through the first half of 2013. The company beat EPS estimates at 0.64 with a 0.68 report as well as $18.2B revenue versus $17.7B revenue expectations. The report was definitely much more positive than Lowe's (LOW). The question, at this point, is can shares move higher or is this nearing a top?
We see a lot of value still in shares. Future PE is just under 20, which does not show strong value, but at the same time, shares are trading at 1.4 price/sales. The company, further, saw its best comp growth since mid-2004 in the latest quarter, and we believe that value is a bit higher with the housing recovery under way. New home sales continue to grow, which is a positive for Home Depot. Pending home sales are also on the rise, which means would be sellers are fixing up homes for the market. These positive trends will continue, and we like HD as a better play than most housing names because it benefits from the recovery as well as other macro-trends.
Moving forward, we like Home Depot as a bull put spread. The company looks solid but has made a lot of recent gains. We like selling the spread and taking on shares on a strong drop. The 62.5060 Apr20 bull put spread looks solid.
Trade: HD, Apr20, 62.50/60 Bull Put Spread
Max Gain: 10%
Another stock we believe is looking solid in the same housing recovery play is D.R. Horton. Among residential construction stocks, DHI has some of the best value and shows a lot of potential over competitors who have priced in future earnings and revenue much more strongly. DHI has a future PE of 15, price/sales at 1.5, and price/book under 2. Price/sales under 2 shows very solid value, and 15 future PE is a level of value as well. How does that value compare to competitors? Lennar (LEN) has future PE at 17, price/sales at 1.8, and price/book at 2.1. Toll Brothers (TOL) has a future PE at 25, price/sales over 2, and price/book at 2. Finally, Pulte Homes (PHM) has future PE at 13.5, price/sales 1.5, and price/book at 3.4.
Why does DHI lag some of its competition?
We aren't sure. The company is expected to grow revenue 42%. LEN, TOL, and PHM are expected to see revenue grow 32%, 34%, and 28%. DHI appears ready for a big year, and we believe that its value is very solid. Best growth with best value makes DHI very attractive. The company's next earnings report is a major catalyst for the company. Earnings are expected to grow just under 50% with revenue over 30%. We believe that its recent pullback has created an opportunity for the stock. Recent data also suggests that the housing recovery is moving at a strong pace. New Home Sales came in at 437K versus 383K expectations yesterday as well as a 0.6% increase in the FHFA Housing Price Index. Pending Home Sales rose 4.5% versus 1.0% expectations. This data is strong, and we believe it has helped put in a bottom in housing stocks.
DHI looks like a great buy over $23.
Trade: DHI, Long
Buy Point: Over $23
On recent strength, we believe that Best Buy looks like a solid bearish position. The company looks in trouble to us as we see its efforts to go private may not work out, and the only strength in the company shares right now appears to be its potential to go private. Since the announcement that founder Richard Schulze would take the company private, shares have declined -3%. Yet, the deal may be going sour. The company delayed earnings until March 1 as it hopes to get a deal from Schulze. If that does not happen by March 1, shares will get crushed. From Bloomberg:
Best Buy "wants to allow for the expiration of the period of time that Schulze has to respond to the company," Jeffrey Shelman, a company spokesman, said today by telephone. The retailer had planned to report earnings Feb. 28, the deadline for Schulze to make an offer. Schulze, who proposed a buyout of $24 to $26 a share in August, has worked with three private-equity firms - Cerberus Capital Management LP, TPG Capital and Leonard Green & Partners LP - to arrange financing, people familiar with the matter have said. In December, the company extended the period for him to conduct due diligence through February.
Overall, things do not look positive for the company right now. Reuters reports that funding for Schulze is in trouble. The founder needs help from private equity firms, but the problem is that BBY is just not an overly attractive business. In a world that continues to develop in the mobile/internet, brick and mortar stores continue to lose appeal. With growth expected to decline 2% in 2013 and 2014, there is no reason to invest in this company. The deal moving sour and growth low, BBY is a definite bearish position. We recommend shorting on a failure of $16.
Trade: BBY, Short
Sell Point: Break of $16
After a weak start to the week, Tuesday and Wednesday have proven strong. Yet, with sequestration around the corner, can we chug higher? The market looks like it will likely be held in check by the cuts expected to come into effect on Friday unless some resolution occurs. Look for a top to be in this area for now.
Chart courtesy of finviz.com.