In two weeks Sirius XM Radio (SIRI) will be reporting first quarter earnings. While there are a few unknowns, it seems unlikely that there will be significant surprises in revenue or free cash flow. The reason these figures should be easily achieved is because the company's subscription model is highly predictable. In addition, at the start of 2013, the company already had 40% of its "over $3.7 billion" revenue guidance figure on the books in the form of deferred revenue. These pre-payments will be recognized over the course of the year.
New Car Sales
Investors in Sirius XM are aware that most of the company's new subscribers have been derived from new car sales. CEO Jim Meyer discussed auto sales growth on the last conference call:
Auto sales certainly provided a tailwind to our growth in 2012 with SAAR climbing 12% in the fourth quarter to around 15 million and growing about 13% to 14.4 million for the full year.
Consensus estimates call for auto sales to rise at a slower rate in 2013, just under 5% to 15.1 million.
So, it was comforting to read the following at Ward's Auto:
U.S. light-vehicle sales continued a steady upward climb in March, as the market posted its 31st straight increase from year-ago and first-quarter 2013's seasonally adjusted annual rate of 15.2 million units marked the highest quarterly total in five years.
Ward's also noted that the figure was above the Q4 2012 rate of 15.0 million and well above the Q1 2012 rate of 14.2 million. New car sales should also provide a boost to used car sales as trade-ins increase the supply of used cars available to dealers. This increased used car activity should support Sirius XM's efforts in marketing subscriptions to buyers of those vehicles.
The Stock Price
With all this good news, the share price has struggled recently. Shares of Sirius XM ended 2012 at $2.89, and on January 2nd closed at $3.02. After first touching $3.25 on February 1st, the stock has been unable to break through that figure. Earlier this month, on an intra-day basis, the stock traded below $3.00 on two occasions, but it has not closed below $3.00 the entire year. On April 16th the shares closed at $3.05 after trading in a narrow range all day.
Even the recent announcement of an improved Internet offering called "MySXM" was greeted with a yawn. If good news isn't moving the share price higher, is there bad news out there in the market that investors should be concerned about? Ward's also noted that the 15.2 million SAAR rate was down from the February rate of 15.3 million. Was the slight decline an anomaly or an omen?
A Bloomberg article late last week had the ominous title Retail Sales in U.S. Decline by Most in Nine Months. The article discussed everything from auto sales and fuel prices to the payroll tax increase and sequestration. Regarding the change in the payroll tax:
Consumer spending had held up early in the year even as taxes took more from Americans' paychecks. Congress agreed to a fiscal pact on Jan. 1 that allowed the tax used to finance Social Security to revert to 6.2 percent, where it was in 2010, from 4.2 percent.
"Households are now making those difficult choices on how to adjust spending," said Ellen Zentner, a senior economist at Nomura Securities International Inc. in New York, who projected sales would drop. "We have no steam going into the second quarter."
Will one of those difficult choices be whether or not to subscribe to Sirius XM? The more time someone spends in their car, the more value they are likely to get from a subscription. If that's true, than falling gas prices may help those subscribers feeling the pinch from smaller paychecks. The article noted:
The retail sales figures, which aren't adjusted for prices, also reflected the decrease in fuel costs. Filling-station receipts dropped 2.2 percent last month, according to the Commerce Department data.
The average cost of a gallon of regular fuel at the pump dropped about 13 cents to end last month at $3.63, the first decrease in March since AAA, the biggest U.S. auto group, began keeping data in 2004. That may prevent spending from slowing even more.
And it may not just be the issue with consumer spending that is weighing on Sirius XM's share price. There are uncertainties specific to the company. Will Meyer be named the permanent CEO? Has the share repurchase program announced last year finally started? Will Liberty Media (LMCA) CEO Greg Maffei, who was recently named Sirius XM's chairman, take a more hands-on approach?
Sirius XM also initiated a "stealth" price increase in the first quarter when it increased the Music Recovery Fee from $1.42/month to $1.81/month on its standard $14.49 package on February 1. Will the increased cost to subscribers finally affect subscriber cancellation rates? In the past that hasn't been the case, either when the company first instituted the fee, or when the basic monthly fee was increased at the beginning of last year.
Is it the right time to invest?
Does the good news about auto sales and gas prices outweigh some of the negatives and unknowns? Maybe. But if one has concerns, there are the analysts who are predominantly bullish on the stock. Yahoo!Finance shows 16 analysts rating the stock and 10 have it rated buy or strong buy and only one gave it an underperform rating. And, of the 15 that have issued price targets, the average is $3.48-$3.50 per share.
If you still have reservations, there is an easy way to hedge one's bet and still go after an attractive return using covered calls. I have written several articles in the past about using this strategy, and with the price at just under $3.05, the potential returns are rather attractive. Using the January 2014 call options, one can buy the stock and simultaneously sell a covered call, reducing one's exposure and limiting one's potential return.
If you are willing to go along with the average of the analysts, why not buy the stock for $3.05 and sell the $3.50 call for $0.19/share. The net cost would be $2.86 (the $3.05 asked price on the stock less the $0.19 bid price on the option). If the analysts have it right, the shares are called away in nine months on January 18, 2014. The net return (excluding commissions) is 22.4% in nine months, or an annualized yield of nearly 31%.
Still too risky? One can go for a lower return with a safer play using in-the-money call options. By selling the $3.00 January 2014 call option for the $0.38 bid price, the net cost of the investment would be $2.62 (the $3.05 asked price on the stock less the $0.38 bid price on the option). When/if the shares are assigned in January, the net return (excluding commissions) would be 14.5% in nine months ($3.00 / 2.62 = 0.145), or an annualized yield of nearly 20%.
For many investors the idea of capping one's return at a 20% or 31% return is unacceptable. For others, the analysts have it all wrong and Sirius XM is a terrible investment and not worth the risk.
The market tends to price stocks by looking ahead, and since the beginning of the year it hasn't seen much to get excited about with Sirius XM. I'm a bit more optimistic on the shares than the market at the current time, but not quite as optimistic as many of the analysts. My own price target falls just below their average, and I am quite comfortable with having sold the $3.50 calls against most of my position.
When the first quarter results come in, investors may find out whether it's the analysts or the market that has the price correct. I believe the covered call strategies outlined above provide investors with the opportunity for a very good return with relatively low risk.
Additional disclosure: In addition to my long positions, I have January 2014 $3.50 covered calls written against many of my long positions in Sirius XM. I also trade blocks of Sirius XM on a regular basis. I have no position in Liberty Media at the current time.