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Alliance Data Systems (NYSE:ADS) provides data-driven and transaction-based marketing and customer loyalty solutions. They have three major focus areas:
  1. Retail Services manages nearly 90 branded credit card and marketing programs for many of today’s leading retail brands.
  2. Epsilon is a full-service marketing firm providing a range of solutions, including consumer database marketing, direct mail, email, and consulting.
  3. LoyaltyOne designs, delivers, and manages a suite of loyalty marketing services, most notably the AIR MILES Reward Program.
Since going public in 2001, every year has shown improved sales and earnings, including the economically savaged 2008 and 2009 periods. Here are ADS’s per share numbers (from continuing operations) as reported by Value Line:
Year
Sales
C/F
EPS
Avg. P/E
52-Week Range
2001
10.29
1.08
0.03
NMF
11.00 – 19.50
2002
11.30
1.36
0.45
44.7x
13.70 – 26.20
2003
12.86
1.84
1.03
23.2x
14.60 – 30.90
2004
15.27
2.68
1.54
24.3x
26.60 – 48.50
2005
19.31
3.41
2.06
19.1x
31.90 – 47.30
2006
25.09
4.79
3.14
16.8x
34.90 – 66.10
2007
29.09
5.97
3.75
19.3x
56.80 – 80.80
2008
28.03
6.39
4.40
12.4x
34.80 – 75.00
2009
37.90
8.40
5.21
9.3x
22.80 – 69.10
As the revenues, cash flow and earnings have grown, the P/E has compressed to the lowest ever post-IPO of this well-performing company. Zacks sees 2010 – 2011 EPS of $5.36 and $6.27, while Value Line is looking for $5.90 and $6.50 respectively.
Value Line notes that ADS has outperformed 95% of their 1700 stock universe for “stock price growth persistence” and is in the 85th percentile for “earnings predictability”. Reuters has an ‘outperform’ rating on ADS and has estimates even higher than Value Line at $5.98 and $6.85 for 2010 – 2011.
Using the lowest, Zacks’ estimates, ADS now trades at < 10.5x this year’s and <9x next year’s expectations. A reversion to a more normal 13 – 14x the 2010 projection would bring ADS shares back up to between $69 - $75 or about 23 – 33% above yesterday’s closing price.
Is that a logical goal? ADS shares changed hands at peak prices of $66 - $80 during each calendar year, from 2006 right through 2009, when sales and earnings were well below today’s levels. With even better fundamentals expected, I see no reason why ADS cannot match or exceed those price points again in the next twelve months.
How many companies can you think of that continued to perform at a record pace during the economic meltdown of 2008 – 2009, and yet trade at about ten times earnings?
If you’re knowledgeable about options and want a somewhat conservative play with ADS you might consider this:
Cash Outlay
Cash Inflow
Buy 1000 ADS @ $56.15 /share
$56,150
Sell 10 Jan. 2012 $60 Calls @ $8.40 /share
$8,400
Sell 10 Jan. 2012 $60 Puts @ $12.00 /share
$12,000
Net Cash Out-of-Pocket
$35,750
If ADS rises to $60 or higher (+ 6.9% or better) over the period through Jan. 2012:
· The $60 calls will be exercised.
· You will sell your shares for $60,000.
· The $60 puts will expire worthless.
· You will end up with no shares and $60,000 in cash.
· You will have no further options obligations.
This best-case scenario result would be a gain of $60,000 - $35,750 = $24,250
$24,250/$35,750 = + 67.8% … achieved over 22.5 months on shares that only needed to rise by 6.9% from the trade’s inception price.
What’s the downside?
If ADS shares remain < $60 on the Jan. 2012 expiration date:
· The $60 calls will expire worthless.
· The $60 puts will be exercised.
· You will be forced to buy another 1000 ADS shares.
· You will need to lay out an additional $60,000 in cash.
· You will end up with 2000 ADS shares.
What’s the break-even point on the whole trade?
On the original 1000 shares it’s their $56.15 purchase price less the $8.40 /share call premium = $47.75 /share.
On the ‘put’ shares it’s the $60 strike price less the $12 /share put premium = $48 / share.
Your overall break-even would be $47.88 /share or $8.27 (-14.7%) below the trade inception price. ADS could drop by almost 15% without causing a loss on this trade.
Disclosure: Author is long ADS shares and short ADS options.
Source: Alliance Data Systems: Building Customer Loyalty