Bears Are Ready for Best Buy Earnings

by Joseph Hargett | March 28, 2012 8:03 am

Best Buy Inc. (NYSE:BBY[1]) traders face a bit of a dilemma heading into tomorrow’s fiscal fourth-quarter earnings report. Specifically, the stock has attracted a heavy degree of investor pessimism despite expectations for solid year-over-year growth.  Currently, analysts are expecting earnings to rise about 9% to $2.16 per share, with revenue seen climbing 6% to $17.2 billion.

However, during the past 90 days, the consensus estimate has fallen two cents per share from $2.18 per share. What’s more, the whisper number for BBY’s fourth-quarter earnings report arrives at a mere $2.09 per share[2], according to WhisperNumber.com.

It’s hard to blame investors and analysts for having a low opinion of BBY. The company missed the consensus third-quarter earnings target by 10 cents per share, as profit fell 13%. Furthermore, Best Buy assumed the role of the Grinch for many consumers during the holiday season, after the company cancelled a plethora of online orders ahead of Christmas[3] due to “overwhelming demand.”

That said, Best Buy does have one pretty important fundamental feather in its cap heading into tomorrow’s quarterly report. According to data from Consumer Intelligence Research Partners, the big-box electronics retailer was responsible for 13% of all Apple Inc. (NASDAQ:AAPL[4]) iPhones sold during a recent three-month period – a mere two percentage points behind Apple’s own iPhone sales figures[5].

Apparently, ruining Christmas trumps iPhone sales, as bears are currently running rampant on BBY. For instance, data from Thomson/First Call reveals that 19 of the 25 analysts following the stock rate it a “hold” or worse, compared to only six “buy” ratings. Additionally, BBY closed Monday a mere seven cents below the consensus 12-month price target of $27. In other words, Wall Street analysts only expect the equity to rise a mere seven cents during the next year.

Short sellers are also getting in on the act, with the number of BBY shares sold short rising 6.8% during the most recent reporting period. As a result, 47.8 million shares, or about 17% of the stock’s total float, are now sold short and would take about 10 days to repurchase at BBY’s average daily trading volume. In layman’s terms, this means BBY is vulnerable to a potential short-squeeze situation in the event of a positive quarterly earnings report.

If short sellers are worried about a squeeze, it isn’t showing up in BBY’s options activity. Typically, shorts hedge their positions by purchasing calls ahead of an event that may negative repercussions. According to data from Schaeffer’s Investment Research, however, BBY’s put/call open interest ratio for the front three months of options arrives at 1.05, revealing that puts are slightly more popular than calls among short-term option players. Furthermore, this ratio has risen from a perch of 0.96, taken just after March options expired.

Technically, BBY has rallied heading into its quarterly earnings report, with the shares up more than 12% since March 14. As a result, the shares have eclipsed both their 50-day and 200-day moving averages and are now poised to challenge long-term resistance near $28.50. BBY has not closed a session above $28.50 since July 27, 2011. Traders should also be aware that the stock’s 14-day RSI is hovering just below overbought territory.

Screen Shot 2012 03 28 at 6.46.04 AM 300x252 Bears Are Ready for Best Buy Earnings
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Those looking for a potential trading idea ahead of earnings might want to consider an April 27/29 bull call spread, a contrarian play designed to take advantage of the excessive pessimism on BBY. A trader would buy the 27-strike call and sell the 29-strike call, paying a debit of 74 cents, or $74 per pair of contracts (the price for this spread at yesterday’s close).

The maximum risk to this trade, if BBY is trading below $27 at April expiration, is the 74 cents paid. The maximum reward, should BBY be trading above $29, is $1.26 (the difference in strike prices less the premium paid).  This is a risk/reward ratio of 170%.

Traders might also want to consider an April 27 straddle (the simultaneous purchase of the 27-strike call and put), which was asked at $2.58, or $258 per pair of contracts, at the close of trading yesterday. This strategy takes advantage of post-earnings volatility from BBY, allowing the trader to benefit from either better-than-expected earnings, or another earnings miss from Best Buy.

As of this writing, Joseph Hargett does not own any shares mentioned here. 

 

Endnotes:
  1. BBY: http://studio-5.financialcontent.com/investplace/quote?Symbol=BBY
  2. arrives at a mere $2.09 per share: http://www.whispernumber.com/whisper.jsp?ticker=BBY
  3. cancelled a plethora of online orders ahead of Christmas: http://gizmodo.com/5870440/best-buy-is-ruining-christmas
  4. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  5. mere two percentage points behind Apple’s own iPhone sales figures: http://allthingsd.com/20120323/best-buy-is-selling-nearly-as-many-iphones-as-apple-itself/

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