THO -- Contrarian Trade Into Earnings

A short term idea ideal for a tax sheltered account

One of the ways I look for short term trades in a tax sheltered account is by finding companies with upcoming earnings. Earnings tend to be a driver for change in share prices as much as any other force. However they can also be a driver to the down side. Therefore the first thing I like to look at is a stocks movement going into earnings.

Companies that run up into earnings price themselves for perfection. While a massive beat can still drive the stock higher; a modest beat or a modest miss can pummel the stock price. Typically then I try to avoid stocks that have had big run ups into earnings. I also try to look at the previous years comps to see whether the setup is favorable. Finally I look for comparable companies to see what the industry trends are. It’s rare that you get a setup that checks all the boxes, but Thor Industries ($THO) into earnings on Monday does this.

Valuation

I find that shares of THO are fairly valued right now. Current THO has an enterprise value of $6.6B. Using a cost of capital of 7% that means a fair return on the invested capital would have to be around $460M per year. FCF in the Twelve Trailing Months is $446M. This is 17% higher than the previous FY which was about 15% higher than the FY before it. All of this indicates that the companies return on capital is close to the expected return. In other words it’s a fairly valued stock with reasonably good growth.

Momentum

We find that the setup on the momentum for THO is favorable on a risk adjusted basis.

From this chart here you can see that the stock has traded sideways over the past 3 months, having peaked in June and August before ultimately pulling in closer to it’s 200 day moving average. I personally prefer a setup similar to this when trading into earnings. The reason why is you have downside priced in, and your risk is lowered. Ultimately I read this as saying worst case scenario the stock drops to the 80s. However best case scenario, the stock could touch the 120s. I know that my personal viewpoint on momentum goes against most technical analysis, but in my experience stocks with huge runs into earnings, typically are boom or bust. I personally don’t like that risk profile.

Comparables

One of the most important aspect (and what really in my opinion should be the most important aspect) is the companies performance relative to market expectations. Here again, I like the setup for THO:

In the chart above you see the stocks of 4 related companies. THO, WGO (Winnebago) are RV manufacturers. LAZY and CWH (Lazyday & Camping World Holdings) are retailers who sell RVs. Notice that over the past 2 months a divergence has emerged with the manufacturers pushing lower and the retailers going higher. In this case we have the benefit of looking at the quarters for the retailers to give us some idea of the demand.

In the past quarters LAZY and CWH both reported strong sales revenue for new RV sales. LAZY’s comp’s year over year were up 37%. CWH’s were up 15%. Logic dictates then that both THOR and WGO will have strong quarters. However what is the street expecting? Not much. Per Yahoo Finance average analyst expectations for revenues are 2.29B. Prior year revenues were 2.31B.

So the street is expecting revenues to be flat in the same quarter when retailers had sails up 15-30% over the prior year? Now this is a possibility. It is feasible that retailers were selling off a glut of excess industries. However the margins they sold the RVs at were at a higher margin then the prior year. This would seem to suggest that demand was higher than supply. In fact both retailers did mention that supply was constrained. So even if the sales number for THO are in line with expectations due to supply constraints, the guidance will likely be strong (to be fair the street does expect guidance to be about 16% higher YOY). While the street loves good comps, it tends to like strong guidance even more.

Overall picture

We see looking closely at THO that it’s not running into earnings at sky high valuations. The bar has been set low in overall expectations, and the comps seem to set up favorably. All of this plus the divergence in price from the retailers gives me confidence that the price of THO and likely WGO will pull in closer to that of the retailers. I believe the earnings for THO is a very likely catalyst for this regression. I calculate the maximum risk is a drawdown of near 10%, while the maximum reward is a run of 30% back to the summer highs. I’m willing to speculate on that risk/reward profile for a trade. I bought THO and WGO in tax sheltered accounts today and will hold both until after THO reports earnings.