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52-week range: $6.98 (Nov. 21, 2008) - $23.84 (Feb. 4, 2008)
Dividend = $0.10 quarterly = 4.69% current yield
American Eagle serves the casual apparel market targeting the 15 – 25 year old market segment. They have about 958 mall-based AE stores in the US and Canada plus 116 stand-alone stores.
Like everyone else in retailing their business is very poor right now. After hitting new all-time high EPS in FYs 2004 – 2007 (FYs end January of the following year) FY 2008 will be down about 45% in the year just ended. Including an expected Q4 drop from $0.66 to just $0.20 full year EPS were likely $1.00 versus $1.82. The current year should be even worse with EPS estimates now running $0.75 for FY 2009.
Why be interested in this stock then? The problems are the result of the recession and not AEO’s execution. When the economy picks up, so will American Eagle’s results. The company has just $75 million in total debt and held over $343 million in treasury cash as of Nov. 1, 2008. With just 206 million shares outstanding that’s $1.32 /share in cash (net of debt). Tangible book value is over $6.50 /share.
At today’s depressed price of $8.52 the well-covered dividend is almost 4.7% and represents just a payout ratio of 40% of last year’s earnings and just 25% of FY 2008’s cash flow.
Is there a near-term catalyst for these shares? No. That’s why I’m looking at a buy/write option combination that uses in-the-money calls and out-of-the-money puts that stretches out to January of 2011.
Here’s a play I put on for myself just a few minutes ago:
…………………………….....................………….. Cash Outlay ….....……… Cash Inflow
Buy 1000 AEO @ $8.52 ………..............……… $8,520
Sell 10 Jan. 2011 $7.50 calls @ $3.00 ……...........…………….....……….. $3,000
Sell 10 Jan. 2010 $7.50 puts @ $2.45 ……..........……………….....…….. $2,450
Net Cash Out-of-Pocket …………………................………... $3,070
On expiration date in January 2011:
If AEO shares are $7.50 or higher (where they are today):
Your $7.50 calls will be exercised.
Your shares will be sold for $7,500.
Your $7.50 puts will expire worthless (a good thing for you as a seller).
You will likely have collected $800 in dividends.
You will have no remaining shares and no further option obligations.
You will have $8,300 cash for your initial $3,070 outlay- a $5,230 gain.
The above result will occur if AEO shares go up, stay the same or even if they decline by up to 11.9% from today’s quote of $8.52/share.
What’s the worst-case scenario?
If AEO shares go below $7.50 you can be forced to buy an additional 1000 shares and would need to pay $7,500 more out-of-pocket at that time.
You would end up owning 2000 shares of AEO.
Your break-even point would be figured as follows:
On the original shares purchased at $8.52 it’s that price less the $3.00/share call premium = $5.52 /share.
On the puts you sold it’s the $7.50 strike price less the $2.45 put premium
or $5.05 /share.
Your average all-in net break-even point would be the average of $5.52 and $5.05 = $5.29 /share (not counting dividends).
Anything less than a 37% drop in share price (from already beaten up levels) would leave you with a profit.
While it’s conceivable that AEO could go that low, these shares have not traded at $5.29 since 2003 when EPS were $0.34 or about one third of current levels. Revenues and book value have each more than doubled since that time. In 2003 there was no yield as opposed to today’s 4.69% rate.
American Eagle has proven itself through previous bad cycles. It has shown profits in each year since coming public in 1994. Chairman Jay Schottenshein and family owned 15% of the stock as of the latest proxy statement.
If you think America will be in recovery mode by 2011 this looks like a good play on a solid company.
Worst case you’ll own 2000 shares of stock at a 5-6 year low price and with 37% downside protection. The best case scenario leads to a 170% profit cash-on-cash in 23.5 months.
Disclosure: Author owns shares and is short options on AEO as described.
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Seems to me you do not believe that the shares could be worthless and that is actually the worst case scenario!!!