Pepsi (PEP) Q2 Earnings Preview & Trade Ideas

by Dan July 9, 2018 1:01 pm • Trade Ideas

Pepsi (PEP) is scheduled to report their Q2 results tomorrow before the open. The options market is implying a little less than a 2% move in either direction which is rich to its average one-day post-earnings move over the last four quarters of only 50 basis points, but inline with the long-term average one-day post-earnings move.

Shares of PEP have had a particularly volatile year, down about 9% ytd, down 11% from its 52-week and all-time highs made in late January, but also up 13% from its recent lows made in early May, which capped a 21% peak to trough decline. Technicians might view $110 as technical resistance dating back to last fall:

Why the volatility and poor performance since late January, massively underperforming the broad market (SPX up 4% ytd)?? Well, it likely has something to do with being one of the largest stocks in the consumer staple space which happens to be the worst performing sector in the S&P 500 (SPX) as investors have sold shares of low growth, high valuation companies with high dividend yields as bond yields have risen in 2018.  Also, PEP gets about half of their sales from outside the U.S. the dollar’s nearly 7% rise since its 52-week lows in February could cap eps upside, coupled with rising transportation costs.

While PEP’s stock has declined, its dividend yield has increased to 3.4%, up from under 3% at its highs, but so has its Price to Earnings ratio, now at about 19x 2018 expected eps and 18x expected 2019 eps with its PE topping out very near 24 at 10-year highs in January.

Estimates for PEP’s eps and sales growth have not changed much, high single-digit eps, and low single-digit sales, but PE has gone down and its dividend yield has gone up, possibly making the stock more attractive to investors. With the stock at very near the mid-point of a very volatile year, it would likely take a meaningful beat and raise to breakout out above $110 on earnings, and a miss for the stock to be headed back to retest the 52-week lows.

But when you have a 2% implied move into an event like earnings for a stock like PEP, that means that if you have a directional inclination, that to define your risk and pick a direction you are only risking 1% by buying the at the money put or call. Still, this is a low percentage way to make money as you need to get a lot of things right to just break-even, first and foremost direction, timing and magnitude of the move.

So what’s the trade? 

If I were inclined to play for a bounce above 110, I would look to take advantage of relatively cheap options prices and look past weekly options to give a little time to play out and not be so binary on the earnings event.

Bullish Trade Idea: PEP ($108.60) Buy July 109 / 113 call spread for $1.10

-Buy to Open 1 July 109 call for 1.35

-Sell to open 1 July 113 call at 25 cents

Break-even on July expiration:

Profits of up to 2.90 between 110.10 and 113 with max gain above 113

Losses of up to 1.10 between 109 and 110.10 with max loss of 1.10 at 109 or lower.

Rationale: this trade risks 1% of the stock price for a potential 2.6% potential payout if the stock is up more than 4% in the next two weeks.

OR

If I thought fundamental headwinds might persist and the company would guidd down, I would look to play for a sustained sell-off over the course of the summer with the stock retesting the 52-week lows just above $95.

Bearish Trade Idea: PEP ($108.60) Buy Aug 24th weekly 108 / 100 Put Spread for $1.65

-Buy to open 1 Aug 24th weekly 108 put for $2.00

-Sell to open 1 Aug 24th weekly 100 put at 35 cents

Break-even on Aug 24th weekly expiration:

Profits of up to $6.35 between 106.35 and 100 with max gain below 100

Losses of up to 1.65 between 106.35 and 108 with max loss above 108

Rationale: this trade risks 1.5% of the stock price offering a potential 6% payout if the stock were to decline 9% over the next 8 weeks. Good risk reward, but need to be convicted and get direction right.

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