Tuesday, December 10, 2013

Lumber Liquidators (LL) - Part 2: Stock Falls, Volatility Explodes; Fraud Accusations Rage; Earnings Disappoint.

LL closed at $89.62, gapping down 13.7% with IV30™ popping 20.6%. The Symbol Summary is included below.

Provided by Livevol

Lumber Liquidators Holdings, Inc. (Lumber Liquidators) is retailer of hardwood flooring, and hardwood flooring enhancements and accessories. The Company offers an assortment of wood flooring, which includes prefinished domestic and exotic hardwoods, engineered hardwoods, unfinished hardwoods, bamboo, cork and laminates, as well as resilient flooring.

I recently wrote about LL on 11-24-2013.  You can read that post by clicking on the title below.

Lumber Liquidators (LL) - The Finger Print of Fraud; Stock Gaps Down on Fraud Accusations; The "Expense Recognition" Game. Is Volatility Mis-priced?

As the title suggests, I questioned if the volatility was too low, or in English, if the risk reflected  the option market in the share price was to low.  I have included the Symbol Summary from that day, below.


Provided by Livevol

Today we can see the stock is substantially lower and the volatility has popped ~ 25%.  Here are a few snippets from the prior article, then we can move on to the new stuff:

I found this stock looking for the day's largest losers, and as is usually the case, there's quite a story behind this drop. The end results is both a stock and volatility story surrounding some scathing remarks made by a short-seller implicating management in multiple types of fraud. Oh, and by the way, the stock was up more than 650% in two-years before this news.

Here's the news, and it is ugly:

Shares of Lumber Liquidators  were getting taken to the woodshed, falling 12% after Whitney Tilson, head of the Kase Capital Management hedge fund, announced a short position in the high-flying wood-flooring specialist. At an investor conference, Tilson noted a government investigation into potentially illegal timber imports by Lumber Liquidators, and suggested the company's gross margins, which have improved to better than 40% lately, were too good to be true. The hedge fund manager also cited a report from the non-profit Environmental Investigative Agency that said Lumber Liquidators' purchases "have fueled rampant illegal logging in Eastern Russia." Shares of the flooring retailer had more than doubled this year before today's drop, riding the broader housing recovery.

Source: The Motley Fool via Yahoo! Finance; Dow Hits Another Record, but Lumber Liquidators and Fresh Market Tumble, written by Jeremy Bowman.

I have added the italics and bold font to draw out the real news.

1. Kase Capital is shorting LL stock.
2. Whitney Tilson pointed out a government investigation into potentially illegal operations.
3. The gross margins for LL could be falsified.
4. Other potential shenanigans in Russia.

The accounting fraud game of expense recognition is often times seen in gross margins.  It can be done in several ways, but two of the most common are:

1. Blatant falsification of costs (under reporting).
2. Knowingly mis-classifying costs from COGS into SG&A and thus artificially boosting gross margins (operating revenue - COGS).

Either of these games is a major no-no, number one being worse than number two, but both, if true and discovered, likely result in an SEC Enforcement Action of Accounting Fraud.

Now remember, these are claims from a short-seller, not claims or actions from the regulators.  But, if there is an existing investigation, that means... there is a volatility story to be told.

Ok... So what happened today?  Here's that news:

Lumber Liquidators retreats after profit outlook misses expectations
Shares of hardwood flooring retailer Lumber Liquidators (LL) are falling after the company provided lower than expected fourth quarter profit guidance. The midpoint of the company's 2014 profit guidance was also below analysts' consensus expectation. WHAT'S NEW: Lumber Liquidators' fourth quarter earnings per share guidance was 69c-72c, versus the consensus estimate of 73c. The company's fourth quarter revenue outlook was in-line with analysts' expectations. For 2014, Lumber Liquidators predicted that its earnings per share would be $3.25-$3.60, versus the consensus estimate of $3.50.

Source: TheFlyOnTheWall  via Yahoo! Finance; Lumber Liquidators retreats after profit outlook misses expectations


Let's look at the two year Charts Tab, below. The top portion is the stock price, the bottom is the vol (IV30™ - red vs HV20™ - blue vs HV180™ - pink).

Provided by Livevol

We can still see that remarkable 650% rise over two-years, but now we can also see the sharp downturn of late with the stock dropping from a high of $119.98 to now below $90.  With the stock at $101 I felt the implied volatility may have been to low.  I'll tell you what, with the volatility popping 25% higher, I still think it may be to low.

Let's turn to the two-year IV30™ chart in isolation below.

Provided by Livevol

We can see the remarkable rise off of the lows in mid November of ~33%.  The IV30™ has been as high as 54.82% this year, so we are near an annual high.  Even over the two-year period we see a high of ~55%.  I dunno, this does not feel like a 50% vol stock given the release today and the lingering accusations from before.  That doesn't mean I think the stock will go down (or up), it just means I think there's a lot of risk in this name right now.

Finally, let's turn to the Options Tab, below.

Provided by Livevol

Dec vol is priced to 58.69% while Jan'14 is priced to 48.23%.  You tell me, does Jan'14 vol feel like fair value right now?

This is trade analysis, not a recommendation.

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