This fast food operator has seen its shares tumble in recent months. Will the upcoming earnings report spring them back to life? 

Jack in the Box (JACK) operates its namesake hamburger oriented restaurants along with the Qdoba Mexican fast casual restaurant. Both are predominantly in the western half of the U.S and along the mid-Atlantic coast. The company was slow to expand into middle of the country or the high growth South.

But grow it has, it currently has over 2,500 Jack in the Box restaurants and 674 Qdoba restaurants and plans to add 25 of the former and 15 of the latter in 2016. It leans heavily on the franchise model, some 1,800 of the former and 350 of the latter, are franchised, which helps shift the risk and stabilize revenues and margins.

With most of the above growth coming in just the past 5 years the stock had an incredible run jumping over 345% from 2012 to their March 2015 high of $98 per share. It also sported, and deserved a very high p/e multiple in excess of 60x forward earnings at its peak.

The growth rate and valuation proved to be unstainable as the past few quarters have made clear. In the most recent earnings report on February for the first quarter of 2016 the company posted a profit of $0.94 per share, a full 10 cents below analyst expectations. Revenue, which came in at $470 million, also came up short $5 million. This meant earnings were flat year over year, and the market was clearly not happy with the result.

It caused shares, which had already been in a downtrend, to tumble to a 52-week low of $62 per share. Since then technical picture of the chart has been improving. The stock bounced, retested the low, and has now been forming a bullish flag above the 50 dma. I think this sets up a good entry point ahead of May 11 earnings report.

First, many of the issues that dragged on profitability were either transitory or have been addressed. One of the big challenges was when McDonald’s (MCD) not only started serving breakfast all day but simplified its deep discount menu. I think many in the industry were surprised but just how much market share that stole during the early lunch crowd. It also forced JACK and other competitors such as Sonic (SONC) to become highly promotional in terms of both advertising and discounting. This ate into profit margins which contracts 17 basis points.

As the bit of novelty from McDonalds all -day breakfast wears off traffic patterns are normalizing, promotions are subsiding and Jack has also revamped some menu items to address that bridge between 10:30 and 12:00 and late night munchers.

At this point, with shares still 35% below last year’s high, and stock trading at discount to slower growing peers the shares are poised to pop on good news.

If the company can match, or better, the 73 cents earnings per share the market is expecting in the second quarter, the valuation should expand to a 25/26 times earnings multiple and give a twelve-month earnings per share to $2.98, and imply a fair value of $74.50. That’s a solid is a massive 8% gain from the current share price. While that might seem like an overly ambitious jump in the share price, it still falls below the level from the prior earnings report.

Still, given the vagaries of reaction to earnings report I want to take a somewhat conservative approach and use an option spread to limit my risk. The strategy I’m employing is a diagonal calendar spread. Specifically;

-Buy to Open June (6/17) 65 Calls

-Sell to Open May (5/20) 70 Calls

For a $3.00 Net DEBIT (+/-0.10)

If the company can deliver on the lowered expectations the stock should jump right back through the $70 level.

Here is what the risk/reward graph on the trade looks like: