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Weekly Newsletter, Saturday, 06/11/2005

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Table of Contents

  1. Commentary
  2. Changes in Portfolio
  3. Portfolio Listing
  4. New Plays
  5. Existing Plays
  6. Watch List

Leaps Trader Commentary

Bad Weather Produces Higher Oil 

I hate to keep spending so much ink on discussions about the state of the oil sector but with the majority of out plays in that sector it deserves being a constant subject. Oil rose, fell, rose, fell all week and closed just under $54 on worries that OPEC will raise production quotas next week. Not that it will do any good but it has the appearance of more oil on the market. OPEC is currently producing at near capacity and pumping about 2.5mbpd over quota. Just raising that quota will only put the stamp of approval on that level of production. 

OPEC says it wants to build up an inventory backlog to prevent the expected end of summer demand spike from pushing prices into the stratosphere. However, with demand rising on a global basis that hope may be in vain. In my market wrap this weekend I mentioned several facts about China and their oil problem so I won't repeat them here but it is safe to say the problem is only beginning. 

Most of the oil stocks fared better than oil prices in general for the week because another quarter has passed with above average earnings. This lowers the effective PE for the oil stocks and makes them a better value. Add in the expected over $60 oil prices this fall and profits will be rolling in even stronger. 

In the news on Friday Chevron announced the FTC had approved the Unocal acquisition. Also in the news was a strong rumor that CNOOC, China Oil, was prepared to make a stronger bid for the Unocal assets. This failed to dampen enthusiasm for Chevron and it closed at the highs for the week. Chevron was depressed in April from the acquisition news and is trading well below its peers. Once the acquisition is complete Chevron will control 11% of U.S. gasoline production. This should give Chevron wings once the acquisition is complete. 

On the bright side Conoco and OXY rallied to new all time highs and appear ready for a strong breakout. 

Kirk Kerkorian must be feeling pretty happy this weekend after his GM play produced about $100 million in profit in only a few weeks. KK owned about 10 million shares when it was trading at $27 and he made his tender offer for $31. That produced a nice $40 million profit regardless of whether anybody tendered at the higher price. When the smoke cleared there was an additional 19 million shares tendered at $31. The news on Friday that the UAW had agreed to talk about healthcare expenses sent GM over $35 intraday with a $34.50 close. That produced another windfall profit for his new 29 million share position. Unfortunately it stopped us out of our GM put for a nice loss. Let's petition KK for a donation to cover our loss. I believe he can afford it. 

I am still allergic to adding any further long leaps given the calendar and a full portfolio. I will make some suggestions in the Watch List section but I am not making them actual plays.


Changes in Portfolio

New Plays

None


Dropped Plays
GM $34.50 General Motors ** Stopped $33.80 **

New Watch List Plays Triggered
DJX
$15.12 Dow Puts

Portfolio Listing & Top Picks


New Plays

Most Recent Plays

4 HEADER, begin SECTION 4 BODY-->

DJX - $105.12 Dow Puts ** Stop Loss $106.50 **

The Dow gave us a nearly perfect entry with the spike to $105.78 to trigger out put entry at 105.50 on Tuesday. The Dow weakened the rest of the week but find some buyers at the close on Friday. 

Unfortunately the Wilshire-5000 is not confirming the weakness and is suggesting there are still buyers just under the current range. 

I suggested this play because I thought Greenspan would confirm that Fisher spoke out of turn and the Fed was still on its measured pace program until Q4. I also expected Intel to fail to impress. Both events came to pass but the market did not implode as I expected. Whether this is a time delayed fuse or the bad news bulls have returned in force we will not know until next week. 

Aug $104 PUT DJV-TZ @ $1.55

No insurance call - Stop at $106.50

Entry $105.50 (6/7)


Play Updates

Existing Plays

CHK - $21.50 Chesapeake Energy ** No Stop **

CHK rallied with the sector to trade over $21 and short-term resistance. This is our low budget energy play and the next real resistance level is in the $23-$24 range. 

Company Info

Chesapeake Energy derives 90% of its revenues from natural gas. They are very aggressive about replacing reserves and will capitalize on the continued increase in prices. Gas prices have soared in the U.S. due to the addition and conversion of electric plants to the cleaner fuel. Several times over the last winter the gas levels supplying those plants dipped to dangerous levels. The demand is increasing faster than supply and the production peak is now estimated to be 2007. Prices are going to continue higher, much higher and Chesapeake is positioned to benefit. 

This summer much of northern California will get its electricity from gas due to a drought in the northwestern hydro-electric grid. Generation levels will be below normal and natural gas is the fall back fuel. 

2007 $20 LEAP Call VEC-AD @ $4.00

Insurance put: July $17.50 CHK-SW @ 90 cents

Entry $19.00 (05/13)

FNM - $58.06 Fannie Mae ** Stop $60.50 ** 

The end of low rates may be in progress with the 10-year note back over 4%. This weakened FNM and put the focus back on the regulators. FNM fell to support at $58 and has held there for three days with not even a minor blip. A break of this level should target $54 once again. 

Company Info

Stronger jobs would mean more home loans for FNM but also higher rates from the Fed. That is not the problem we fear. Regulators are increasing their attack on the entity and Greenspan reiterated his warning on May-5th. He wants Congress to limit the multibillion-dollar holdings of FNM/FRE and warned again that any major problem with either could severely damage the U.S. markets. He favors allowing them to only hold the minimum level of mortgages as required by their charter. This would be a drastic cutback from current levels. 

Fannie Mae has been suffering from numerous ailments including accounting problems. The regulator for FNM has asked for more power to dig deeper. We suspect any deeper digging could turn up some more skeletons. 

2007 $50 LEAP Put VFN-MJ @ $5.40

Insurance Call 
June $55 FNM-FK @ $2.00, exit 6/06 $3.60 

Entry $55 (5/04)

APC - $77.30 Anadarko Petroleum ** No Stop **

APC continued to rebound and press the current highs. Once over $80 we could see acceleration in the price. The insurance put will expire in June and is currently worthless at $65. This is the kind of problem we wish for. 

Company Info

Anadarko has 2.37 billion barrels of proven reserves. They are the largest independent in a field of giants. Buying reserves is cheaper than finding them. 

Anadarko has just completed a restructuring program and raised estimates on May-2nd. They expect output to rise +5% in 2005 and costs to be below industry trends. S&P is estimating $8.55 for earnings in 2005 and a price target of $85. 

2007 $75 LEAP Call OCP-AO @ $10.10

Insurance Put 
June $65 APC-RM @ $0.85 

Entry $70.50 (5/04)

COP - $55.94 Conoco Phillips ** No Stop **

COP rallied above prior resistance and came within a few cents of a new all time high. Any storm damage in the gulf should push oil prices higher and COP should breakout into the clear on the news. The June $50 put will expire worthless baring any disaster. 

Company Info

COP reported earnings of $4.10 that rose +80% over the year-ago period. Analysts had only expected $3.29. They said unplanned down time at refineries kept them from doing even better. They also said they were going to spend $3 billion between 2006-2010 to increase their ability to handle the cheaper sour crude. 

COP has been aggressively purchasing assets around the globe and especially in Russia. Putin has said repeatedly that COP assets and agreements are not at risk and that COP is a partner with Russia in producing their oil. 

2:1 Split on June 2nd gave us 2 of each. 

(2) 2007 $50 LEAP Call OJP-AJ @ $7.88

Insurance put:
(2) June $50 COP-RJ @ $1.08

Buy the put insurance only if you feel you need it. We are far enough away from the entry point that I feel relatively safe. 

Entry (4/18 $49.00)

OXY - $76.01 Occidental Petroleum ** No Stop **

OXY broke out to a new high again and closed at that level on Friday. The June $65 put is now worthless but I doubt anyone cares since OXY is up nearly +$10 since our entry. 

Company Info

OXY declared a quarterly dividend of 31 cents in early May and appointed former U.S. Secretary of Energy, Spencer Abraham, to their board. Earnings in 2004 were a record $2.6B and as the CEO pointed out on Friday it was more than a billion more than they earned in 2000. Not a bad growth record. Q1 earnings were up +74% over Q1-2004. 

OXY reported earnings on April 26th of $2.16 per share compared to estimates of $1.99. OXY said it had higher than expected production, strong pricing and record chemical sales. Still it failed to produce the blowout earnings of COP due to hedging. 

OXY reported an agreement with Oman to invest $2B in the Mukhaizna oil field and upgrade production from 10,000 bbls per day to 150,000 per day. I would happily invest $2B once to get $3B return per year. Good job!

OXY is the 239th largest company in the world and an oil giant. 
Occidental's principal activities are to explore for, develop, produce and market crude oil and natural gas. The operations are carried out through two segments: Oil and Gas and Chemical. The Oil and Gas segment develops, explores for, produces and markets crude oil and natural gas. The Chemical segment manufactures and markets basic chemicals. The company operates primarily in the United States, Qatar, Yemen, Colombia, Oman, Pakistan, Canada, Russia, Ecuador and the United Arab Emirates.

2007 $70 LEAP Call VXY-AN @ $10.00

Insurance Put: 
June $65.00 OXY-RM @ $1.40

Entry $68.00 (4/19)

XOM - $58.32 Exxon Mobil ** No Stop ** 

XOM continues to move slowly higher due to the weight of it billions of shares. XOM has roughly $30 billion in cash and an acquisition could be in the cards very soon. 

Company Info

XOM reported a +44% jump in earnings but missed analyst estimates. After items XOM earned $1.15 and analysts were expecting $1.20. XOM hedged to capture high oil prices and prices continued to move higher. They also saw a drop in production as mature fields continued to decline. XOM said it will spend $15-$16 billion in capex in 2005 in an effort to discover/produce more oil. They also said they were going to buy back $3.5 billion in stock in the current quarter. Their record profits of $7.86 billion for the quarter give them plenty of cash for anything they desire. Maybe a couple acquisitions would help that sagging production. 

XOM has larger reserves and more cash than any other oil company. They have to find something to do with their $30 billion and it will either be returned to the shareholders or used to buy more reserves. 

XOM is the largest oil company in the world and while it has the largest reserves it also has the highest overhead cost. 

2007 $60 LEAP Call ODU-AL @ $6.70 

Insurance Put:
July $55 Put XOM-SK @ $1.20

Entry $58.00 (4/19)

XLE - $43.65 Energy SPDR ** No Stop **

The XLE continues to move higher given the new emphasis on the oil service index in the press. Drillers and specialty companies are being named as alternatives to the integrated oils. Buying in any oil sector helps the diversified XLE. 

Company Info

The XLE SPDR is composed of 27 energy stocks and represents about 8% of the SPX. This is the 8% that helped push the SPX to the current levels with the rise in oil over the last year. In fact the XLE has far exceeded the SPX in performance over the past year.

The XLE functions like an energy index and should rebound or bottom before oil stocks in general. Once traders start nibbling at the individual stocks in the index we will get our first glimpse of a rebound in the making. 

I chose a leap close to the money because there was no material price difference for the Leaps $2-3 away. Insurance is cheap and I expect this to be a very long-term play. 

BUY 2007 $40 LEAP Call ORJ-AN @ $5.60

Insurance put:
Buy June $39 Put XLE-RM @ $1.35

Entry $39.75 (4/18)

VLO - $74.09 Valero Energy ** No Stop **

VLO gained more than any other oil stock in the portfolio this week and is nearing strong resistance in the $75-$80 range. I have confidence VLO will eventually breakout and be a star performer. The June 60 put will expire worthless next week. 

Company Info 

VLO has been weak since the announcement it was buying Premcor. This should be a very good deal for them and the combined companies will control a large portion of the refinery business. Think of it as a buying opportunity. 

Valero is the largest independent refiner in the U.S. and one that has made the switch to the higher profit margins of sour crude. Oil prices are generally quoted using the West Texas Light Sweet price. The sour crude sells for significantly less and will become the dominant variety as oil supplies dwindle. Sour crude has been running about $10 a bbl under sweet crude. Valero is seeing even bigger discounts from less desirable grades from Mexico and Alaska. It costs more to process the sour crude and fewer refineries can handle it. This forces the price of that sour crude lower. Finished gasoline is priced basically on the price of a barrel of sweet crude. This means the same gas Valero produces from cheaper sour crude sells for the same price as the gas produced from sweet crude. This enables Valero to capture a significant profit margin. They had a record year in 2004 due in part to their ability to process the cheaper grade of oil. The company has already said 2005 profits will be higher in 2005 even if margins narrow for others. 

Company website: http://www.valero.com/About+Valero/

Valero reported earnings on April 21st of $1.92 that more than doubled the prior year of $.91 cents. VLO fell slightly in trading because analysts had estimates of $1.97. Shucks, they missed estimates by a nickel but more than doubled last year. Let's sell them. Duh! They rebounded as eager traders rushed into the gap and they closed at $74.86 on Friday, more than $5 above the earnings dip at $69.55. 

2007 $75 LEAP Call VHB-AO @ $14.10

Insurance put: 
June $60.00 VLO-RL @ $2.05

Entry $68.00 (4/15)

CVX - $56.29 Chevron Texaco ** No stop **

CVX is breaking free of the resistance range we have seen since the Unocal acquisition made the news. It closed over the 100 day average at 55.50 and appears to be in breakout mode now that the Unocal acquisition has been approved by the FTC. 

Company Info

Chevron spiked to $54.50 on May 6th on news of an oil find in Utah by Wolverine where Chevron has extensive leases. It was also announced that Chevron had won a portion of the 15 blocs up for bid in Libya. 

Chevron posted earnings that disappointed the street due to several unplanned outages at various refineries. CVX saw refining profits fall -36% but the condition is expected to be temporary. The stock is also weak due to uncertainties about the Unocal acquisition. 

Chevron announced in early April that it was purchasing Unocal for $18 billion in cash and stock and both CVX and UCL dropped sharply. This was not a surprise for Chevron to make the purchase but the timing caught everyone off guard. 

In theory everyone was waiting for oil to drop in Q2 and allow the next round of acquisitions to be made at a more reasonable value. Instead Chevron did a take under on Unocal by offering less than the current share price. It is a good deal if you can pull it off. 

Chevron beat out several other firms including China's CNOOC who had been a hot pursuer but had to drop out at the last minute after it could not complete the final terms in time. 

Chevron will likely sell off about $3 billion in non-core assets once the deal is consummated. The main asset Chevron wanted was the 1.7 billion barrels of proven reserves and tens of thousands of acres of additional leases still to be explored. Chevrons current average cost of produced crude is $27. After selling the non-core assets they will end up with the Unocal proven reserves at about $9 a bbl plus billions in other assets like gas fields, power plants and joint ventures around the world. This was a very sweet deal for Chevron. 

It may take some time for the cloud to lift from the stock price but the next jump in oil prices should do wonders. Chevron dropped back to its 100-day average at $55.50 on the news and this should be very strong support. There is not expected to be any hurdles to getting the deal approved as most of the assets are either out of the country or will be divested as part of the deal. 

The Unocal leap was actually triggered when the price hit $59 on the announcement. With UCL trading at $58.74 at Friday's close there would not have been any material movement. Because any Unocal leap will eventually end up being a Chevron leap I am electing to use the previously recommended Chevron leap as the actual position. I am using Friday's close for the entry price. 

2007 $60.00 LEAP Call VCH-AL @ $5.60
2007 $57.50 LEAP Call VCH-AY @ $6.70
Reference: UCL 2007 $60 LEAP Call VCL-AL @$6.60

Insurance Put: 
June $55 Put CVX-RK @ $1.65

Entry $56.67 (04/07)

GM - $34.50 General Motors ** Stopped $33.80 **

GM spiked over $35 on the UAW news and kept the Dow in positive territory on Friday. It also stopped us out of our put for a -2.20 loss. 

Company Info

GM got a huge pop from the obviously self-serving Kirk Kerkorian tender for 28 million shares at $31. GM was trading at $27.50 when he announced the tender. What idiot would tender for $31 when he could buy all he wanted at $27? An idiot who already owned 22 million shares and wanted to make a cool $4 bucks on the pop. Maybe Kirk was sly like a fox rather than dumb like a beginner trader. Now he can unload his shares and cancel his tender for a nice profit. 

I was out of the office when the spike to $33 occurred or I would have jumped on the chance to sell the call for a $3 profit. I hope a few readers did not let that opportunity pass them by. 

For those who believe as I do that GM with its $200 billion in debt and growing will eventually break $25 to the downside I would suggest doubling up at this level. Ironically the put is worth more today than when we entered at a lower level back in April.

My long-term view is very bearish on the automakers due to the potential for $100 dollar oil over the next year or so. If $2.50 gas is bad for business $5.00 gas will be a death knell for gas-guzzlers. 

With earnings approaching there is a good possibility GM will reveal some more negative details about its profits and its pension/healthcare problems. 

I am using the 2007 leap puts because I think this will be a long term problem for GM and the other car makers as well. We could easily see prices in the teens before this put expires. 

2007 $30 PUT VGN-MF @ $7.20, exit $5.00, -2.20

Insurance Call
May $30 Call GM-EF @ $1.50, exit 5/08 $1.25, -0.25

Entry $29.35 (4/04)


Leaps Trader Watch List

The Dow gave us a nearly perfect entry on out short term DJX put position but after seeing the lack of reaction to the Greenspan and Intel news I am not sure if I should be excited of not. It is like a poker game where the first three cards look promising enough to make a bet but the fourth card changes your outlook entirely. Instead of increasing out bet on a Dow drop we are in a position where checking to the power is the right move. If we are going directional I would have thought this was the week with both the Greenspan and Intel event. Fortunately it was cheap at $1.55 and we have a tight stop at 106.50. 

In my market wrap I mentioned that JP Morgan had singled out several energy stocks as ripe for a takeover. Those names were SRE, FTO, SUN, TLM, D, AYE and HOC. Of those names only D, Sun and AYE have leaps. 

FTO looks like a rocket but October is the farthest month out and after three weeks of gains I would like to see it rest before making an entry. 

SUN has leaps but they are grossly expensive as in the $17 range and higher for slightly out of the money. I hesitate to play those given the current build up in expectations. 

Dominion has leaps out to Jan-2008 and after the big drop in early May they are reasonable. I don't like Dominion as an energy play as it is mostly a power company. It does have six trillion CF of gas assets and 7900 miles of pipelines but nothing to get excited about. 

AYE is also a power company and one that burns about 18 million tons of coal annually. While their fuel expense may be less than a gas fired utility they do have about a 250 year supply of fuel. Gas plants could runs out of gas over the next ten years. Still, power plants are not exciting investments for me. 

The SRE chart shows an upward pattern but one that is moving very slowly and showing no life. 

HOC, Holly Corporation, is a petroleum refiner with a capacity of 110,000 bbls per day. They make light fuels like gasoline, diesel and jet fuel. They would make an attractive target for acquisition but they are too small to be attractive to the bigger firms. 

TLM, Talisman Energy is by far the best target in my opinion. They are projecting nearly 500,000 bpd of production for the rest of the year and are active drillers. Many of their active assets are in Southeast Asia and that makes them a prime target for China Oil and its acquisition program. The company is producing about $1B in cash flow per quarter with about a 25% margin with production output increasing. 

TLM has no leaps but the stock is cheap at $37 and call options for Jan-06 are $5 ITM and $2.95 OTM. I would jump on the Jan-$40 calls TLM-AH for $2.95. As fast as the stock is rising it could be $40 by the end of the week. 

I did not add any new leap candidates this week but I believe the Talisman info is as good as it gets. Since there are no leaps I am not making them an official play but rest assured I think it is a strong opportunity. 

On our watch list EBAY has drifted back to just over $36 and coming very close to our $34 target price. 

CCU continues to wander and I will remove it next week if it does not go directional. 

Dropped Entries

None


New Watch List Entries

None

Current Watch List

EBAY - $36.61 Ebay Inc

CCU - $30.52 Clear Channel Communications


************************* 


CCU - $30.52 Clear Channel Communications

** Breakdown Target $28.00 **
** Breakout Target $32.50 **

Radio is changing with the advent of satellite and conventional AM/FM is fighting an uphill battle. 


Breakdown Target
BUY 2007 $25 LEAP PUT VYU-ME currently $1.80

Breakout Target
Buy 2007 $30 LEAP PUT VYU-MF currently $3.70

No insurance call - Stop at $35.00 

************************* 

EBAY - $36.61 EBAY Inc

** Breakdown Target $34.00 **
** Breakout Target - None **

If we get continued dip I would be happy with an entry at $34. 


Breakdown Target
BUY 2007 $35 LEAP CALL OYI-AU currently $6.60

Insurance put - OCT $30 PUT XBA-VF currently $1.40

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