We cut two positions last week and I am recommending another drop this week. All have been profitable but excitement is lacking. Last week we cut Kimberly Clark (KMB) and GameStop (GME). This week I am recommending we close the Starbucks position.
We exited KMB and GME with gains and I want to exit Starbucks while we still have a gain. Shares hit resistance at $60 for the fourth time three months and sold off. The excitement is fading and while the fundamentals are still strong it appears investors are losing interest in the stock.
CLOSE SBUX on Monday.
Original Play Recommendations (Alpha by Symbol)
BA - Boeing Company Profile
Boeing declined slightly and gave back some of the prior week's gains. In the news they won a $3.2 billion order from the UK for the P-8A antisubmarine plane. The 737 variant carries torpedoes, cruise missiles, bombs, mines and an entire package of electronic warfare sensors to detect threats both on the surface and under the surface of the ocean.
Original Trade Description: March 13th.
Boeing designs, develops, manufacturers, services and supports commercial jetliners, military aircraft, satellites, missile defense, human space flight and launch systems worldwide. If it flies on earth or in space Boeing probably has their hand in its design and manufacture.
Boeing has had a relative dry spell in orders in 2016. For the prior four weeks they signed no new orders for commercial aircraft but they made up for it last week when they booked the biggest order of the year. They sold one 767 to FedEx, four 777s to United Airlines and 25 new 737s to United. However, at the same time United cancelled four 787 orders. That represents a net new order total of about $2.5 billion. Earlier in the year United also committed to buy (40) 737-200 aircraft at a list price of $80.6 million each.
So far in 2016, counting the orders from last week, Boeing has new orders for:
1 Boeing 767
1 Boeing 787
88 Boeing 737s
10 Boeing 777s
Boeing also has orders from the Air Force for 179 KC-46 tankers built out of 767 airframes. That contract is worth $43 billion and they have to be delivered by August 2017. The first 18 are already in production with Boeing working on some outside their buildings in Everett Washington. They do not have enough room inside the manufacturing facility because they are backed up on 787 deliveries. Last July FedEx bought 50 of the 767s in a freighter configuration. Boeing expects to sell more than 1,000 model 737 freighters with most going to China and Asia. Boeing sees $550 billion in aircraft demand from Southeast Asia in the years ahead.
While orders may be slow so far in 2016 the backlog of business is very healthy. Boeing delivered 750 jets in 2015 and expects to easily beat that number in 2016. As of the end of January Boeing had an order backlog of (4,392) 737 planes, (20) 747, (80) 767, (524) 777 and (779) 787s. The biggest order block is the 737s and that is one of Boeing's most profitable planes. The total backlog is something like 7 years of orders. Historically the backlog has run 2-3 years of production so it is more than double that today.
Add in the satellite and missile businesses and that is one busy company. As oil prices rise in late 2016 and 2017 the demand for more energy efficient planes will boost their orders even more. Some airlines are making do today with older less efficient planes because fuel is so cheap. Once prices rise again so will the orders. China's demand for planes is rising with double-digit growth in passenger traffic. One out of every four planes built goes to China.
Boeing expects to begin delivering the 777X models in 2019. The big jets are very expensive. The 777X-8 will cost $371 million and seat 350-375 passengers. The 777X-9 will list at $400 million and seat 400-425 passengers. They will have carbon fiber wings, burn 12% less fuel and be 10% cheaper to operate than competing aircraft.
Shares of Boeing declined in January after news of an SEC probe into the company's "program accounting" that shifts R&D expenses and production costs. They are the only major company to use that method but the technique is recognized under GAAP. Basically they are allowed to calculate profits over the life of the program and assign average costs to each airplane. That allows them to recognize profits earlier in the life cycle of each model but it reduces the profits on the back end. Nothing is expected to come from the SEC probe. Boeing is a very large company and they would not do anything that would jeopardize their future.
The analyst consensus for the stock is a target of $165 with a close of $124 on Friday. Earnings are April 20th.
Position 3/14/16 with a BA trade at $125.50
Long Jan $130 LEAP Call @ $7.85, no initial stop loss.
Short Jan $100 LEAP Put @ $4.44, no initial stop loss.
Net debit $3.45.
CSC - Computer Sciences Corp - Company Profile
CSC joined forces with 360Globalnet to offer claims processing worldwide. Shares posted a gain for the week and closed at the high of the week with resistance at $32 likely to be broken next week.
Original Trade Description: February 21st:
CSC is an information technology and professional services Fortune 500 firm that provides solutions in North America, Europe, Asia and Australia. They reported earnings last week of 71 cents that beat estimates for 69 cents. However, revenue declined -10.2% to $1.75 billion and missed estimates for $1.859 billion. The stock was crushed for a nearly -20% loss from $31 to $24 on the news. Shares recovered to trade just over $27 for the last week.
During the quarter they spun off their public sector business and merged it with SRA International and the merged company began trading on the NYSE under the symbol CSRA. This was responsible for a portion of the revenue decline.
However, the Global Business Service (GBS) segment saw revenues decline -8.2% due to a decline in consulting revenues. Overall the segment produced $1.6 billion in revenues for the quarter, which were up +35%.
Global Infrastructure Services (GIS) revenues declined -12.2% to $854 million. This was due to a continued decline in their legacy business, which is being replaced by their new cloud offerings. New business awards rose +4% to $1 billion.
Total company bookings rose +21% to $2.7 billion. Operating income rose +9.2% to $190 million.
CSC ended the quarter with $1.83 billion in cash and long-term debt at $2.67 billion.
On February 11th the Supreme Court of Victoria, Australia, approved the acquisition of WXC Limited for (AU)$427.6 million. CSC believes the acquisition of UXC will strengthen their global commercial business by adding the UXC platform to the CSC cloud, cyber and big data offerings. Back in August CSC acquired two other companies, Fruition Partners, a service-management technology provider and London-based Fixnetix, a provider of front-office managed trading software for capital markets.
They are also acquiring Xchanging, a UK company that provides software and outsourcing services for the insurance industry for $697 million. That deal is currently going through the regulatory approval process.
The point here is that CSC is a leading provider of information technology and they are growing rapidly through acquisitions. They are moving towards a mix of cloud based higher margin products that will be beneficial over the long term. They are also buying back stock with a new authorization in January. They paid a special dividend of $10.50 when they spun off the public sector business in Q4. That accounts for the $10 drop in the stock price at the end of November.
The big drop in the stock last week came from lowered guidance. The company guided for earnings in the range of $2.40-$2.60 because of their acquisition expenses, reduced revenue after the spinoff and delays in the government order renewal process and constricted federal spending.
They have plenty of business as evidenced by the $2.7 billion in new bookings and 16% earnings growth.
I believe the selloff it overdone and long-term the value will return to CSC shares. The options are cheap and the stock does not have to rebound far to put us into the money. This is purely a value play on an oversold stock that should move higher in a positive market.
I do not want to enter the position until that rebound appears so I am putting a $28.50 entry trigger on the position.
Position 2/26/16 with a CSC trade at $28.50
Long Jan $30 LEAP call @ $2.50. see portfolio graphic for stop loss.
CVX - Chevron Corp - Company Profile
Chevron shares saw some profit taking on falling oil prices. No specific news.
Original Trade Description: February 21st:
Chevron Corp explores, produces and refines oil and gas on a global scale. The upstream division explores and produces oil and gas. The downstream division refines the oil, produces petrochemicals and liquefies and distributes LNG around the world. Chevron is the real deal with operations in every facet of oil and gas production and distribution.
Despite the low oil prices Chevron continues to announce the completion of multiple projects to significantly enhance ongoing production. Currently Chevron produces about 2.54 million Boepd globally. They have a global refining capacity of 1.9 mbpd where profits offset the decline in crude prices. In Q3 Chevron had net income of about $2 billion. They generated cash from operations of $5.4 billion and paid out $2 billion in dividends.
The company has announced a decrease in capital expenditures from $42 billion in 2013 to $25 billion in 2016 and as low as $20 billion in 2017 depending on the market. This was helped by most of the work being completed on their two LNG facilities in Australia at a cost of nearly $60 billion. These facilities are preparing for first LNG and will be a source of a huge production increase for Chevron over the next three years.
On January 27th Chevron announced a $1.07 dividend for Q1 and they are confident cash flow will cover dividends through 2017. The CEO said maintaining the dividend will be their top priority in a period of low oil prices. Their current yield is about 5.1%.
The company announced on January 26th, first gas at the Chuandongbei Project in Southwest China. The project covers more than 800 square kilometers and is thought to contain more than 3 trillion cubic feet of gas. The LNG project consists of three trains that can process 258 million cubic feet of gas per day. The first train is now in operation and the other two trains are under construction and nearing completion. Chevron owns 49% of the project and China National Petroleum owns 51%.
In December they announced first oil from the Moho Bilondo development offshore the Republic of Congo. The project is 50 miles offshore in 4,000 feet of water. The initial project has 11 wells that are expected to produce 40,000 bpd. In November they announced first oil from the Lianzi Development Project also offshore the Republic of Congo. This project is 65 miles offshore in 3,000 feet of water and is also expected to produce 40,000 bpd.
Chevron has such strong financials that along with Exxon they were the only two companies not included in the recent Moody's warning of ratings downgrades. The rating agency said they were going to downgrade 120 oil and gas companies and 55 mining companies. Chevron and Exxon were exempted.
In the last earnings cycle for Q3 Chevron beat estimates by 37.9% and has posted an average beat of 15.11% for the last four quarters. Their refining and chemicals businesses have offset the losses from the lower oil prices. Chevron is set to announce earnings on Friday. I would not normally recommend a long position ahead of earnings but Chevron has a lot to brag about and production increased significantly in Q4. Conservative investors may want to wait until next week to enter the position.
Chevron shares have shown relative strength to the market because of their balance sheet, high production, new projects coming online and the dividend. That means we should be somewhat insulated from a price crash. Once oil prices do begin to rise for whatever reason we should see Chevron shares outpace the sector because of their relative strength.
Chevron probably has more new production in the pipeline than any other U.S. company. Most of that production is gas with two monster projects in Australia. The Gorgon project is a multibillion dollar LNG facility with the export capability of 15.6 million tons per annum (MTPA)(2.184 Bcf/d) of LNG to Asian markets. Demand for gas to Asia is expected to double by 2025. The fields feeding this LNG plant have more than 40 Tcf of gas with new discoveries every month. The first train of the three-train project is under construction and should be operational in 2015.
The $29 billion Wheatstone project will consist of two LNG trains with a combined capacity of 8.9 MTPA (1.25 Bcf/d) with the option to expand to 25 MTPA (3.5 Bcf/d). The first LNG output will be in 2016. More than 80% of the gas supplied to Wheatstone will come from Chevron fields. Another 20% will come from an Apache find in the same region. Chevron has made 21 major discoveries of gas in the region since 2009. The initial discovery was 9 Tcf of gas but more is being added every month.
There have been some worries recently about a surplus of LNG with numerous projects getting close to commencing operations. Chevron was one of the first to sanction the major projects in Australia and they presold the vast majority of their production for the next 20 years. If LNG prices do decline, Chevron will be protected. The Australian projects are close to Asia so shipping is less of an expense making their gas more desirable. With the projected startup later this year and full production by the end of 2016 this will be a monster boost to Chevron's global production.
Gorgon is the world's largest LNG project since 2010 and Australia's largest LNG project. Chevron owns 47% and Exxon and Shell own 25% each. Chevron spent $4.5 billion in 2014 and is expected to spend $3 billion in 2015 on Gorgon. Just beginning operations turns this project from a money pit into a moneymaker with revenue net to Chevron of $2.1-$2.9 billion a year.
These are just two of the dozens of projects Chevron has in progress. In the last ten years, Chevron has added 10.2 billion barrels of oil equivalent to its reserves.
The biggest factor in Chevron's favor is the pending start of the Australian LNG operations. This will significantly increase global production, reduce capex and increase cash flow. The earnings reports in 2016 will show significant improvements.
I am recommending an optional short put to offset some of the premium for the expensive LEAP calls.
Long 2017 $90 LEAP Call @ $8.05, see portfolio graphic for stop loss.
Short Jan $70 LEAP Put @ $3.94, see portfolio graphic for stop loss.
Net debit $4.11.
DIS - Disney - Company Profile
Disney has already hit $1.0 billion in overseas ticket sales for 2016. That is the earliest that has ever happened and there are several more blockbusters heading into theaters in the coming months. Zootopia is closing in on $700 million globally and Deadpool is near $350 million in the USA.
Original Trade Description: February 1st:
Disney has been pummeled since its $120 high in November. The problem for Disney was comments that ESPN subscribers are declining. This was attributed to cord cutting from the cable companies as consumers move to sites like Netflix and Amazon for streaming downloads. This is not the case although I am sure there are some losses for that reason.
However, Disney said there was a lack of a large number of major sporting events in 2015 that would keep ESPN subscribers happy. Disney said the 2016 Olympics would help bring those subscribers back. ESPN is only one of dozens of Disney networks and the rest are doing just fine.
In case you missed it Star Wars: The Force Awakens has earned over $2 billion worldwide and still going strong. This compares to only $572 million for Episode VI the Return of the Jedi that was the most popular movie in the prior seven movies. Merchandise sales are approaching $1 billion. This is a cash printing machine and it is only going to get better from here.
Remember, Disney now has Marvel, Pixar and Star Wars (Lucasfilm) all under the same roof.
Disney Movie Schedule
Jan 29th, 2016 - "The Finest Hours"
Mar 4th, 2016 - "Zootopia"
April 15th, 2016 - "The Jungle Book"
May 6th, 2016 - "Captain America: Civil War"
May 27th, 2016 - "Alice: Through the Looking Glass"
June 17, 2016 - "Finding Dory"
July 1st, 2016 - "The BFG"
Aug 12th, 2016 - "Pete's Dragon"
Nov 4th, 2016 - "Doctor Strange"
Nov 23rd, 2016 - "Moana"
Dec. 16, 2016 - "Star Wars Anthology: Rogue One"
Mar 17th, 2017 - "Beauty and the Beast"
April 14th, 2017 - "Ghost in the Shell"
May 4th, 2017 - "Guardians of the Galaxy II"
May 26, 2017 - "Star Wars: Episode VIII"
June 16, 2017 - "Toy Story 4"
Mid 2017 - "The Incredibles 2"
July 17th, 2017 - "Pirates of the Caribbean"
Late 2017 - "Thor: Ragnarok"
Early 2018 - "Frozen 2"
May 4, 2018 - "Avengers: Infinity War - Part I"
2018 - "Untitled Star Wars Anthology Project"
May 3, 2019 - "Avengers: Infinity War - Part II"
2019 - "Star Wars: Episode IX"
We should not overlook their theme parks, which are also doing great. Disney said they are considering a tiered pricing for tickets with high volume attenfance dates costing more. The three levels for the season pass holders would be gold, silver and bronze. Gold passes could be used any day at any time and would obviously be the most expensive. Silver would only be good for off peak days and not valid for holidays. Bronze would be the cheapest and would only be valid on certain off peak periods. Currently discounted tickets for those customers spending multiple days and with children under the age of ten begin around $100.
Shanghai Disney will open on June 16th and they expect 40-60 million people in the first year. At $100 or more per ticket the revenue is astromonical. The park is located within 4 hours drive time of 330 million people.
Don't forget their theme cruises. Disney is not having any problems filling up their cruise ships and prices have remained strong.
The only real challenge to Disney today would be a slowdown in consumer spending. The company said they are not seeing any decline despite the drop in retail sales numbers over the last several months. Consumers are just spending their money on diffrent things like cable movies, theme parks and iPhones.
Disney has earnings on February 9th. Normally I would not recommend a stock ahead of earnings but this could be a blowout given the unbelievable cash flow from Star Wars. Even if they disappoint there is decent support at $90 and profits are only going to rise in subsequent quarters from the items mentioned above.
Shares have found support in the $92-$93 range despite the recent market volatility. I expect shares to rise as we approach earnings. I am putting an entry trigger just slightly above $96 just to make sure we have upward movement after Friday's big gain. If shares decline again I would be thrilled to enter the position at $92.
Update 2/21/16: Disney reported strong earnings but was punished again as shares fell to $86 despite the record earnings. Earnings of $1.73 compared to estimates for $1.45 and revenue of $15.2 billion compared to $14.75 billion. Earnings rose +36% and revenue +14%. They reaffirmed strong guidance and the stock was still knocked for a -5% loss. Once the smoke cleared and calmer heads prevailed the stop rallied back to pre announcement levels at $96.
There is nothing wrong with Disney. The CEO said they even saw a rise in ESPN subscriptions in January and they were expecting big gains as they offered their sports package in various other bundles. The worry over Disney's revenue growth has become so pervasive that everyone is afraid to buy the stock.
However, this is only going to be a temporary situation. Disney released a teaser for Star Wars episode VIII last week so the hype is already beginning. Episode VIII The current Star Wars movie has grossed over $2 billion and still going strong.
Position 3/1/16 with a DIS trade at $97.50
Long 2017 $105 LEAP Call, entry $5.20, see portfolio graphic for stop loss.
FFIV - F5 Networks - Company Description
F5 spiked over $105 on Tuesday but faded with the market. The $105.25 level is now resistance. No specific news.
Original Trade Description: March 13th.
F5 Networks develops, markets and sells application delivery networking products that optimize the security, performance and availability of network applications, servers and storage systems.
With the vast amount of Internet traffic now being served over mobile devices utilizing 4G speeds and now advancing towards significantly faster 5G speeds it is imperative for companies to improve the speed and security of their networks.
Just to catch everyone up on how much faster 5G (5th generation) is than 4G here is a comparison.
3.5G = 42 Mbps (megabytes per second)
4G/LTE = 100 Mbps
4G/LTE.Cat 4 = 150 Mbps
4G/LTE Adv = 1,000 Mbps
5G = 5,000 Mbps to 10,000 Mbps (estimates)
The 5G standards have not been officially defined but multiple vendors are touting speeds with existing equipment up to 7,500 Mbps. Qualcomm is currently producing Snapdragon processors for smartphones with Cat.10 modems that are capable of 450 Mbps.
To put all of this in perspective for F5 Networks. At advanced 4G/LTE speeds you could download an entire standard definition movie in under 5 seconds. A theoretical 5G speed could download an entire HD BlueRay movie in under a second.
Obviously that means the servers and networks delivering this content securely must also have this capability, otherwise those superfast mobile devices will be suffering significant lag times.
Since most datacenters and networks are still delivering content at the 3G rate there is a vast amount of untapped opportunity for those companies like F5 that are bridging the technology gap.
You hear about the Internet of Things (IoT) and how much network capacity will have to increase to add tens of billions of additional devices like lights, thermostats, refrigerators, every TV now being produced and nearly every car now being produced as an Internet hot spot.
As cloud systems garner additional customers the vast amount of storage required plus the amount of network connectivity required to access that storage is growing exponentially. This week I added a new cloud account with Amazon to use as a backup and I have been uploading 150 Gb of data continuously for the last 4 days and the job is only half done and Amazon has fast servers.
Securing all that data and network traffic and delivering it instantly is what F5 does. They provide multiple highly concurrent platforms and specifically position service providers for next generation networks.
As an illustration they offer a blade server (VIPRION B445) that can handle 1.2 billion concurrent connections and more than 20 million connections per second using only an 8 blade chassis and 100 Gbe hardware. I would explain how fast that is but it would require far more space than I have here. To say it is mind boggling would be an understatement.
In their Q4 earnings they reported earnings of $1.32 that beat estimates for $1.27. Revenue rose +5.8% to $489.5 million, which also beat estimates. Service revenues rose +14.9%. The company guided for earnings in Q2 of $1.61 to $1.64 and analysts were expecting $1.32.
Shares rallied on the earnings beat to plateau at $100 over the last week. I believe that $100 level is going to break and we will see shares retest the recent highs at $120 in the months ahead.
Position 3/18/16 with a FFIV trade at $101.50
Long Jan $105 LEAP Call @ $9.75, no initial stop loss.
Short Jan $85 put @ $4.85, no initial stop loss.
Net debit $4.90
GE - General Electric - Company Info
GE traded sideways all week but is still holding the prior week's gains. No specific news.
Original Trade Description: December 20, 2015:
GE has been slowly drifting higher since the 2009 market lows. Most of 2014 and 2015 the stock was stuck churning sideways. The situation changed in early October this year after a big activist investor got more involved. It's making a difference. The S&P 500 is down -2.6% year to date. Yet GE is up +20% in 2015 and should continue to outperform in 2016.
GE is in the industrial goods sector. According to the company,
"GE is the world's Digital Industrial Company, transforming industry with software-defined machines and solutions that are connected, responsive and predictive. GE is organized around a global exchange of knowledge, the 'GE Store,' through which each business shares and accesses the same technology, markets, structure and intellect. Each invention further fuels innovation and application across our industrial sectors. With people, services, technology and scale, GE delivers better outcomes for customers by speaking the language of industry. www.ge.com"
One of the biggest changes at GE has been the company's long-term transformation to get rid of its financial assets that have been an albatross around its neck for so long. Management is focusing on the company's roots, which is industrial products and innovation.
The company recently held their annual meeting with analysts. The year ahead brings a lot of challenges. The global market is still struggling. The U.S. economy is limping along at +2% growth. Plus the strong dollar hurts sales outside the U.S. In spite of these headwinds GE's CEO Jeffery Immelt is bullish on 2016.
Management is forecasting 2016 earnings to rise +15% on revenue growth of +2% to +4%. That is impressive for such a massive company like GE who does so much business overseas. They also foresee paying investors $8 billion in dividends and spending $18 billion on stock buybacks in 2016. GE provided a long-term 2018 earnings forecast of more than $2.00 per share compared to $1.30-1.20 a share in 2015. They expect to return $55 billion to shareholders in dividends and buybacks between now and 2018. That sort of investor-friendly action could help GE weather any market volatility in 2016.
The stock has been showing relative strength the last few months. The stock held up pretty last week too during the market's volatile moves. GE tagged multi-year highs on Wednesday. The point & figure chart is bearish and forecasting a long-term target at $53.00.
The action in GE's stock over the last few weeks is either a new top or it is a new base. We are betting it is the latter.
Long 2018 $30 LEAP call @ $2.60, see portfolio graphic for stop loss.
GME - Gamestop Company Profile
We closed this position for a minor gain on Monday ahead of earnings. It was the right decision as shares declined to a three week low on Thursday.
Original Trade Description: February 28th
Gamestop was originally a reseller of used video games. As the business model matured, they moved into new games, game consoles and recently into smart phones, tablets, MP3 players, headphones and manner of consumer electronics. They are a certified Apple consumer electronics reseller, an authorized AT&T reseller and Cricket Wireless seller of prepaid cell phones. As of January 31st, they operated 7,100 stores in 14 countries.
Gamestop's death has been reported prematurely numerous times and they just keep reinventing themselves in the expanding market. When more games became downloadable rather than cartridge or CD based everyone thought that was the death knell for the company. Instead they ramped up their sales of consoles and consumer electronics to increase their customer base and store traffic.
Recently they even ramped up their quarterly dividend to 37 cents ($1.44 annually) to yield 5%. Very few companies paying a 5% dividend are in danger of going out of business. The current dividend will be paid on March 22nd to holders on March 9th.
Gamestop will report earnings March 24th after the close and hold a conference call at 5:PM ET. They will also host an investor conference on April 13-14 and feature presentations from the leadership team and tours of the retail brand family. They are doing everything possible to be recognized as a growing business. They are a Fortune 500 and S&P 500 company.
All of these initiatives are foiling the plans for those traders holding the 37.7% short interest. That represents 39.5 million shares and the average daily volume is 1.69 million. That equates to a very bad week for the shorts if prices were to suddenly spike higher.
Other traders have been selling puts on GME at a record rate. Selling puts on a stock is a bullish strategy with expectations for the stock to go higher. On one day last week, more than 4,000 March $28.50 puts were sold at $1.40 each. Two days later another 4,000 $29.50 puts were sold at $1.38 on average.
There is resistance at $30.85 but I am going to recommend an entry at the open on Monday. Once the stock moves over that resistance level we could see a flood of short covering.
Closed 3/21/16: Long Jan $33 call @ $3.00, exit $3.45, +.45 gain.
HCN - Welltower Company Profile
No material move but still holding the recent gains. No specific news.
Original Trade Description: March 6th
Welltower is an independent equity real estate investment trust. They acquire, plan, develop, manage and monetize real estate assets. The company primarily invests in senior living and health care properties, including medical office buildings, inpatient and outpatient medical centers, senior living communities and life science facilities.
With the boomer generation rapidly entering into old age and facing all the health problems associated with getting older, Welltower has positioned itself to capitalize on this trend. Welltower operated in markets with relatively high real estate values where the barriers to entry are higher than average. Entering a high priced market and building new properties would take a large amount of cash and a long time to be profitable. Welltower got an early start and is already well positioned. Welltower believes they have the best healthcare real estate portfolio in the industry.
Welltower does not hold its properties forever. Once they have peaked in terms of revenue and life cycle they liquidate and use the funds to acquire new properties in desired locations to further enhance the portfolio. They sold off their life sciences portfolio in 2015 for a tidy profit.
The company has increased scale in the most attractive real estate markets in the country including Southern California, Northeastern U.S. and in London. Real estate prices are only going higher in those locations along with rents and the cost of medical services. Welltower is not buying facilities in places lke Cheyenne Wyoming where the population cannot afford healthcare and senior living communities are all supported by Medicaid payments. They are building/buying in the high-income areas where rising rents can be supported by the population. Welltower's average senior living property is 12 yrs old and located in an area with a $78,387 median income. For their competitors the average is 18 yrs old and median income is $53,996. Over the past five years, Welltower has invested approximately $1.2 billion a quarter into real estate.
Welltower has about 2.5% of the more than $1 trillion U.S. healthcare real estate market and they own some of the top properties. Over the next 45 years the U.S. population over 65 is projected to double and the number of seniors over age 85 is expected to triple. Welltower expects the healthcare real estate market to double or triple over the next 20 years. Over the period 2014 to 2014 the amount spent on healthcare is expected to rise 76% to more than $5.4 trillion or nearly 20% of GDP.
Since its IPO in 1971, the company has generated an average total return of 15.6% per year for shareholders.
In Q4 HCN reported earnings of $1.13 that beat estimates for $1.12. Revenue of $1.03 billion also beat estimates for $979.4 million. The company is projecting full year earnings of $4.50-$4.60 per share.
In early February HCP Inc, another REIT posted a major earnings miss and impairment charge related to some property sales. The entire REIT sector was crushed. HCP fell from $35 to $25 and that disaster knocked Welltower from $63 to $53 in a guilty by association sector dump.
Welltower has already rebounded back above the $63 level from that drop thanks to communication from the company saying we are not HCP and we are better positioned.
Earnings are May 5th.
Welltower closed at $66 and has resistance at $70. The 2015 high was $85. I am recommending we buy the $70 call, currently $3.70. If readers would like to reduce that premium outlay, you can sell short the Jan $50 put at $1.65 to give you a net debit of $2.05.
Long Jan 2017 $70 call @ $3.70, no initial stop loss.
Short Jan 2017 $50 put @ $1.88, no initial stop loss.
Net debit $1.82.
JCI - Johnson Controls - Company Profile
JCI declined slightly in the weak market. Still holding the prior week's gains. No specific news.
Original Trade Description: February 8th
JCI is a diversified technology and industrial company worldwide. They design, produce and market building efficiency systems including heating, air conditioning, security, controls and mechanical equipment. They also have a division that manufacturers interior products, control systems, instrument panels, seating and passenger systems for cars and trucks. Their Power Solutions division makes batteries for normal cars and trucks as well as hybrid and all electric vehicles.
What makes JCI important to us today is their recently announced merger with Tyco (TYC). Tyco manufacturers fire and security systems and is headquartered in Ireland. After the merger JCI shareholders will own 56% of the combined entity to be called Johnson Controls Plc. Once the merger is completed the company will spin off the automotive segment to be called Adient leaving Johnson controls with a pure play on the HVAC, controls, fire, security products marketplace plus the Power Solutions division that will produce batteries for electric vehicles. Current JCI shareholders will own 56% of Adient.
The Johnson Controls company will have about $32 billion in revenue and Adient around $17 billion in revenue. The synergies to the merger include $150 million in tax savings because of the Ireland domicile. Another $500 million will come from eliminating corporate redundancies and from operational synergies. There will also be additional revenue synergies which has not been quantified. Both Tyco and JCI existing customers will immediately have a new range of products available to them. This should result in a significant sales boost in the first three years.
Normally when a merger is announced one of the companies sees their stock decline. That did not happen in this case. Tyco shares spiked 10% and are continuing to move higher while JCI shares moved sideways for the last two weeks but made a four-week high on Thursday. Friday's market crash knocked some of the wind out of JCI shares but they only declined -66 cents.
The actual merger has a long way to go since it was just announced on January 25th. With Tyco shares rising and JCI shares having put in a solid base at $34 I expect JCI shares to return to growth mode in the coming weeks.
This is a good deal for both companies. It will not only create a powerhouse in the building systems market but throw off the automotive business into another entity where it can be acquired by one of the larger players.
Earnings are April 28th.
Position 2/16/16 with a JCI trade at $36.75
Long Jan $40 LEAP Call @ $2.45, no initial stop loss.
KMB - Kimberly Clark - Company Info
The position was closed at the open on Monday and that turned out to be the high for the week. We exited with a nice $3.53 gain.
Original Trade Description: December 6, 2015:
There are not many public companies that have been around as long as KMB. The company has a history going back more than 140 years. It looks like investors are still bullish on it with KMB trading near all-time highs.
KMB is in the consumer goods sector. According to the company,
"Kimberly-Clark (KMB) and its well-known global brands are an indispensable part of life for people in more than 175 countries. Every day, nearly a quarter of the world's population trust K-C's brands and the solutions they provide to enhance their health, hygiene and well-being. With brands such as Kleenex, Scott, Huggies, Pull-Ups, Kotex and Depend, Kimberly-Clark holds No. 1 or No. 2 share positions in 80 countries."
The company has beaten Wall Street's earnings estimates the last three quarters in a row. A stronger labor market in the U.S. combined with lower gasoline prices should be a tailwind for consumer spending in the globe's biggest economy. Meanwhile KMB is pursuing high-growth opportunities in emerging markets.
Technically the stock has been trading sideways in the $117.00-123.00 zone the last seven weeks. The recent bounce near the bottom of its trading range might suggest a bullish breakout soon. The point & figure chart is bullish and forecasting at $163 target. Tonight I am suggesting investors wait for KMB to close above $123.00 and then buy calls the next morning with an initial stop loss at $116.95.
Closed 3/21/16: Long Jan 2017 $130 Call, entry $7.50, exit $11.03, +$3.53 gain.
12/16/15 Trade begins. KMB opens at $124.75
12/15/15 Triggered with KMB @ $124.44, above our $123.00 trigger
NFLX - Netflix - Company Info
Shares barely moved last week. The candles were very short and thin with volume very low. Nobody is buying or selling. Everyone is waiting for a catalyst. Earnings are April 21st. Remember, Netflix expanded into 130 new countries in early January. That means revenue could explode higher when they report earnings.
We may not be able to replace our stopped call because every big spike explodes the call premiums. We will either have to wait for a dip or simply continue to hold the short put. We still have $9.45 in net premium received from selling the put after subtracting the $5.59 loss in the call. That will cover much of the price of a new call once a buying opportunity appears.
Original Trade Description: January 24th.
Netflix has a plan for total domination of streaming video. On December 31st they were active in 60 countries. In early January, they announced they had expanded into 130 additional countries a full year ahead of schedule. The original plan was to complete the expansion by the end of 2016. This gives them a huge additional base of prospective users of more than 450 million broadband accounts. Everyone around the world knows of Netflix. Many have been waiting for them to open in their country. Netflix could gain more than 25 million new users in 2016 alone. They currently have just under 75 million. The 190 countries does not include China. They are working on getting into China but the government has put numerous censorship roadblocks in their path that need to be overcome. They expect to be in China in 2017. They added 4.04 million international subscribers in Q4 and that was just from the existing 60 countries.
Netflix said it was targeting young, outward-looking, affluent consumers with international credit cards and would spread out from that base.
Last year Netflix raised prices for new subscribers by $1 to $10 a month for unlimited high definition streaming. Existing subscribers were left at the $8 level. Now the company is saying those grandfathered under the $8 plan will see their exemption expire in May. They can continue paying $8 a month for standard definition but the rate will rise to $10 for HD shows and movies. Premium subscribers getting 4K UHD videos will be paying $12 a month. With 75 million subscribers this represents a cash windfall with the $8 rate rising 50% to the $12 level if you want UHD. Netflix said they were already seeing very fast adoption of the $12 plan by existing users. Plus, premium subscribers can stream to 4 devices simultaneously rather than just 2.
Netflix plans to stream more than 600 hours of original content in 2016 compared to 450 hours in 2015. There will be 31 new and returning original series, up from 16 in 2015. There will be two dozen original feature films and documentaries, 30 children's series and a variety of comedy specials.
Analysts believe Netflix earnings are going to soar in 2017 as the adoption of streaming in those 130 new countries begins to accelerate. That is good news because Netflix shares are highly overvalued according to normal metrics. Revenues have been rising 25% annually and streaming content obligations rose by 15% in 2015. They are paying a lot for content but they are essentially taking it off the market to prevent anyone else from competing. They can now use that content in 190 countries so they are leveraging their assets to expand future revenue. Their current PE of 346 is less than half of Amazon's 851 PE. They are operating on the same business model as Amazon. If you build it subscribers will come. When they finish their expansion phase, which is limiting earnings today, they will be highly profitable with more than 200 million subscribers by 2020. That equates to $2 billion a month in revenue. That is a month, not a year.
Buying Netflix requires a leap of faith that investors will return to it as a momentum growth stock. After the earnings report shares have been weak as traders looking for an earnings bounce move on to other stocks in hopes of repeating the process. Shares closed at $100 on Friday after a low of $97 during Wednesday's market crash.
I am suggesting we target that $97 level for a long entry. However, the LEAPS are so expensive we have to use a combination play to make it work.
One option would be to buy the stock and sell a January $110 LEAP covered call, currently $17.50. If we buy the stock at the $97 target we are protected against a decline to $80 by the premium we receive. If Netflix does not drop significantly and rebounds to more than $110 then we make roughly 20% or $20 over the next year. We cannot complain about a 20% gain in this market. If Netflix shares did decline significantly so $90 or so, the option premiums will shrink significantly and we could buy back the $110 LEAP for a profit and then buy a LEAP at a lower level for less money.
Another option would be to use a combination position where we buy the LEAP and then sell a put spread or a naked put to offset the cost of the LEAP call. One example would be to buy the $110 call for $17 and sell the $90 put for $14.25 giving you a net debit of $2.95 to be long Netflix for the next year. If shares declined under $90 you "may" be obligated to buy the stock at $90 "if" it was put to you. With the volume of puts on Netflix that potential is minimal but it does exist. If you were put I would sell a covered LEAP call to cover any losses and you still have your $110 long call for when the stock rebounds.
The option I am recommending is the combination play. If Netflix trades at $97.25 we enter the following trade. I am using the even dollar strikes in case there is another stock split in 2016.
Position 1/26/16 when NFLX traded at $97.25
Still short January 2017 $90 LEAP put @ $14.95, no stop loss.
Net debit 5 cents. If we are put the stock our cost will be $74.95 and a bargain.
Closed 2/3/16: Long January 2017 $110 LEAP call @ $15.00, exit $9.41, -5.59 loss
The call position will be replaced once the market volatility eases.
NKE - Nike - Company Info
Nike dropped $4 after earnings because the strong dollar reduced revenue significantly. Without the dollar impact, it would have been a huge beat. They also guided for the rest of the year based on the dollar and that put them under analyst estimates. However, growth is still strong and futures orders were up significantly. China future orders were up +34%. Analysts believe the dip will be temporary.
Original Trade Description: January 24th
Nike split 2:1 on December 23rd at $132 and the stock went straight down from there. When a stock is a major fund holding and it splits, there is a rush to the exits by some funds. They can sell the new shares nearly tax-free when it is classed as a stock dividend and they still have the same number of shares in the original position. Some funds have restrictions on the number of shares they can hold in any single position. A stock split doubles the number of shares and sometimes puts them over the limit and they sell the extras. These factors cause what is called "post split depression." Nike shares have now experienced that depression.
Shares declined from the $66 level the day of the split to $56 last week on fears the holiday retail selling may have been weak. Given Nike's predominant position in athletic leisure apparel they will always be the dominant seller compared to Under Armour and LuluLemon.
The reported earnings in late December of 90 cents, that rose +22% and beat estimates for 85 cents. Revenue rose +4% to $7.686 billion but missed estimates for $7.808 billion because of the strong dollar. Excluding the dollar impact revenues rose +12% and well over $8 billion.
The company guided for earnings growth in the "mid teens percentages" and said there was no weakness in China. They announced a $12 billion stock buyback program in November and raised their dividend by +14%.
Nike is targeting $50 billion in annual revenue by 2020 with online direct ecommerce sales of $7 billion, up from $1 billion in 2015. Online sales rose +51% in 2015.
Competitor Under Armour is targeting total sales of $8 billion by 2018 to put that aggressive Nike target into perspective.
Nike plans to begin selling in Mexico, Chile and Turkey in 2016. Nike began e-commerce sales to Canada, Switzerland and Norway in the last quarter.Sales in China rose +28% despite the economic downturn. North American sales rose +10% with futures orders up +14%.
Earnings are March 22nd.
I am recommending we buy the $65 LEAP with a Nike trade at $62.25 to confirm the rebound from the lows last week.
Long January 2017 $65 LEAP @ $4.08, see portfolio graphic for stop loss.
SBUX - Starbucks - Company Info
Starbucks ran into resistance at $60 and failed again. The coffee company is not performing and I am recommending we close the position while we still have a gain.
CLOSE THIS POSITION
Original Trade Description: January 24th.
We were stopped out of the Starbucks position by a penny on the January 20th market crash. The company reported great earnings and failed to decline. The only hiccup was a temporary decline in sales growth in Europe because of the terrorist attacks. CEO Howard Schultz said they were headed for a record quarter in Europe until the Paris attack and then everything came to a screeching halt. He also said buying and traffic patterns were returning to normal and 2016 should be a good year. They reported 9% same store sales increases in the U.S. and 6% elsewhere other than Europe. Earnings growth is expected to be 15% annually for the next five years. They are opening 500 stores a year in China for the next 5 years and Schultz expects China's revenue to exceed the U.S. in the years to come. Schultz said at the current low stock price they were "backing up the truck" to buy as many shares as possible.
The world seems to have an insatiable appetite for coffee. Starbucks is more than happy to help fill that need. The first Starbucks opened in Seattle back in 1971. Today they are a global brand with locations in 66 countries. SBUX operates more than 21,000 retail stores with more than 300,000 workers.
A few years ago Business Insider published some facts on SBUX. The average SBUX customer stops by six times a month. The really loyal, top 20% of customers, come in 16 times a month. There are nearly 90,000 potential drink combinations at your local Starbucks. The company spends more money on healthcare for its employees than it does on coffee beans.
The company's earnings results were only mediocre most of 2014 year. You can see the results in SBUX's long-term chart below. After incredible gains in 2013 SBUX has essentially consolidated sideways in 2014. SBUX broke out of that sideways funk after it reported earnings in January 2015.
In late 2014 SBUX announced their five-year plan to increase profitability. Here's an excerpt from a company press release:
"The seismic shift in consumer behavior underway presents tremendous opportunity for businesses the world over that are prepared and positioned to seize it," Schultz said (Howard Schultz is the Founder, Chairman, President, and CEO of Starbucks). "Over the next five years, Starbucks will continue to lean into this new era by innovating in transformational ways across coffee, tea and retail, elevating our customer and partner experiences, continuing to extend our leadership position in digital and mobile technologies, and unlocking new markets, channels and formats around the world. Investing in our coffee, our people and the communities we serve will remain at our core as we continue to redefine the role and responsibility of a public company in today's disruptive global consumer, economic and retail environments."
"Starbucks business, operations and growth trajectory around the world have never been stronger, and we are more confident than ever in our ability to continue to drive significant growth and meet our long term financial targets," said Troy Alstead, Starbucks chief operating officer. "We have more customers visiting more stores more frequently, both in the U.S. and around the world, than at any time in our history. And we expect both the number of customers visiting our stores and the amount they spend with us to accelerate in the years ahead. With a robust pipeline of mobile commerce innovations that will drive transactions and unprecedented speed of service, Starbucks is ushering in a new era of customer convenience. We believe the runway of opportunity for Starbucks inside and outside of our stores is both vast and unmatched by any other retailer on the planet."
The company believes they can grow revenues from $16 billion in FY2014 to almost $30 billion by FY2019. To do that they will expand deeper into regions like China, Japan, India, and Brazil. SBUX expects to nearly double its stores in China to over 3,000 locations in the next five years.
They're also working hard on their mobile ordering technology to speed up the experience so customers don't have to wait in line so long at their busiest locations. This will also include a delivery service.
Part of the five-year plan is a new marketing campaign called Starbucks Evening experience. The company wants to be the "third place" between home and work. After 4:00 p.m. they will start offering alcohol, mainly wine and beer, in addition to new tapas-like smaller plates.
The company recently launched its first ever Starbucks Reserve Roastery and Tasting Room in Seattle, near their iconic first retail store. The new roastery is supposed to be the ultimate coffee lovers experience. CEO Schultz said they will eventually open up about 100 of these Starbucks Reserve locations.
SBUX continues to serve up strong earnings and revenue growth too. The fourth quarter of 2014 saw a huge jump in SBUX gift cards. One out of every seven Americans received a SBUX gift card.
SBUX has been reporting very strong overseas sales growth and consistently healthy same-store sales growth globally.
Long Jan 2017 $60 LEAP Call @ $3.05, no stop loss
Prior position stopped 2/5/16:
Long Jan 2017 $65 call, entry $4.01, exit $2.47, -1.54 loss
TOL - Toll Brothers - Company Profile
Minor decline in a weak market. No news.
Original Trade Description: February 28th.
Toll Brothers is a builder of high dollar semicustom homes. They also develop golf courses and country clubs around which they construct master planned communities and sell lots to other builders in addition their own home construction.
Toll shares have been crushed since December but have rebounded since they reported earnings last week. The company reported earnings of 40 cents that matched estimates. Revenue rose 8% to $928 million that beat estimates for $916 million. Orders in Q4 rose +17.6% to 1,250 homes. Buyer traffic rose +13% in the first three weeks of February.
While the earnings were not a big beat of Wall Street estimates the guidance was strong. The company expects to sell 5,700 to 6,400 homes in 2016. The average low end pricing was raised to $810,000-$850,000 and the high end homes sell for as much as $2 million. The average selling price in Q4 was $873,500.
The CEO said business activity was strong and there was no signs of a recession. The CEO said, "The stock market seems to be pricing in a steep decline in the economy, and along with it, our sector. We on the other hand, are seeing signs that reflects strength and positive momentum in our business."
I believe Toll shares will rebound to the mid $30s as the homebuilder numbers from the spring selling season begin to appear. I am recommending a LEAP position but my exit target will be in the $37 range and we could be out of this position in the summer.
There is resistance at $28.35 so I am putting an entry target of $28.50 on the position.
Position 3/1/16 when TOL traded at $28.50
Long 2017 $30 LEAP call, entry $3.00. No initial stop loss.
TRN - Trinity Industries - Company Profile
$1 drop on Thursday on no news. Support at $18 held. The next resistance is around $22.50
Original Trade Description: February 21st:
Trinity Industries manufacturers rail cars, highway guard rails and steel beams for infrastructure projects, structural towers for wind turbines and electrical distribution grids, oil and chemical storage tanks, barges to transport grain, coal, aggregates, tank barges to transport oil, chemicals and petroleum products. The company was founded in 1933.
Shares crashed last week after they reported earnings that beat the street but guidance that disappointed. Earnings of $1.30 easily beat estimates for $1.07 but revenue of $1.55 billion missed estimates for $1.61 billion. They had full year earnings of $5.08 per share.
They guided for 2016 to earnings of $2.00 to $2.40 per share. The challenge is the slowdown in orders for railroad tank cars and barges to transport oil. With oil prices crashing the producers and refiners are cutting back on capex spending until prices recover. Trinity said revenue in 2016 could decline -32%. Shares declined -35% over two days on the news.
They are also divesting their galvanizing business, think galvanized highway guardrails, and are slowing production in the highway products division and aggregate business.
The key here is that Trinity is now trading at a PE of 3. Yes 3.47 to be exact. With earnings in the middle of their range at $2.20 and a PE of 10 that would equate to a $22 stock price.
Here is the good news. The company has $2.12 billion in cash and undrawn credit. They are not in financial trouble. They authorized a $250 million share buyback starting January 1st. They have an order backlog of $5.4 billion in orders for 48,885 railcars. They received orders for 2,455 cars in Q4 and their backlog stretches out to 2020. The barge division received orders for $190.1 million in Q4 and had a backlog of $416 million as of December 31st. The structural tower segment has $371.3 million in order backlogs.
They recognize that tankcar and barge orders are going to remain slow until oil prices recover, which should happen later this year.
This stock is extremely oversold and should recover as the shock of the post earnings drop wears off and oil prices begin to rise. Note on the chart that the stock price began to decline at the same time the price of oil began to crash in August 2014. I view this as a remarkable opportunity for long-term investors.
I am recommending the $23 2018 LEAP to get us well past the recovery in oil prices and any further weakness in the sector. Remember, Trinity produces a lot of railcars for carrying all types of products other than oil. That demand is not going to disappear and they already have order backlogs stretching into 2020.
I understand that buying a 2018 LEAP is a stretch of the imagination for some investors. However, at $2 you will not have much at risk and it becomes a buy and forget investment. If Trinity returns to the 2015 highs at $35 that LEAP would be worth $12 and a 500% return. With a PE of 3.47 there is very little risk.
At their current valuation they could also be an acquisition candidate. This is a great business that has been overly punished by the oil crash.
I am still going to put an entry trigger on this position. Since the post earnings drop is only one day old we do not know if it will continue. I would love to buy this stock as cheap as possible but I also do not want it to run away from us. If it continues lower, I will change the strike price and entry to keep pace.
Position 3/7/16 with a TRN trade at $17.75
Long 2018 $23 LEAP Call @ $2.65, no initial stop loss.
UTX - United Technology - Company Description
UTX held up well in a weak market. No specific news. Resistance at $101 is the next challenge.
Original Trade Description: March 6th.
United Technology is an $80 billion company that provides technology products and services to building systems and aerospace industries worldwide. They build elevators, refrigeration units, electronic security products, electric power generation and management, etc. The aerospace segment supplies flight sensing and management, engine controls, intelligence, reconnaissance, maintenance, engine components, landing systems, etc. I could go on for several paragraphs but the key here is that they do everything and do it well.
A couple weeks ago Honeywell and United Technology acknowledged they had held talks about a merger/acquisition. Honeywell reportedly offered $108 billion or $108 per share for the company. United said the offer undervalued the company and would not succeed in getting regulatory approval. Honeywell "strongly" disagreed with that assesement.
Honeywell and United have been talking on and off for 15 years about some sort of merger because their business lines would fit together very well. Reportedly there were serious discussions in may 2011 when UTX approached HON about a merger. Those talks failed and the companies began talking again in April 2015. Those talks also failed to reach an agreement.
Honeywell approached the chairman and the CEO of UTX again in February and initial talks were highly positive. However, they fell apart again a week later when UTX said the price was too low and they could never get regulatory approval.
On March 1st, Honeywell said it had dropped all plans to pursue an acquisition of UTX because the company appeared unwilling to negotiate.
A UBS analyst recommended buying UTX because the "company is still in play" whether from Honeywell or somebody else. With shares at $97 and the last "undervalued" Honeywell offer at $108 that leaves plenty of room for upside. Even if no acquisition comes to pass, the shares were trading at $125 last March. With acquisition interest I believe UTX shares could head back to those highs over the next few months, market permitting.
Earnings are April 19th.
I am recommending two entry points for this position. If shares move higher, we will enter the play at $98.25. If shares move lower in a weak market we will enter the position at $94.25. ONLY ENTER ONE POSITION using the first entry point that is hit.
Position 3/17/16: With a UTX trade at $98.25
Long Jan $105 LEAP Call @ $3.50, no initial stop loss
WDC - Western Digital Company Profile
Citigroup reiterated a buy rating on WDC and raised the price target $7 to $60. The analyst said WDC was better positioned than Seagate (STX) with the SanDisk merger. Shares hit resistance at $51.50 on Tuesday and then sold off again.
Original Trade Description: March 20th.
Western Digital develops, manufactures and sells data storage devices that enable consumers, businesses, governments and other organizations to create, manage, experience and preserve digital content worldwide. They produce hard drives for consumer PCs and enterprise servers. They produce solid-state drives (SSDs) that contain flash memory and operate at many times the speed of a conventional mechanical disk drive. They produce direct attach storage solutions for private and public clouds with storage per device of up to 24 TB.
Several months ago Western Digital agreed to buy flash memory maker SanDisk for roughly $80 per share or $16 billion. SanDisk has a revolutionary new memory technology that is due to hit the market soon and is considerable faster than existing flash memory. Western will be able to incorporate this super fast flash into its products and move well ahead of competitor Seagate Technology (STX). Seagate purchased competitor Samsung and Western Digital purchased Hitachi over the last several years. That leaves Seagate and Western Digital as the only major disk storage manufacturers in the world.
The shareholders of WDC (90%) and SNDK (98%) recently approved the merger and the U.S. and EU regulatory agencies have given approval. China is the only major country still working on their approval process. The merger is expected to complete in Q2. However, China could elect to drag out the approval process in order to extract concessions from the combined companies. They have done this before as in the Hitachi acquisition. Western is expected to derive $500 million in synergies from the SanDisk acquisition in the first two years and another $500 million by 2020. Institutional Shareholder Services, a company that advises investment firms, believes there will be up to $1.1 billion in cost synergies. That is a huge plus for WDC.
When Western Digital bought Hitachi in 2012, China approved the transaction but required WDC to maintain manufacturing and sales separate from WDC manufacturing and sales for 2 years. At the end of that period China tried to impose new restrictions and after a long battle they finally relented in December. Western will finally be able to fully integrate the Hitachi acquisition into Western's manufacturing process. That is expected to provide them with another $500 million in synergies over the next two years.
As a result of the SanDisk merger, Western Digital will have an opening to spread out in the flash storage market. SanDisk will be able to leverage Western's decades of market share in the hard drive market to expand on its flash storage into laptops, notebooks, tablets, PCs, etc. This is a win-win for both companies.
Western Digital shares have bounced around between $40-$50 for the last two months as the acquisition headlines played out in the market. Western's partner, China's Unisplendor, pulled out of the deal. They had planned on investing $3.78 billion in Western Digital and western was going to use that money to help finance the $19 billion SanDisk acquisition. When Unisplendor pulled out, Western negotiated a new deal for $15.8 billion with SanDisk and the deal went forward. That period saw shares drop to $40. Western announced debt deals last week to raise $17 billion in the market and the merger is looking very good. Now that all the hysteria is over the shares should begin to move higher as we get closer to completion. Shares gained $3 on Friday as the debt sale and shareholder approvals were announced.
Analysts are upgrading their ratings with Needham upgrading to strong buy and Citigroup to a buy. Needham has a price target of $90.
I am recommending we take a position ahead of the completion with the understanding that China could drag out the approval date. I gave serious consideration to using a 2018 LEAP but decided to go with 2017 instead. We can always roll forward late in 2016.
Earnings are April 28th and we will hold over the announcement.
Position 3/20/16 with WDC at $49.15
Long Jan 2017 $55 LEAP Call @ $4.90, no initial stop loss.
Short Jan 2017 $35 LEAP Put @ $2.70, no initial stop loss.
Net debit $2.20.
XOP - Oil Exploration ETF - ETF Description
The XOP is holding near the highs after Russia and OPEC confirmed an April 17th meeting in Doha Qatar to discuss a production freeze. I am amazed investors are so gullible and have driven oil prices higher on a bunch of headlines that will eventually amount to nothing.
Original Trade Description: February 28th.
The XOP is an ETF focusing on oil and gas exploration and production companies in the USA. There are 65 companies held by the ETF. More than 82% are oil and gas producers and 18% are refining and marketing companies. Only three companies comprise more than 3% of the weighting and that is due to price declines in other positions. The average weighting is about 2.4% for the majors and 1.5% for the minors.
In recent weeks we have seen oil prices trade as low as $26 and as high as $35. The two times it declined to the $26 range are more than likely the bottom for prices. The rebound to $34 last week came on daily headlines from the Middle East on Russia and OPEC countries getting together to agree on a production cap to limit future production and hopefully allow the glut to shrink.
Unfortunately, OPEC produced at a record high of 32.6 mbpd in January and freezing production at that level only guarantees continued excess production. Crude prices are rising because speculators believe that any agreement between OPEC and non-OPEC producers could eventually lead to a production cut when OPEC meets on June 5th.
The problem is that very few OPEC members have ever lived up to prior agreements. They all claim to produce to their quota but most overproduce and that is why we are in this mess today. Saudi Arabia got tired of always being the swing producer that had to cut even more production because everyone else was overproducing. They said if everyone cannot honor the quota then we will open the pipelines and the prices will show you the error of your ways.
Saudi Arabia did this in 1998 for the same reason and oil prices fell under $10. The rest of the OPEC nations finally caved in and promised to honor the quotas and Saudi relented and slowed production and prices rebounded. Some producers failed to learn the lesson last time and are having to suffer through it again.
Russia has agreed to limit/cut production three times in the past and never honored their agreement.
This is the problem today. Nobody wants to be the only one to honor a freeze only to have everyone else gain market share at their expense. If the group can agree to a freeze and audit the results and finds that the agreement worked then that would provide a basis for cooperation on a production cut at the June 5th meeting.
The entire oil crash problem is ridiculous. If OPEC would agree to cut production 2.0 mbpd the price would be back at $65 or more within a few months and eventually move even higher. The lack of trust and cooperation is costing them billions of dollars every day and they are too stubborn to fix it.
The reason for adding this ETF position now is that everyone is talking and that could lead to an eventual production cut. Also, U.S. production has declined more than 500,000 bpd since the peak last April at 9.61 mbpd. U.S. production has declined -135,000 bpd in just the last five weeks. The active rig count is crashing with total rigs falling to 502 last week, down -1,429 from their high of 1,931 at the peak in 2015.
Oil prices at $30 are finally having a material impact on U.S. production and the IEA expects production to decline another -500,000 bpd in 2016 and -200,000 bpd in 2017.
Also, the spring refinery maintenance season will be over at the end of March. At the peak of the maintenance season more than 2.0 mbpd of capacity is offline. When all those refineries go back to work the current inventory build cycle will end and four months of inventory declines will begin. This always raises the price of crude oil in the summer.
Lastly, pipeline outages in Iraq and Nigeria have removed 800,000 bpd of crude from the market and that should continue for at least two more weeks. An increase in violence in Libya is preventing a resumption of production and slowing exports.
Because of the low gasoline prices gasoline U.S. demand rose to a three month high at 9.576 mbpd last week and is expected to continue rising as we move into the summer driving season.
The XOP appears to have bottomed at $23 at least for the time being. If any of the factors described above cause a decline in excess production and increase in global demand then oil prices will rise and exploration companies will breathe a sigh of relief as their stock prices rise as well.
Oil prices will return to significantly higher levels in the next two years. There have been 8 boom/bust cycles since the early 1980s. Prices always return to levels where a significant number of producers throw in the towel and then rebound to new highs because of a lack of production. Demand rises about 1.2 mbpd per year. This oil crash is crushing future production with more than $200 billion in new projects canceled. It is just a cycle and the cycle will repeat.
When oil prices were $50 back in early October the XOP was over $40. I would really like to buy the 2018 LEAPS instead of the 2017 LEAPS but the prices are almost double. We will be better off to own the 2017 strikes and then roll into the 2018 strikes as the 2017 positions near expiration.
I am putting an entry trigger on the position just in case oil prices do take another dive lower. If that happens, I will lower the entry and the strike price.
Position 3/2/16 when XOP traded at $25.75
Long 2017 $28 LEAP Call, entry $3.10, no initial stop loss.
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