Home sales are booming and oil prices should begin to rise in April. Time to go fishing in each sector.
Stocks Dropped from Watch List:
JCI - Johnson Controls - Moved to active portfolio.
Play was opened on 2/26 when JCI traded at $36.75.
CSC - Computer Sciences - Moved to active portfolio.
Play was opened on 2/26 when CSC traded at $28.50.
Active Watch List Stocks:
DIS - Disney
This position remains unopened until DIS trades at $97.50.
TRN - Trinity Industries
This position remains unopened until TRN trades at $17.75.
New Watch List Entry:
XOP - Oil Exploration ETF - ETF Description
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.
With a XOP trade at $25.75
Buy 2017 $28 LEAP Call, currently $2.88, no stop loss.
TOL - Toll Brothers - Company Profile
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.
With a TOL trade at $28.50
Buy 2017 $30 LEAP call, currently $2.75. No initial stop loss.
Active Watch List Play Descriptions:
DIS - Disney - Company Profile
Disney continue to languish under resistance at $97 but it also refuses to move lower. The intraday dip to $93.20 on Wednesday was immediately bought but shares could not move over $96 on Friday.
This position remains unopened until DIS trades at $97.50.
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.
With a DIS trade at $97.50
Buy 2017 $105 LEAP Call, currently $4.75, no initial stop loss.
TRN - Trinity Industries - Company Profile
Trinity continues to hold around $16 as the big drop is digested. No news.
This position remains unopened until TRN trades at $17.75.
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.
With a TRN trade at $17.75
Buy 2018 $23 LEAP Call, currently $2.45, no initial stop loss.