Option Investor
Newsletter

Daily Newsletter, Tuesday, 1/31/2017

Table of Contents

  1. Market Wrap
  2. New Plays
  3. In Play Updates and Reviews

Market Wrap

Biotech Rescue

by Jim Brown

Click here to email Jim Brown

The markets crashed again at the open but a rebound in the biotech sector rescued the Russell and Nasdaq from big losses.

Market Statistics

The biotech sector rebounded from the opening dip after a meeting at the White House with pharma CEOs turned out to be a love fest rather than a cage match. The president convinced them he was going to lower taxes and speed up drug approvals at the FDA. Investors must have believed them because the Biotech Index ($BTK) spiked 3.72% and the S&P Biotech SPDR (XBI) surged 4.13%. This lifted the Nasdaq and the Russell 2000 off their lows and powered the Russell to a 9 point gain. I suspect short covering was a big factor since many traders expected Trump to give the CEOs a hard time about drug prices.



There was a flurry of economic reports today but none were market movers. The employment cost index for Q4 rose +0.5% compared to +0.6% in Q3. Private wages were up +2.3% on a year-ago basis. Government wages rose +2.1% and benefit costs rose 2.0% over the same period.

Consumer confidence for January declined slightly from 113.3 to 111.8. The three-month moving average is 111.5 and the highest level since 2001. The present conditions component rose from 123.5 to 129.7 but the expectations component fell from 106.4 to 99.8. Potential auto buyers fell from 13.9% to 12.0%, homebuyers fell from 6.7% to 5.2% and appliance buyers declined from 52.6% to 51.1%. With the president now in office the thrill of victory may be fading into voter remorse for some citizens regardless of their voting preference.


The Texas service sector outlook survey for January fell from 20.6 to 16.2. The revenue component declined from 21.3 to 16.2 and employment from 6.9 to 4.8. Components for selling prices and capex spending plans were flat but input prices fell from 29.9 to 23.4. The future business outlook fell from 40.3 to 33. The report was ignored.

The calendar for Wednesday is packed. The Fed decision at 2:PM will be the most important but nobody expects them to change interest rates. There is only a 4% chance of a rate hike according to the CME FedWatch Tool.


The estimates for the ADP Employment report for January declined slightly to 165,000 but that is still 12,000 jobs over the December number. The Nonfarm Payrolls on Friday saw the estimates rise slightly from 165,000 to 171,000 over the last several days.

The ISM Manufacturing Index is expected to decline only slightly and should not be a market mover as long as it is in that range.


Today was all about earnings and Exxon (XOM) started the parade before the open. Exxon reported the smallest quarterly profit in 17 years because of low prices in oil and gas. Profits fell -40% to the lowest since 1998. Adjusted earnings were 89 cents and beat estimates for 72 cents. Revenue of $61.016 billion beat estimates for $60.606 billion. Production averages 4.121 million Boepd, a 3% decline from 2015. The company took a $2 billion write down on reserves. Exxon said it would pay $5.6 billion in stock to fund acquisitions in the Permian Basin. Exxon's capex spending declined 35% in Q4.

The reserves write down has been expected. The SEC inquired into their accounting practices several months ago when they had not taken any charges while everyone else in the sector was slashing previously booked reserves. If a company makes a discovery of 10 million barrels with oil at $75 and it costs $50 to produce it, those reserves must go away if oil prices fall to $40. If it costs significantly more to produce than it is worth then the company takes a charge to those booked reserves. This does not mean the oil went away. It is still there in the ground and they still own it. If prices returned to $75, the reserves could then be produced at a profit and they would go back on the books at the correct price.


United Parcel Service (UPS) shares were crushed after the company reported business was too good. The company said a rapid shift to home deliveries exposed how much further the company has to go to keep up with the volume. They vowed to spend an additional $1 billion to further automate warehouses and delivery systems. That pushed their 2017 capex to $4 billion. The company said they deliver an average of 1.1 packages at residential addresses but commercial addresses average multiple packages and that lowers costs. Delivering more residential packages means more residences and that adds to costs. One online transaction tracker said transactions rose 13% in November but the dollar volume only rose 4%. During the quarter, UPS delivered 1.4 billion packages, a 7.1% increase. Average daily shipments rose 5% to 19.6 million.

Earnings came in at $1.63 with analysts expecting $1.69. Revenue rose 5.5% to $16.9 billion and just below estimates for $17 billion. UPS guided for full year 2017 for earnings of $5.80 to $6.10 and analysts were already expecting $6.17. They blamed the strong dollar for reducing 2017 earnings estimates by 30 cents per share. UPS had hedged against the dollar but those hedges are not enough to prevent the losses. The current hedges expire in 2017 and the program is being replaced. Shares fell -$8 on the earnings news.


Harley-Davidson (HOG) reported earnings of 27 cents that missed estimates for 32 cents. Revenue of $933 million also missed estimates for $986 million. The misses were due to lower shipments. Revenue on Harley-Davidson branded bikes fell -8.8% to $685.5 million. They shipped 42,414 motorcycles compared to 48,149 in 2015-Q4.


Under Armour (UA) reported earnings of 23 cents that missed estimates for 25 cents and was below the 24 cents earning in the year ago quarter. Revenues of $1.308 billion rose 11.7% but missed estimates for $1.412 billion. Wholesale sales rose 5% and online sales rose 23%. For all of 2017 revenues are expected to rise 12-13% on a currency neutral basis to $5.4 billion but that was well below analyst expectations for $6.06 billion. They said slower customer traffic in Q4 and lower demand for footwear and apparel plus international challenges were to blame. The lower traffic caused significant promotional activities, which reduced average selling prices. They also said a shift in the product mix was to blame for lower revenue. The cheaper shoes were selling and high prices shoes were being heavily discounted.

Analysts blasted the conference call saying the lowered guidance was strange since they are rolling out in all the Kohls stores in the near future. That is a lower dollar retailer and will probably sell the low end of the Under Armour line, therefore further dragging the average selling price lower.

They also reported that their newly hired CFO would be leaving the company for personal reasons effective immediately. That is never good news. Analysts were piling on the downgrades on the belief the athleisure fad could be slowing along with the high priced shoe phenomenon.


MasterCard (MA) shares fell -$3 after reporting earnings of 86 cents on revenue of $2.756 billion, up +9.5%. That beat earnings estimates by a penny but missed revenue estimates for $2.9 billion. They guided for low double-digit revenue growth in 2017 and earnings growth in the mid teens. However, they said first half revenue growth would be lower than the second half because of higher incentive promotions. MasterCard process an average of 65,000 transactions per minute.


The big dog in the earnings parade reported after the close. Apple (AAPL) reported earnings of $3.36 per share compares to estimates for $3.21. Revenue rose 3% to $78.35 billion against expectations for $77.25 billion. This was the first quarter of growth after three quarters of declining sales. They guided for Q1 for revenue of $52.5 billion and did not give EPS guidance. Analysts were expecting $2.08 on revenue of $53.79 billion making that guidance slightly weak but Apple normally does that.

The revenue for Q4 was a record for Apple and they sold a record number of iPhones, iPhone services, Mac and the Apple Watch. Services revenue rose 18% to $7.2 billion. To put that in perspective that service revenue is about the same as Facebook will report in total revenue. The company sold 78.29 million iPhones and estimates were for 75.1 million. However, Q4 had an extra week in 2016. If you subtract out for that week you get 72.7 million and that still beat estimates. In Q3 they sold 76.5 million units. They also launched the iPhone 7 earlier than normal but offsetting that was a big hit from foreign currency issues.

iPad sales of 13.1 million missed estimates for 15 million units. Mac sales rose 7% to $7.24 billion. The Apple Watch, Air Pods, Beats headphones and wifi routers were lumped into the other category with $4 billion in sales, a decline of about 8%. The Apple app store and services generated $7.2 billion, up 18%. The game Super Mario Run was downloaded 80 million times in the quarter.

Apple's cash hoard rose to $246.1 billion, up $8.49 billion from Q3. Apple's cash alone would be ranked as the 13th largest public company in the world. Apple shares rallied $4 in afterhours. That would be equivalent to about 28 Dow points at the open on Wednesday.


Arconic (ARNC), formerly Alcoa, reported adjusted earnings of 12 cents compared to estimates for 13 cents. Alcoa spun off the commodity business into a new entity called Alcoa and renamed the core business as Arconic. The company makes engineered metal parts for the aerospace, automotive and other industries. The Alcoa CEO, Klaus Kleinfield, remained with Arconic. There has been a lot of activist chatter about getting rid of the CEO because of his pattern of lackluster results. After the earnings tonight, activist investor Elliott Management, which owns 10.5%, launched a proxy fight to replace the CEO and has nominated five independent candidates for the board. Elliott claims it can increase the share price to between $33 and $54 a share. After the earnings, the share price trade in a $1 range but ended where it started at $22.45.


Match.com (MTCH) shares fell -8% after reporting earnings of 29 cents compared to expectations for 24 cents. Revenue of $320 million missed estimates slightly. They issued weak guidance for Q1. They also said they were selling their Princeton Review unit to ST Unitas. Shares fell sharply to $15.90.


The big earnings report for Wednesday is Facebook after the close. On Thursday, it is AMGN, AMZN and CMG.



Markets

The markets opened with another big decline but the happy smiles coming out of the White House meeting with the big pharma CEOs turned the Nasdaq and Russell 2000 around quickly. The S&P was not impressed. The S&P did not rebound from the support at 2,268 until 2:30 and then it added 10 points in just a few minutes. From the velocity, this appeared to be either short covering or a buy program. There were $500 million in market on close orders to buy on the NYSE.

The 2,268 level was the low on Monday so that appears to be a new support level. The S&P almost got back to positive territory but ended with a loss of 2 points. The 2,300 level has replaced the Dow 20,000 target as the critical level for the market.


The Dow was down -186 points at the low and recovered nearly 80 of those points in the closing rebound. The index was still severely handicapped by Goldman Sachs, Boeing, JP Morgan, IBM and Caterpillar. Those were the stocks that rallied significantly after the election and they are paying the price this week.

The unlikely group of winners at the top simply could not generate enough gains to offset the many losers. This scenario could continue for additional days. The Dow dipped below 19,800 at 1:30 and came very close to closing under that level, which would have been a sell signal. Support is actually 19,750 and the low was 19,784 so there was a little cushion on the bottom of the dip. Resistance remains 20,100.



The Nasdaq Composite did manage to break back into positive territory by a point thanks to the biotechs. The Nasdaq 100 big cap index lost 12 points for the day. There are no big cap stocks in the winners list except for Apple and that was because of the afterhours gain. Note the majority of the winners are biotech stocks.

The biotech sector was experiencing a major short squeeze and that may not carry over into Wednesday. The Nasdaq futures are up 13.50 in afterhours and we should open higher in the morning thanks to Apple.



The Russell 2000 made a miraculous recovery from being down -7 at the open to closing with a 9-point gain. Again, that is all due to the biotech recovery. We should not expect this rebound to continue.


Wednesday's market is a tossup but we should begin in positive territory thanks to Apple. With jobs, manufacturing and the FOMC decision, the morning would be lackluster with volatility appearing after the Fed decision. With those Dow big caps giving back their post election gains, that could be the anchor dragging the market lower if there are no headlines to offset the declines.

Enter passively, exit aggressively!

Jim Brown

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New Plays

Commodity Boom

by Jim Brown

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Editor's Note

Demand for frac sand is booming and could hit record levels in 2017. Yes, the energy sector is bouncing back and there could be a shortage of frac sand by 2018.


NEW BULLISH Plays

EMES - Emerge Energy Services - Company Profile

Emerge Energy Services LP acquires, owns, operates, and develops a portfolio of energy service assets in the United States. The Sand segment is involved in the production and sale of various grades of industrial sand primarily used in the extraction of oil and natural gas, as well as in the production of building products and foundry materials. Company description from FinViz.com.

Emerge recently sold off its fuel division to Sunoco and it now a pure play on frac sand. According to analysts the demand for frac sand was in the 63 billion pound range in 2016. That is expected to grow to 107 billion pounds in 2017 and 146 billion in 2018. The prior peak was in 2014 at 106 billion pounds.


Selling a commodity that every energy producer needs is similar to store merchants getting rich during the gold rush by selling picks, shovels and wheelbarrows. There is very little risk in sand as long as energy prices are stable over $50.

Emerge raised $167 million through its sale of the fuel business and another $34 million in a secondary offering in November. Funds were used to acquire more sand and continue development of their SandMaxx technology, which is a proprietary fluid for keeping sand in a liquid state while fracking. Normally sand sinks in water so some sort of suspension liquid is needed to keep it in the fluid while it is circulated through the well.

Emerge pays a dividend that yields 15.25% at current prices.

Earnings Feb 23rd.

Shares were up on Tuesday despite a weak market.

Buy EMES shares, currently $17.95, initial stop loss $16.45

No options recommended because of wide spreads.



NEW BEARISH Plays

No New Bearish Plays



In Play Updates and Reviews

Biotech Rebound

by Jim Brown

Click here to email Jim Brown

Editors Note:

The biotech sector rebounded +3.7% today and helped lift the Russell and Nasdaq into positive territory. The biotech sector stocks are heavily represented in the Russell. The rebound in biotechs was due to President Trump meeting with the drug companies at the White House this morning and promising them faster drug approvals.

This could be a one-day short covering event or it could provide some lasting support. Time will tell but all our small cap stocks posted minor gains today.





Current Portfolio


Stop Loss Updates

Check the graphic below for any new stop losses in bright yellow. We need to always be prepared for an unexpected decline.


Profit Targets

Check the graphic below for any profit stops in green. We need to always be prepared for a profit exit at resistance.





Current Position Changes


CARA - Cara Therapeutics
The long stock position was entered at the open.



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BULLISH Play Updates

BOX - Box Inc - Company Profile

Comments:

No specific news. Still holding the recent highs. No weakness at all.

Original Trade Description: January 21st.

Box, Inc. provides cloud-based mobile optimized enterprise content collaboration platform that enables organizations of various sizes to manage their enterprise content from anywhere. The company's platform enables users to collaborate on content internally and with external parties, automate content-driven business processes, develop custom applications, and implement data protection, security, and compliance features. Box, Inc. offers its solution in 22 languages. It serves healthcare and life sciences, financial services, legal services, media and entertainment, retail, education, energy, and government industries. Company description from FinViz.com.

Box is rapidly growing its customer for document management for companies with a global workforce. They are competing with other companies for cloud collaboration and access. More than 69,000 companies worldwide now use Box. They have broken into the media sector and now many production companies use Box for storing and distributing their production content. This has given Box a new niche in the market. Box has partnered with Salesforce.com, IBM and Microsoft in the cloud space. Their goal is to partner and grow with them rather than compete with those giants.

The company reported a smaller than expected loss for Q3 and expect to post an even narrower loss for Q4. Their guidance for Q4 is a loss of 13 cents on revenue of $109 million. That is better than the 26 cents loss in Q4-2015.

Earnings March 1st.

Shares broke out to a new 52-week high on January 12th before pulling back slightly with the market. They closed 5 cents below a new 52-week high on Friday.

Position 1/23/17 with a BOX trade at $17.10

Long BOX shares @ $17.10, see portfolio graphic for stop loss.



CARA - Cara Therapeutics - Company Profile

Comments:

No specific news. This position started out well with a whopping $1.14 gain on the first day. Let's hope this trend continues.

Original Trade Description: January 30th

Cara Therapeutics, Inc., a clinical-stage biopharmaceutical company, focuses on developing and commercializing chemical entities designed to alleviate pain and pruritus by selectively targeting kappa opioid receptors in the United States. The company is developing product candidates that target the body's peripheral nervous system. Its lead product candidate includes I.V. CR845, which is in Phase III clinical trials for the treatment acute postoperative pain in adult patients, as well as completed Phase II clinical trials for the treatment of uremic pruritus disease. The company is also developing Oral CR845, which is in Phase IIa clinical trials for the treatment of moderate-to-severe acute and chronic pain; and CR701, which is in preclinical trial stage for treating neuropathic and inflammatory pain. It has licensing agreements with Chong Kun Dang Pharmaceutical Corporation to develop, manufacture, and commercialize products containing CR845 in South Korea; and Maruishi Pharmaceutical Co., Ltd to develop, manufacture, and commercialize drug products containing CR845 for acute pain and uremic pruritus in Japan. Company description from FinViz.com.

This is a small company with only a $400 million market cap. However, the drug they are current testing has the potential to be a multibillion dollar blockbuster. The drug is CR845 and it treats acute and chronic pain. It does not cross the blood brain barrier to there is no euphoria that users get when they take opioid drugs. Test subjects were injected with 15 times the normal dosage and they reported feeling no different than when taking a placebo. There is no risk of overdose and it is not habit forming.

It does not have any of the other opioid side effects including nausea, vomiting, respiratory depression, sedation and constipation. The drug is also an anti inflammatory and long lasting. The typical dosage it 1 pill twice a day.

In hospital tests post operative use of morphine was cut almost in half. For chronic osteoarthritis the drug was more effective than controlled release oxycodone.

There are 60 million post operative patients in the U.S alone each year. There are more than 140 million prescriptions written for pain meds. This has the potential to be a blockbuster.

Cara presented at the JP Morgan Healthcare Conference in mid January and shares are taking off as investors learn about the potential for this drug.

Earnings March 9th.

Position 1/31/17:

Long CARA shares @ $14.37, see portfolio graphic for stop loss.

No options recommended because of wide spreads and low volume.



CX - Cemex - Company Profile

Comments:

No specific news. Still holding at the 52-week high. S&P upgraded their credit rating from B+ to BB-.

Original Trade Description: January 25th

CEMEX, S.A.B. de C.V. produces, markets, distributes, and sells cement, ready-mix concrete, aggregates, and other construction materials in Mexico and internationally. The company also offers various complementary construction products, including asphalt products; concrete blocks and roof tiles; architectural products; concrete pipes for storm and sanitary sewers applications; and other precast products comprising rail products, concrete floors, box culverts, bridges, drainage basins, barriers, and parking curbs. In addition, it provides building solutions for housing projects, pavement projects, and green building consultancy services; and information technology solutions and services. The company has operations in Mexico, the United States, Northern Europe, the Mediterranean, South America, the Caribbean, and Asia. Company description from FinViz.com.

Bernstein Research researched all the contractors that could supply materials for a border wall. In the Bernstein map below Cemex is represented by the red blocks. Building 1,000 miles of wall, which is what Trump has promised will take a lot of concrete.

Cemex is one of the world's largest suppliers of cement and readymix concrete. Analysts believe the wall will cost between $15 to $25 billion to build and concrete would be a major expense. Based on various comments about what Trump is asking for, analysts expect 7 feet deep and up to 40 ft high for 1,000 miles. That will take 7.1 million cubic meters of concrete worth $700 million. However, engineers believe it would be easier and cheaper to build precast panels like the wall in Israel and other places. That would allow the panels to be constructed close to Cemex locations and not have 1,000 concrete trucks rotating up and down the wall every day. The picture below is the Israeli wall made with concrete panels and it stretches 420 miles.

Regardless of how the wall is constructed, it will take a lot of concrete and Cemex is going to be a supplier. Cemex has a large presence in the U.S. so it is immune from the US First rule.

Earnings Feb 9th.

CX shares have already spiked in January once it became apparent the wall was actually going to happen. The stock broke out to a new high on Wednesday and probably has a long way to go.

Position 1/26/17:

Long CX shares @ $9.42, no initial stop loss.

Optional: Long July $11 call @ 52 cents. No initial stop loss.




BEARISH Play Updates

CONN - Conn's Inc - Company Profile

Comments:

No specific news. Decent rebound but a dead stop at prior support at 10.75 that now appears to be resistance.

Original Trade Description: January 26th

Conn's, Inc. operates as a specialty retailer of durable consumer goods and related services in the United States. It operates through Retail and Credit segments. The company's stores provide home appliances comprising refrigerators, freezers, washers, dryers, dishwashers, and ranges; furniture and mattress, including furniture and related accessories for the living room, dining room, and bedroom, as well as traditional and specialty mattresses; and home office products consisting of computers, tablets, printers, and accessories. Its stores also offer consumer electronics, such as LED, OLED, Ultra HD, and Internet-ready televisions; and Blu-ray players, and home theater and portable audio equipment. Conn's, Inc. also provides repair service agreements, installment credit plans, and various credit insurance products. As of March 29, 2016, the company operated approximately 100 retail locations in Arizona, Colorado, Georgia, Louisiana, Mississippi, Nevada, New Mexico, North Carolina, Oklahoma, South Carolina, Tennessee, and Texas. Company description from FinViz.com.

In the Q3 earnings cycle, Conn's reported a smaller than expected loss of 12 cents. Analysts were looking for -19 cents. Revenue of $308.4 million and below the $395.23 million in the year ago quarter. They guided for Q4 same store sales to decline -10%. At the end of Q3 analysts were expecting a profit of 13 cents and revenue of $453.44 million. The odds of them beating this forecast are slim. Zacks said the analyst estimates have declined significantly to a loss of 52 cents for Q4. They have dropped 11 cents in just the last 30 days.

Conn's sells electronics along with appliances and furniture. Electronics sales are being dominated by Amazon and Best Buy. The furniture sector has been slow and appliances are hit and miss. With appliance prices rising sharply it has cut down on buyers that can afford the big ticket items.

Earnings March 7th.

I believe Conn's will continue lower. Shares broke to a two month low on Thursday when support at $10.75 failed.

Position 1/27/17:

Short CONN shares @ $10.50, see portfolio graphic for stop loss.

No options because of wide spreads and no open interest.



ENDP - Endo International - Company Profile

Comments:

The company announced the approval of a NDA for ephedrine sulfate injection in surgical settings. Shipments of the drug are expected to start in February. Shares rebounded 43 cents.

Original Trade Description: January 14th

Endo International plc develops, manufactures, and distributes pharmaceutical products and devices worldwide. Its U.S. Branded Pharmaceuticals segment offers chronic pain management products, such as BELBUCA, OPANA ER, and Percocet; Lidoderm for opioid analgesics; and Voltaren gel for osteoarthritis pain, as well as XIAFLEX for treating Peyronie's and Dupuytren's contracture diseases. This segment also provides Supprelin LA for central precocious puberty treatment; testosterone replacement therapies, such as Aveed and TESTOPEL, as well as Fortesta and Testim gels; Frova and Sumavel DosePro for migraine headaches; Valstar, a sterile solution for intravesical instillation of valrubicin; and Vantas for the palliative treatment of prostate cancer. The company's U.S. Generic Pharmaceuticals segment provides tablets, capsules, powders, injectables, liquids, nasal sprays, ophthalmics, and transdermal patches for pain management, urology, central nervous system disorders, immunosuppression, oncology, women's health, and cardiovascular disease markets. Its International Pharmaceuticals segment offers specialty pharmaceutical products in various therapeutic areas, including attention deficit hyperactivity disorder, pain, women's health, and oncology; generic, branded generic, and over-the-counter products in the areas of dermatology and anti-infectives; injectables for the treatment of pain, anti-infectives, cardiovascular, and other therapeutics areas; and healthcare services, products, and solutions to hospitals, pharmacies, and practitioners, as well as for government healthcare programs. The company also provides Monarc subfascial hammock to treat female stress urinary incontinence; and Elevate transvaginal pelvic floor repair system for the treatment of pelvic organ prolapse. It sells its branded pharmaceuticals and generics directly, as well as through wholesale drug distributors. Company description from FinViz.com.

Endo is a small $3 billion market cap company but they have been around since 1920. They are headquartered in Dublin Ireland and could easily be impacted by an import tax. They do have some common products and they do have earnings.

Endo has been benefitting from raising drug prices and a study underway to determine how much companies have raised prices over the last ten years is bound to highlight Endo as a serial hiker. The company already warned that the pricing environment was going to remain challenging in 2017 with 30% year over year declines in generics. If the new replacement for Obamacare does require bidding for generic drugs as Trump has mentioned, Endo could be under a lot of pressure. Add in the import taxes and it could be ugly. Investors are anticipating these events and the stock is falling.

On Thursday somebody bought 4,000 February $12.50 put for 70 cents. That is a $280,000 bet they are going lower. If Trump repeats his desire for lower drug prices in the inauguration speech, the drugs companies are going to collapse again.

Update 1/26/17: Endo announced 90 jobs cuts as part of a restructuring effort to save $40-$50 million a year. The company said it would take a charge of up to $20 million on the terminations. Those must have been some very highly paid people. Endo employs 6,400 so these layoffs are minimal. Shares rose 10 cents on the news.

Earnings February 7th.

Position 1/17/17:

Short ENDP shares @ $13.22, see portfolio graphic for stop loss.

No options recommended because of price and spreads.



FRED - Freds Inc - Company Profile

Comments:

Evercore expressed doubt that Fred's could financially complete the acquisition of additional Walgreen's stores as required in the WBA/RAD merger. The new agreement contemplates Walgreens may have to sell an additional 335 stores. That is nearly 50% more than the 865 Fred's has already agreed to buy. Evercore said that may be too large of a commitment for Fred's.

Original Trade Description: January 23rd.

Fred's, Inc., together with its subsidiaries, sells general merchandise through its retail discount stores and full service pharmacies. The company, through its stores, offers household cleaning supplies, health and beauty aids, disposable diapers, pet foods, paper products, various food and beverage products, and pharmaceuticals to low, middle, and fixed income families in small- to medium- sized towns. It also sells general merchandise to franchised Fred's stores. As of January 30, 2016, the company operated 641 company-owned stores, which included 60 express stores in 15 states and 18 franchised stores under the Fred's name, as well as 372 pharmacies and 3 specialty pharmacy facilities primarily in the southeastern United States. It also operates 18 franchised stores under the Fred's name. Company description from FinViz.com.

Freds has been in retail trouble for over a year. Their same store sales continue to decline since every grocery store, Walmart and Target in America has added a pharmacy. Shares had been in decline until Walgreens/Rite Aid agreed to sell Fred's 865 Rite Aid stores in an effort to get FTC approval for the WBA/RAD merger. That would make Fred's the third largest drugstore chain in the U.S. and shares doubled on the news.

A funny thing happened on the way to the merger. The FTC said last week they did not believe that was enough of a consideration to approve the merger. Walgreens has 8,200 stores and Rite Aid has 5,000 stores. Selling Fred's 865 Rite Aid stores was not enough. The combined WBA/RAD would have more than 12,500 stores to Fred's 1,500. CVS would become number two at 9,655 stores. The FTC believes the post merger environment would create two heavyweights that would dominate their respective areas.

Shares of Fred's have been in decline for a week on the worry the FTC will either block the merger OR they will be forced to sell a much larger block of WBA/RAD stores to Fred's and the company will not be able to complete the transaction or they will become too big too fast and begin losing money like crazy as they try to ramp up distribution and management to handle the suddenly increased store count.

Fred's announced a secondary offering on Friday to raise money for the acquisition. If the deal changes that causes additional problems. If the deal were to triple in size, Fred's would have to do another secondary to raise the additional cash and it could be a whopper of an offering.

Earnings March 9th.

I believe Fred's will continue to give back those monster gains from the December headline. If the WAG/RAD merger approval gets extended that creates more indecision for Fred's.

Update 1/26/17: The Walgreen's CEO said the company remains "actively in discussions" with Rite Aid about the regulatory concerns. We are discussing "all the instruments and actions we can put in place to facilitate this process." The merger agreement is set to expire on Friday and he did not say whether it would be extended.

Update 1/30/17: Walgreens and Rite Aid announced a restructuring of their merger agreement. Walgreens said in order to satisfy the FTC they may have to sell more stores, possibly a lot more. Fred's is contractually liable to buy any stores that Walgreens or Rite Aid decide to sell. Over the long term this would be positive for Freds but over the short-term it means they would have to take on more debt and probably make another secondary offering. That should be negative for the stock price.

Position 1/24/17:

Short FRED shares @ $14.97, see portfolio graphic for stop loss.



GNC - GNC Holdings - Company Profile

Comments:

The NFL rejected GNC's proposed advertisement. The NFL said they had a standing policy not to promote supplements. The NFL said GNC was on a list of prohibited companies because they promote products banned by the league.

FOX has been getting an average of $5 million per 30 seconds of airtime and that is a fee GNC will no longer have to pay but the ad was supposed to be a kickoff of their new marketing campaign.

Original Trade Description: January 28th

GNC Holdings, Inc., together with its subsidiaries, operates as a specialty retailer of health, wellness, and performance products. The company operates through three segments: Retail, Franchise, and Manufacturing/Wholesale. Its products include vitamins, minerals, and herbal supplement products; and sports nutrition products, diet products, and other wellness products. The company sells its products under the GNC proprietary brands, including Mega Men, Ultra Mega, Total Lean, Pro Performance, Pro Performance AMP, Beyond Raw, GNC Puredge, GNC GenetixHD, and Herbal Plus, as well as under third-party brands. It operates a network of approximately 9,000 locations under the GNC brand worldwide. The company sells its products through company-owned retail stores; Websites, including GNC.com and LuckyVitamin.com, as well as Drugstore.com; domestic and international franchise activities; third-party contract manufacturing; and e-commerce and corporate partnerships. Company description from FinViz.com.

On January 19th GNC was cut to a sell by Goldman saying the already reduced earnings estimates were still too optimistic. GNC tried to sell itself last year and the deal fizzled. Then they announced a restructuring of the brand and the store format. As part of the relaunch of GNC they slashed prices across half their product line and discontinued many products entirely. The company also ended its Gold Card loyalty, which had been in effect for more than a decade. Six million members were paying $15 a year in exchange for discounted prices.

The GNC CEO said "the new GNC leaves the old, broken model behind" but we know "it will take time for the changes to take hold and translate into improved financial results." That is an implied earnings warning for the next couple quarters.

Earnings Feb 9th.

With earnings in two weeks this will be a short-term position. After looking at the cart I doubt many investors will want to hold the stock into the earnings event and that should cause a further decline next week.

Position 1/30/17:

Short GNC shares @ $8.77, see portfolio graphic for stop loss.

No options recommended because of the distance from the stock price. However, the Feb $7.50 put is only 25 cents. That might be an interesting lottery play to hold over their earnings report. If they get slammed on earnings again that could be a winner.



IWM - Russell 2000 ETF - ETF Profile

Comments:

The Russell exploded higher after an opening dip thanks to a strong rebound in the biotech sector after President Trump met with the drug companies in the White House this morning. The biotech sector rebounded 3.7%.

Original Trade Description: December 10th

The IWM ETF seeks to track the investment results of the Russell 2000 Small cap Index.

The Russell is up +232 points or 20.1% in the last 22 trading days. It is grossly over extended and many small cap Russell stocks are up 30% to 40%. I understand the bullish sentiment that believes the economy will be better in 2017 but it will not be because of President Trump. His proposals will take months to get through the House and Senate and there is likely to be some major battles. Obamacare will not go away until 2018 or longer because it takes a long time to plan and execute a change that big. Lower taxes will not happen until 2018 because it will take months for both houses to vote on an acceptable tax bill. I seriously doubt they will change rates in the middle of the year. Any change will not occur until 2018.

I could go on but you get the picture. Typically, there is a honeymoon phase after a new president is elected. This phase has run its course. There are 14 trading days left in 2016 and any new highs are likely to be made before Christmas. After Christmas, investors may begin to worry and once into January and a new tax year, the selling could be dramatic. Do you remember January 2016? The market was not nearly as overextended as it is today and the Dow fell -2,150 points in just two weeks. Entering into a new tax year allows traders to capture profits and invest that money for another year before paying taxes.

Dow - January 2016

We also have the potential for a really messy inauguration or even a terrorist attack at the event. That potential will give cautious investors another reason to take profits in January.

I am recommending a long put on the Russell ETF. There is no stock vehicle we can use other than the VXX to capitalize on a market sell off. The VXX is flawed and while it may go up, it may not go up enough to make it worthwhile and it is volatile from day to day. I chose the Russell ETF because the premiums are cheap and the volatility should work in our favor. If you cannot use options then I suggest you buy the VXX shares at the first sign of market weakness after Christmas.

There is also another trigger factor to consider. The Dow is approaching 20,000 and that could be a massive sell the news event given the big gains. Since the Dow could hit that level this week I am recommending we initiate our long put position in advance.

Because the market could still rise, I want to follow the IWM higher and enter the position only when the ETF rolls over.

The ETF has short-term support at 137.75 and again at $137.25. I am recommending we enter the position with a dip to $137. If the Russell continues higher, I will continue raising the entry point as needed.

Position 12/12/16 with an IWM trade at $137.00

Long Feb $134 put @ $3.38, see portfolio graphic for stop loss.



SHLD - Sears Holdings - Company Profile

Comments:

No specific news. Share rebounded only 12 cents from Monday's 14-year low.

Original Trade Description: January 9th

Sears Holdings Corporation operates as a retailer in the United States. It operates in two segments, Kmart and Sears Domestic. The Kmart segment operates retail stores that offer a range of products, including consumer electronics, seasonal merchandise, outdoor living, toys, lawn and garden equipment, food and consumables, and apparel; and in-store pharmacies. It provides merchandise under the Jaclyn Smith, Joe Boxer, and Alphaline labels; Sears brand products, such as Kenmore, Craftsman, and DieHard; and Kenmore-branded products. As of October 31, 2015, this segment operated approximately 952 Kmart stores. The Sears Domestic segment operates stores that provide appliances, consumer electronics/connected solutions, tools, sporting goods, outdoor living, lawn and garden equipment, apparel, footwear, jewelry, and accessories, as well as automotive services and products, such as tires, batteries, and home fashion products. It also offers appliances and services to commercial customers in the single-family residential construction/remodel, property management, multi-family new construction, and government/military sectors; appliance and plumbing fixtures to architects, designers, and new construction or remodeling customers; parts and repair services for appliances, lawn and garden equipment, consumer electronics, floor care products, and heating and cooling systems; and home improvement services, as well as protection agreements and product installation services. This segment provides merchandise under the Kenmore, Craftsman, DieHard, Covington, Canyon River Blues, Metaphor, Outdoor Life, Structure, and Apostrophe brands, as well as under the Roadhandler, Ty Pennington Style, and Alphaline brands. As of October 31, 2015, this segment operated 735 Sears stores. Company description from FinViz.com.

We played Sears as a short several times before. We were stopped out on Dec-30th when the CEO arranged a bridge loan to get them out of trouble temporarily. Now that the holiday numbers are starting to come in, the results are very dismal. Sears is eventually expected to file bankruptcy.

In November, they posted a GAAP loss of $748 million and an adjusted loss of $333 million. Gross margins fell to 19.2% compared to JC Penny at 37.2%. Sears is forced to severely discount items to attract what few shoppers they have. Same store sales at Kmart fell -4.4% and -10% at Sears. Revenue fell -12.5% to $5.0 billion.

Earnings March 9th.

Fitch warned Sears will burn through $1.5-$1.8 billion in cash this year and even selling off the Craftsman brand will only gain them an additional 12 months of life.

Sears closed at a new 14-year low on Dec-28th and the outlook is growing increasingly dim. Suppliers fear a bankruptcy in 2017 once the holiday shopping is over. Several suppliers have halted shipments to Sears on fears they will not be paid.

In early January, they announced they were closing 150 stores. There are 109 Kmarts and 41 Sears stores. Last week they announced the sale of the Craftsman brand to Stanley Black & Decker for $900 million but they get less than half of that in cash. The rest is paid out over the next 3-5 years. That shows how desperate they are for cash since they originally expected to raise $1.5 to $2.0 billion on the sale. Now they are looking to sell the Kenmore and Diehard brands.

With the Craftsman sale and the loan from the CEO and a new $500 million loan secured by real estate, they have developed about $1.5 billion in Liquidity. Fitch warned Sears will burn through $1.5-$1.8 billion in cash this year and even selling off the Craftsman brand will only gain them an additional 12 months of life.

When they announced the Craftsman sale at less than expected terms, the stock fell back from the early January gains. The outlook is grim despite the short-term cash inflows.

Update 1/11/17: In an OP-ED piece Forbes said the sale of Craftsman signaled the opening of the final chapter for Sears. They said the Craftsman sale and the potential sale of the Kenmore and Diehard brands represented a "going out of business" sale.

Update 1/19/17: Sears announced it was ending its decades old employee discount program. They are going to allow employees to earn points on purchases that will be good for future discounts. Currently they get a discount on items at the time of purchase. By scrapping that plan, the company gets the money up front and maybe the employee will use their points on future purchases. The point values differ on different types of merchandise. If Sears eventually files bankruptcy, the points would disappear. This is another sign the company is in trouble.

Update 1/21/17: Moody's downgraded Sears credit rating from Caa1 to Caa2. Moody's said Sears is running out of stuff it can sell for cash. They only have 211 properties that are unencumbered and worth about $2.5 billion. With the company burning cash at the rate of $1.5 billion they are rapidly approaching the end of the line. Moody's said they could raise cash with the sale of the Kenmore and Diehard brands but after that they are done. There is nothing left to sell that will produce a large inflow of cash.

Update 1/25/17: Fitch Ratings took another look at Sears and reiterated they expect a $1.6 billion cash burn for 2016 and $1.8 billion in 2017. The Barron's laid out the problems ahead for Sears and that tanked the stock on Wednesday.

Update 1/26/17: Moody's joined Fitch in another downgrade on Sears credit instruments. The debt instruments were cut from Caa2 to Caa3 because of accelerating cash burn and declining asset base. The WSJ had another article today negative on the outlook for Sears. Sales at companies like Mattel and Hasbro declined sharply in Q3 suggesting Sears and others did not reorder and earnings could be dismal.

Update 1/30/17: Sears announced a sale-leaseback arrangement with CBL & Associates for five Sears stores and two auto stores. A sale-leaseback is where the company sells the properties to raise cash and then agrees to lease them back from the buyer for a specific term. This is another sign Sears is continuing to have a cash crunch. This transaction leaves Sears with only 204 properties that are unencumbered and could be sold for cash out of the 1,680 stores they operate. Every time they sell a property they take on debt in the form of leases and that means the amount of cash burn increases with each deal.

Position 1/10/17:

Short SHLD shares @ $8.97, see portfolio graphic for stop loss.

No options recommended because of price.




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