The LEAPS portfolio is holding its gains despite removing that $1,400 winner from the active list last week. The problem for the coming week is the potential for the market to fade now that the biotech rally has run its course. The ASCO meeting is in progress and will end on Tuesday. While a select few stocks could rally after the meeting, the vast majority could give back their pre conference gains.
If this happens the broader markets could be weak. We have a wide range of positions and some could buck a market decline while others could follow it lower. We are hedged with the IWM puts but that is only a minor offset to any potential losses. There is no harm in taking profits rather than waiting on stop losses to be hit.
In theory, investing in LEAPS is a long-term proposition where we hold over earnings in anticipation of a long-term gain. LEAPS should be exited in the normal November rally.
Original Play Recommendations (Alpha by Symbol)
AAPL - Apple Inc Company Profile
Apple shares hit $100 and then rolled over to close the week at $98 on more worries about peak smartphones. With sales slowing for all manufacturers, it brought back worries that Apple could suffer the most because of their high price point. There was also a story with no credible source suggesting Apple could move to a 3-year upgrade cycle from the current 2 year. That rekindled the peak smartphone conversation. We are going to hold this position until September in hopes of the normal ramp into the new release announcement.
In a recent interview CEO Tim Cook said, "Apple has great innovation in the pipeline" and "We are going to give you things that you can't live without that you just don't know you need today." We want to own Apple shares when those innovations are announced.
Original Trade Description: May 1st.
Apple designs, manufactures and markets smartphones, tablets, digital music players, personal computers and smart watches internationally. If you do not know what Apple does, you have been living in a cave somewhere for the last 20 years.
Apple's problem started about a year ago as analysts began to worry about competition from Android devices and saturation of the market for Apple devices. Hypothetically, if the smartphone market is 500 million phones a year and Android's market share is growing, then Apple's saturation point is fast approaching or at least that was the theory.
Apple has continually surprised analysts with their sales growth. As the premium phone on the market there seems to always be new customers that want to trade up to an iPhone. Offsetting the total smartphone market limitation they are pushing into India, Africa and 3rd world countries that are seeing a rise in the number of consumers that can afford a $700 phone.
Apple released the 4-inch model SE with a price point of $399 to try and combat their market share losses in poorer environments. Not everyone wants a giant Model 6+ to carry around all day. In Asia, smaller phones are the most popular.
Analysts predicted sales in Q1 would decline for the first time in years. Apple also guided lower and shares crashed. When they actually reported earnings that missed estimates, shares crashed again. iPhone sales declined to 51.2 million, down -16% from the year ago quarter. It was the first year over year decline in iPhone sales ever. Apple guided to sales of $41-$43 billion for the current quarter and analysts were expecting $47 billion.
Apple is having a couple bad quarters because the iPhone 6 was such a success and the iPhone 6s did not have any must have features that made people rush out to upgrade again so soon. The iPhone 7 to be announced this September is rumored to be feature rich so people are simply waiting for the next model to make their upgrade decision.
Apple shares normally rally in Q3/Q4 on those product announcements. This year should be no different except we are starting out from a much lower base.
I believe Apple will shake off this period of slow sales thanks in part to the release of the SE and the expected release of the Model 7 versions in September. Apple shares typically rise into the announcement period.
I am recommending the January $100 call, currently $5.50. If you want to offset some of that premium you could sell the $75 put, currently $2.54. The odds of Apple shares being under $75 by January are very slim. Conservative investors could just buy the call and hang on for the ride.
I do not plan on holding this position until January. Typically, Apple shares peak on the release date of the new phone. They announce the phones in September and begin delivery in November. We will exit a couple days ahead of the delivery date.
Long Jan $100 LEAP Call @ $5.60, no initial stop loss
Short Jan $75 put @ $2.48, no initial stop loss
Net debit $3.12.
ATVI - Activision Blizzard - Company Profile
Investors sold the news on the strong sales of the new Overwatch game even though sales were above estimates. Give it time.
Original Trade Description: May 22nd.
Activision Blizzard designs, developes and publishes online, personal computer, video game console, handheld, mobile and tablet games. The company operates through two segments, Activision Publishing, Inc. and Blizzard Entertainment, Inc. The company develops, publishes, and sells interactive software products and content through retail channels or digital downloads; and downloadable content to a range of gamers. It also publishes subscription-based massively multiplayer online role-playing games; and strategy and role-playing games. In addition, the company maintains a proprietary online gaming service, Battle.net that facilitates the creation of user generated content, digital distribution, and online social connectivity in its games. Further, it engages in creating original film and television content; and provides warehousing, logistical, and sales distribution services to third-party publishers of interactive entertainment software, as well as manufacturers of interactive entertainment hardware products.
At the end of Q1 ATVI had 544 million monthly active users thanks to the acquisition of King Digital. King had a very diverse network of 463 million global game players. Activision said the acquisition will be accretive to 2016 revenues and earnings by 30% and significantly accretive to free cash flow per share. It also brings 463 million players into the Activision Blizzard massive multiplayer PC games like World of Warcraft that have monthly subscription fees.
Activision actually has a World of Warcraft movie premiering on June 10th. If you go to the movie you will get a copy of the PC game World of Warcraft free. The movie characters have custom weapons that will be available to players after the movie debut.
The new game "Overwatch" has been played by 9.7 million people in the open beta phase where it is released to the public in order to get the bugs out of it. It is a good bet the majority of those players will be buyers when the game launches on May 24th. The Star Wars Battlefront game had 9 million players in beta and has now sold 14 million copies.
Activision said they were working with Twitch and Instagram and would be producing a lot of content on Facebook live. They are planning on launching live streams of E-Sports programming to all of Facebook's 1.6 billion users. E-Sports provides live competition by gamers for millions of dollars in prizes as other gamers watch. Activision just launched its MLG.tv live streaming platform where gamers can watch others play in real time.
Webush believes ATVI could earn $3 per share by 2018 with $2 per share in 2016. The company reported 23 cents for Q1 on record revenue of $1.46 billion. Those numbers were up from 16 cents and $1.28 billion. Analyst estimates were for 12 cents and revenue of $823 million. The company raised guidance for Q2 and for the full year. They are guiding for earnings of 38 cents in Q2, up +192% on revenue of $1.38 billion, up +81%. For the full year they guided to earnings of $1.78, up +35% and revenue of $6.28 billion, up +36%.
Adding to earnings were continued sales of Call of Duty: Black Ops 3 and Candy Crush Jelly Saga. The headlines about the launch of Overwatch on May 24th should provide a positive lift for the stock.
I am proposing we buy the 2018 LEAP to give this acquisition of King Digital time to mature. We are probably going to see some retracement of the post earnings gains but I expect that to be light. Support is $34 and shares closed at $37.50 on Friday.
Long Jan 2018 $40 LEAP call @ $6.00. No initial stop loss.
BA - Boeing Company Profile
Boeing dropped sharply on Tuesday after the company said it had pushed the first KC-46 tanker delivery to August 2017 from March with the full 18 planes to be delivered by January 2018. The reason for the delay is the fueling system components made by Cobham. The full contract could rise to 400 planes but the Milestone C production decision was delayed by the Airforce from June 2016 until August. Boeing did announce a $3.2 billion contract win to manufacturer JDAM gps guidance kits to turn dumb bombs into smart bombs. This is an expansion of a prior $1.75 billion contract already in force. The government needs more bombs after dropping more than 20,000 bombs and missiles on ISIS targets.
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.
Update 4/11/16: Boeing had a good month in March. The company booked orders for 69 new planes. A 767-300F, (4) 747-8F, (4) 777-300ER and (60) 737s. In just the first week of April then landed 17 new orders. So far in 2016 they have sold 122 model 737s, 11 model 777s, four 747s, one 767 and one 787. They sold 140 year to date but had 18 cancellations of prior orders for a net gain of 122. The total order backlog today is 5,740 planes.
Update 5/15/16: Boeing rallied after their investor day when they told analysts they expect profit margins to rise to double digits in 2017 and possibly to the mid-teens percentages in the years to follow. The company discussed plans to modify existing models to better fit what customers want to buy in an effort to take market share from Airbus. Production of the 777 jetliner will fall from 8.3 per month to 5.5 in late 2018 and 2019 while it ramps up production of the new 777x. Boeing said it would pay back $30 billion in deferred costs from the 787 saying 70% would come from selling larger, more profitable versions at higher prices. Boeing plans to ramp up production to more than 900 total plans a year by 2020.
Position 3/14/16 with a BA trade at $125.50
Long Jan $130 LEAP Call @ $7.85, see portfolio graphic for stop loss.
Short Jan $100 LEAP Put @ $4.44, see portfolio graphic for stop loss.
Net debit $3.45.
CVX - Chevron Corp - Company Profile
Niger Delta Avengers claimed they blew up two Chevron wells on Wednesday using 100 gunboats, 4 warships and jet bombers. I would take those claims with a big grain of salt. Chevron said nothing about the reported attack. So far attacks have cut Nigerian output by 900,000 to 1.1 million bpd. The drop in production is keeping support under prices.
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
The Zootopia movie broke over $1 billion in revenue this weekend and that offsets the lacluster domestic gross of $51 million for Alice Through the Looking Glass. The Finding Dory and Big friendly Giant (BFG) movies open later in June and are sure to be winners. Shares rebounded slightly for the week. Shanghai Disney opens on June 16th. Shares held over support at $98.
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.
EMR - Emerson Electric - Company Profile
Still holding the gains from the prior week's rebound. No news.
Original Trade Description: May 8th.
Emerson Electric designs and manufactures products and provides services to industrial, commercial and consumer markets worldwide. They cater to all areas of industry with electrical measurement and control products, power generation products and automation of critical energy infrastructure.
In the recent earnings cycle they reported 66 cents compared to estimates for 63 cents. Revenue of $4.928 billion beat estimates for $4.891 billion. However, earnings declined -62% mostly because of the drop in demand from the oil and gas sector. Revenue declined -9$ for the same reason.
They guided for the current quarter to earnings of 85 cents. Full year revenue is expected to decline 2% to 5%. Full year earnings are expected to be $3.05-$3.25.
While they beat expectations, the performance was lackluster. With one of their major sectors in steep decline, it was remarkable that they beat earnings and raised guidance. When the oil and gas sector begins to rebound they are positioned for a huge bounce in earnings. The decline in oil and gas was priced into the stock at the January lows of $42. Shares rebounded with oil prices to $56 before earnings and dropped back to $52 with the weak market.
The CEO said Europe was better than it was just a few months ago and the rest of the world met expectations. The U.S. remained a trouble spot in certain segments.
The company is preparing to spin off its network power segment saw rising demand from data centers and telecom spending. He predicted the overall order book would turn positive in April/May and ramp up when capex spending returned to the energy sector.
Emerson is a solid company. They are not growing earnings significantly because of the energy sector but they are still tending to business. The spinoff of the network power division will provide a boost to the stock and allow Emerson to focus on the more profitable process management and power generation side of the business. The spinoff is expected to be completed by September 30th. The spin will provide cash to Emerson and allow them to put that cash to work in other areas and buyback stock. The CEO said, while they continue to proceed on the spinoff they are also talking to interested parties about an outright sale that would provide even more cash and flexibility. They are also in talks to sell the motors, drives and power generation business, which will further improve the company focus.
The company declared a quarterly dividend of 47.5 cents payable June 10th to holders on May 13th. They had operating free cash flows of $719 million for the quarter and expects to produce $3 billion in FCF for all of 2016.
The company is a steady performer with a lot of headline events coming over the next six months. These sales events will provide cash and improve profitability.
Shares declined from $56 to support at $52 after earnings and buyers were waiting. Options are inexpensive and the spin/sales events should power the stock higher.
Long JAN $55 call @ $2.70, no initial stop loss.
FFIV - F5 Networks - Company Description
No specific news. Still fighting resistance at $110.
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, see portfolio graphic for stop loss.
Short Jan $85 put @ $4.85, see portfolio graphic for stop loss.
Net debit $4.90
HCN - Welltower Company Profile
Shares are rebounding after the poor jobs report that pushed a potential rate hike farther out in the year. The company's debt was also upgraded from Baa2 to Baa1 by Moody's. The preferred stock rating was upgraded from Baa3 to Baa2. The positive outlook was revised to stable.
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 like 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 August 2nd.
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, see portfolio graphic for stop loss.
Short Jan 2017 $50 put @ $1.88, see portfolio graphic for stop loss.
Net debit $1.82.
IWM - Russell 2000 ETF ETF Profile
The Russell ETF continued to rebound to $116 in a monster short squeeze aided by semiconductors, biotechs, energy and financials. Resistance is $115 is in play and Monday will be a pivotal day for direction.
Original Trade Description: March 27th
I am picking the Russell 2000 ETF for multiple reasons. The first is that the Russell has rebounded the least of the major indexes. The high on the Russell 2000 was 1,296 in June of last year. The Russell declined to 943 at the low in February for a -27% drop. The rebound from that February low to Thursday's close at 1,079 has been 14%. However, the index has gone sideways for the last three weeks while the large cap indexes moved higher. The Russell failed to reach critical resistance at 1,120 and a 50% retracement of 10-month decline. There is significant resistance at 1,120 and again at the 61.8% retracement at 1,162.
The Russell is weak for multiple reasons. Financials make up the largest sector in the index with health care and energy also major components. Those sectors have been under extreme pressure so far in 2016. There is a rising call on the political front to break up the big banks and introduce price controls on drugs that will severely damage health care and biotech stocks. The energy sector has actually provided some lift in the last two months but the price spike to $41 in WTI is not likely to last.
I believe the rebound to 1,100 in March could be another lower high and the setup for a lower low in the months ahead. In an election year, the market is typically pressured by candidates on the campaign trail. They throw out dozens if not hundreds of things wrong with the economy and what they are going to do to fix it. Of the two major candidates, analysts believe Clinton would be less damaging to the market than a loose cannon like Trump. They have no political history for Trump and some of the things he says he will do, like tariffs on China and Mexico would cause an instant recession.
As we move out of the primary cycle in June and the leaders begin mudslinging towards each other the tone of the debate is going to become increasingly ugly. Normally that weighs on consumers and on the equity markets. There is always the potential for riots surrounding the conventions and that is market negative. If we head into October with a candidate unfavorable to the market in the lead, we could see significant declines.
Add in the potential for further ISIS attacks in Europe and the USA and that is another problem for the market to digest. Economically the economy is worsening. The Q4 GDP was revised up to 1.39%, which is barely growth at all, and the Q1 GDP is now forecast at 1.4% and declining. The Fed, despite Janet Yellen's calming words, appears desperate to hike rates in April. No less than four Fed heads made those claims last week. If the market believes the Fed is going to accelerate its rate hike cycle the market will decline. Earnings are now forecast to decline -8.7% in Q1.
There are lots of potentially negative factors to consider and very few if any positive factors. All the future market catalysts are negative. That could change at any time but that is the outlook today.
I am recommending we buy the January $100 LEAP put, currently $5.92. I would recommend launching this position at $110 and adding to it at $115 on the IWM. This will lower our overall cost in the position. Also, you could sell short a January $85 put, currently $2.31 to reduce the initial net debit in the total position.
The S&P futures are up slightly on Sunday night. I am expecting the market to rally on Mon/Tue as fund managers window dress their portfolios.
Position 3/29/16 with an IWM trade at $110
3/29 - With IWM trade at $110, Long Jan $100 put @ $4.93, no initial stop loss.
4/27 - With IWM trade at $115, Long Jan $100 put @ $3.50, no initial stop loss.
Short Jan $85 put @ $2.00, no initial stop loss.
Net initial debit $2.93.
JCI - Johnson Controls - Company Profile
No specific news. Shares rallied to close at a 6-month high.
JCI declared a quarterly dividend of 29 cents payable July 5th to holders on June 10th. They have paid consecutive dividends since 1887.
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.
Update 5/2/16: They reaffirmed that the JCI/TYCO merger is still on track and is set to close on Oct 1st. They also filed the initial Form 10 Registration Statement with the SEC for the Adient spinoff to shareholders after the Tyco merger is completed in October. JCI shareholders will receive 1 share of Adient for every ten shares of JCI they own. Adient will have 230 locations in 33 countries with 75,000 employees and $20 billion in revenue.
Position 2/16/16 with a JCI trade at $36.75
Long Jan $40 LEAP Call @ $2.45, see portfolio graphic for stop loss.
NFLX - Netflix - Company Info
Netflix shares sank the last two days with a weak big cap tech market. Amazon's Bezos said Prime Video could become the fourth pillar of Amazon's entire business. The other three are Retail sales, Prime memberships and Amazon Web services. Amazon spent an estimated $2 billion on video content for Prime in 2015. He said Amazon and Netflix are not competitors. "Customers will subscribe to both." Investors were not so confident and shares retreated about $3 from their Tuesday high.
Hedge funds are currently holding $3.4 billion in shorts on Netflix or 9% of the float.
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.
Update 5/2/16: Netflix shares declined on lower guidance for international subscriber growth. Analysts were too excited about the 130 countries they opened for Netflix service in early January. Netflix said early distribution issues and marketing slowed adoption but they did expect that to increase as they completed the rollout. Consider the details involved in opening up 130 countries at the same time. That would be a huge task. However, now that all are open and signing up customers the rest is easy.
Netflix took in $7.1 billion in revenue over the last 12 months. That was a 23% increase. First Call expects that to grow to $8.77 billion in 2016 and $11 billion in 2017. That is 29% and 26% growth respectively. Yes, despite the stock decline, revenue growth is accelerating.
The company said it was planning on spending another $6 billion on content in 2017, up from $5 billion in 2015. CEO Hastings is using the Amazon growth model. If you build it, they will come and it will be harder for competitors to catch you.
17 million subscribers are about to see their $7.99 monthly fee rise to $9.99 and that would add about $450 million a year in revenue. The company expects to add 2.5 million new subscribers in Q2 and 9-11 million in the second half of the year as the international platforms gain speed. With a debt to equity ratio of only 5% they are planning on issuing some more debt late in 2016 and/or early 2017 to cover the content acquisition process. Their last debt issuance is selling at a premium in the aftermarket at $1.08 per $1 in value. This is highly sought after and the company believes it can get a highly desirable rate on its next issuance.
Position 1/26/16 when NFLX traded at $97.25
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.
Position 5/10/16 when NFLX traded at $93.25
Long Jan 2017 $100 call @ $10.10, no stop loss.
Previously Closed 2/3/16: Long January 2017 $110 LEAP call @ $15.00, exit $9.41, -5.59 loss.
SCTY - Solar City - Company Profile
No specific news. Shares fell -6% last week on a downgrade by Deutsche Bank. They continued to decline to support at $21 but appear to be holding at that point.
Original Trade Description: May 15th.
SolarCity Corporation designs, manufactures, installs, monitors, maintains, leases, and sells solar energy systems to government, residential, and commercial customers in the United States. The company provides solar energy systems; solar lease and solar power purchase agreements; MyPower loan agreements; grid control/energy storage systems; zep solar mounting systems and proprietary software. It also sells electricity generated by solar energy systems to customers.
This has been a bad quarter for the solar stocks. Multiple companies have missed earnings and lowered guidance. Solar City was no exception. The company lost -$2.52 compared to estimates for -$2.32. However, revenue of $122.6 million easily beat estimates for $110 million. They guided for the current quarter for a loss of $2.70-$2.80 and analysts were expecting $2.13. The company cut estimates for full year installations to 1,000 to 1,100 megawatts compared to analyst estimates for 1,250 megawatts. Shares dropped -21% on the news to support at $16.50. Shares are down -65% in 2016.
The company said they were expanding into new states in the second half and that would increase sales. Also, sales are normally up in the summer months because roofs are not covered with snow.
They blamed the weak first quarter on regulatory challenges and increased prices that slowed sales. Nevada regulators said they were increasing fees to connect your solar installation to the grid and they were reducing the price the utility companies were going to pay for your power when it reaches the grid. That slowed installations in Nevada. I would think utility companies would like the extra power because they do not have to pay to generate it.
There was also some uncertainty about the extension of the investment tax credits for solar installations. The government did not extend the credits until last December.
Solar City actually installed much more wattage than expected. The company had forecasted it would install 180 megawatts in the quarter. They actually installed 214 megawatts, up 40% from year ago levels. The problem came from the bookings. They only booked 160 megawatts to add to the order backlogs. That meant their backlogs shrank for the quarter. However, the CEO said bookings were up +25% in March/April.
This play recommendation is a bet on Elon Musk as much as it is a bet that Solar City will continue to improve its sales and reduce expenses. There have been rumors that Musk was thinking about taking Solar City private for multiple reasons. Whether that happens or not is of course unknown. However, I do not expect Musk to let Solar City fail or continue to post negative results. He will direct the company and if the current CEO cannot post solid improvements, I am sure Musk can find somebody that will.
Earnings Aug 8th.
I wanted to play the 2018 LEAPS but they were too expensive. With the stock at $19 after trading at $65 just a few months ago there are high expectations. I am going to settle for a January 2017 call and we can revisit the 2018 LEAP question when we exit this position.
Shares dipped to $16.50 and have already rebounded to $19.60 in only 4 days. I expect the rebound to be steady since most of the three week decline was in sympathy to other solar earnings misses in the sector.
Long Jan $22 call @ $4.15, initial stop loss $16.25.
Short Jan $10 put @ $1.95, no initial stop loss.
Net debit $2.20.
SWHC - Smith & Wesson HoldingsCompany Profile
The gun manufacturers crashed after the FBI reported background checks rose only 2.6% in May compared to 14.4% in April. May background checks totaled 942,970 compared to 918,710 in the prior May. There was little help from politicians in early May with gun control out of the headlines. However, over the last week it has been front and center so I would expect June sales to rise. President Obama went on a rant in filming for a Sunday news show so that should also help. He admitted his presidency had caused more gun buying than any other point in history. Smith & Wesson (SWHC) fell -7% and Sturm Ruger (RGR) fell -4.8%.
Earnings are June 16th and that could provide a bounce.
Original Trade Description: March 27th
Smith & Wesson was founded in 1852 and manufacturers firearms in the U.S. and internationally under many different brands but primarily Smith & Wesson.
Gun sales are booming. Sportsman's Warehouse said gun sales rose +34% in Q4 alone. With every terrorist attack or mass shooting more consumers rush out to buy guns for self defense. With the potential for additional attacks in the U.S. this trend is not going to slow. However, sales are cyclical. They surge after attacks like San Bernardino or after speeches by politicians about gun control. President Obama has been the best gun salesman we have ever had. Every push by the administration to get more laws passed results in millions of new gun sales.
In their Q4 earnings where there was a surge in gun sales after San Bernardino, the company reported earnings of 59 cents that beat estimates for 41 cents. Revenue rose +61% to $210.8 million and easily beat estimates for $182.3 million. The company guided significantly higher for the current quarter to revenue of $210-$215 million compared to estimates for $196 million. Earnings are expected to be 51-53 cents. That is a 13.7% increase in revenue and 20% increase in earnings. For the full year, they guided to earnings for $1.68-$1.70 and analysts were expecting $1.42. This was also higher than the company's prior forecasts for $1.36-$1.41 from January.
The company said inventories were depleted because of the high demand and they were focused on increasing production rates to keep up with demand.
Shares rocketed higher after the earnings in early March and they were already up strongly since December. I hesitated to buy the top since it was making new highs every week. Last week a New York public advocate gave us a buying opportunity.
The New York public advocate, Letitia James created an excellent buying opportunity in a stock that normally refuses to go down. James sent a letter to the SEC demanding they investigate Sturm Ruger (RGR) because their guns are used in crimes. She did the same thing to Smith & Wesson back on December 15th. Seriously? Guns are used in crimes? Who does not know that?
James believes investors in these companies could suffer "reputational risk" if people find out they own shares of SWHC or RGR. She also urged Toronto Dominion Bank (TD) to stop financing the firearms manufacturer. She threatened the bank with the possible loss of "millions of dollars in contracts" from New York City if they continue to finance gun manufacturers. I wonder if she is going to attack auto manufacturers next for people injured in accidents? Thank you Letitia for the entry point.
I am also recommending this in the Option Investor newsletter on a shorter time horizon.
Earnings are June 16th.
I am using an entry trigger just in case the stock continues lower on the NYC advocate hatchet job.
Update 4/17/16: Sturm Ruger (RGR) and Smith & Wesson (SWHC) got some bad news on Friday. A judge in Connecticut ruled that a 2005 law that shields gun manufacturers from lawsuits brought by victim's families does not prevent victim's families from arguing that the semi-automatic rifle used in the Sandy Hook school shooting should not have been sold to civilians.
The case has no chance in court. The gun was made by Bushmaster Firearms, a subsidiary of Remington Arms, and no relation to either Ruger or S&W. However, the bad ruling by this judge means the families will sue Remington and there will be plenty of bad press before it is settled.
The gun belonged to Adam Lanza's mother and was stolen from a locked closet by her son and used to kill her and the victims at the school. The AR-15 style rifle is the most popular sporting rifle in America with millions sold every year by dozens of different companies.
Remington should not incur any liability by the son's illegal use of the firearm any more than GM is liable for the thousands of people killed every year by drunk drivers using GM cars. If a person decides to purposefully drive his car into a crowd of people, nobody is going to sue GM.
Since our LEAP had already declined to 90 cents on the first set of bad news in early April I am not going to close the position. We will tough it out and wait for the next set of NCIS numbers.
Position 3/28/16 with a SWHC trade at $27.15
Long 2017 $30 LEAP Call @ $3.08, see portfolio graphic for stop loss.
Position 4/25/16: Added Jan $30 call @ $1.05
Adjusted cost on current position now $2.05.
VRX - Valeant Pharmaceuticals Company Profile
Valeant shares spiked to our entry trigger at $30.50 on Wednesday and the position is now live. Earnings are Tuesday before the bell so you know there will be some volatility. Hopefully it will be positive.
Original Trade Description: May 8th.
The Yahoo profile for Valeant says, "Valeant develops, manufacturers and markets pharmaceuticals, over-the-counter products and medical devices worldwide." They have dozens of name brand products and earn billions of dollars a year.
They were a serial acquirer and went on a buying spree that astonished the sector. CEO Michael Pearson was credited with making dozens of timely decisions that turned into a basket of golden eggs for the company.
Last year they ran into trouble when they were found to have likely acted improperly with a specialty mail-order pharmacy company named Philidor. Papers show that Valeant was the only customer for Philidor and they had purchased an option to acquire Philidor and consolidated Philidor's results into Valeant's own financial results. The entire thing appeared to be suspect to short seller Citron Research. They blasted out a short sell paper asking a lot of uneasy questions and making a lot of unsubstantiated claims as they always do when they attack a company.
Also suspect was a practice of sending out millions of dollars of product to specialty pharmacies and then claiming the profits from those drugs before they are actually sold. They also claimed the unsold inventories at those pharmacies as still on Valeant inventory lists. One specialty pharmacy was R&O, which was 100% owned by Philidor, which was secretly owned by Valeant. Citron believes this was a scam to deceive the auditors and claim sales of drugs that were not really sold. Citron dug up links to other "captive" pharmacies owned by Philidor, including West Wilshire Pharma, SaferX Pharma, Rando Pharmacy and Orbit Pharmacy. All were supposedly online drug stores and all their domain names were registered on the same day by the same person.
Since the Citron report went public Valeant ended its relationship with Philidor and the stock declined from $263 to $25. Some are trying to say that Valeant did not know about the captive pharmacies and Philidor was trying to scam Valeant. This would be hard to believe given the hundreds of millions of dollars in drugs flowing to Philidor.
Fast forward to the present. Bill Ackman and several other activist fund people have been named to the board. CEO Michael Pearson has been fired and Perigo CEO Joe Papa has been hired to replace him and started on May 1st. Ackman appears to be running the board. His firm has lost more than $1 billion in Valeant stock so he is a man on a mission.
Creditors extended the deadline for filing the annual report from April 29th to May 31st but Valeant filed it as promised on April 29th. The 10K spelled out the minor restatement in the financials where some sales were moved from 2014 into 2015. It also listed numerous probes, inquiries and suits currently in progress.
Valeant is a solvent company. They said they were "comfortable with its current liquidity position and cash flow generation for the rest of the year and remains well positioned to meet obligations."
Ackman said he could restore value to Valeant relatively quickly. Filing the 10K and hiring the new CEO were the first steps.
Secondly, Ackman said they were going to install a new management team within a "matter of weeks, not months" and that would reassure investors as well. Ackman said he was confident he would recover all his money in the Valeant investment. He bought VRX shares at $161 and again somewhat lower than that.
Ackman said Valeant was willing to sell off noncore assets to raise cash and pay down debt to improve the financial picture. Valeant only has a market cap of $11 billion today compared to nearly $100 billion back in August of 2015. This drop is entirely due to the confusion over Philidor and possible impropriety. The board now claims there was no additional problems other than the $58 million restatement of earnings.
The last time Valeant issued guidance they were projecting $12.6 billion in revenues for 2016. Adjusted EPS of $13.50 a share. Double digit sales growth and $2.25 billion in debt reduction. A company that can produce $13.50 in earnings at a relatively mild PE of 10 would be worth $135 per share.
They have plenty of assets they can sell to raise cash if needed. According to analysts their Bausch & Lomb division is worth as much as $20 billion by itself or twice the current market cap of the entire company.
I believe Ackman will get the ship righted again. His reputation depends on it plus the $1 billion he has lost. The potential for Valeant shares to decline significantly has been greatly reduced with the resolution of the accounting probe and termination of Pearson and Schiller. I am sure the company made some mistakes. However, the sum of the parts is worth more than $118 a share according to a BMO analyst.
The stock has been crushed. The odds of a significant additional decline from here have been significantly reduced. The odds of a dramatic rebound have greatly increased.
In the LEAPS portfolio, we want stocks with the potential for significant appreciation. Once positive announcements become commonplace with Valeant the shares should rebound appreciably. Just filing the updated financials was a major step forward.
Valeant shares have been extremely volatile. They dropped 13% intraday on two different days in the first week of May. We need this volatility to subside before we enter into a new position on Valeant. There are analysts who claim Valeant could trade down to $20. Others believe it could hit $75 by the end of the year.
I am recommending we buy the Jan $45 call and sell a $25 put to offset the cost of the call. Premiums are expensive on Valeant because of the potential for a huge rebound. The stock was $263 a year ago and I do not expect that again but we could easily see the current price double or triple given the strong earnings potential.
The recent high was $38.50. If the stock moves over that level we want to enter the position. I would rather not play in the current volatility range that knocked us out of the last position.
Position 6/1/16 with a VRX trade at $30.50
Long Jan $40 LEAP Call @ $4.72, no initial stop loss.
Short Jan $25 LEAP Put @ $5.00, no initial stop loss.
Net credit 28 cents.
WDC - Western Digital Corp - Company Profile
Shares up $2.25 for the week after we added this position at the open on Tuesday. Needham reiterated a strong buy on the stock after the CEO bought $1 million in shares on the open market.
The option prices shown in the portfolio listing for WDC are incorrect. I mistakenly put in 2017 leaps instead of 2018. I cannot correct it this week because the program I use for price updates has already zeroed the prices from Friday as they prepare for Monday's market open.
These are the correct prices:
Long 2018 $50 call @ $7.75, no initial stop loss.
Short 2018 $30 put @ $4.20, no initial stop loss.
Original Trade Description: May 29th.
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 SanDisk acquisition was completed on May 12th.
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 crashed to $41 on May 19th after the acquisition was completed. They revised their guidance as a combined company. They now expect current quarter revenue in the range of $3.35-$3.45 billion compared to the prior forecast of $2.6-$2.7 billion. Earnings are expected to be between $.65-$.70 cents compared to the prior forecast for $1.05. The new guidance now includes interest costs of about $220 million. They incurred $30 million in debt issuance costs and $50 million in interest prior to closing on the acquisition. I believe WDC is going to rally off the recent lows and through resistance at $51. The combined companies are much stronger with a wider range of products than Seagate and sales late this year and in 2017 are going to be much stronger.
Analysts upgraded their ratings with Needham upgrading to strong buy and Citigroup to a buy. Needham has a price target of $90.
We tried to play WDC back in March but were stopped out on a decline after Seagate warned on expected revenue for 2016. WDC also suggested enterprise spending had slowed. However, after completing the acquisition and revising guidance analysts are suddenly more bullish saying the guidance was conservative. With shares $8 off the lows it appears investors are trying to buy the bottom. There is decent resistance at $51 that could provide a pause point. However, as a combined company with dozens of new products I believe they will eventually push through. I am going to recommend a 2018 LEAP with an offsetting put because WDC could take a couple quarters to really build up some new product momentum.
Long 2018 $50 call @ $7.75, no initial stop loss.
Short 2018 $30 put @ $4.20, no initial stop loss.
Net debit $3.55.
XOP - Oil Exploration ETF - ETF Description
Crude prices are holding near $50 on the falling dollar after OPEC failed to take any action to limit production at the Thursday meeting. At this point the risk to prices could be to the downside but we are moving into the high demand summer season. I considered closing this position but prices typically peak in August. I am willing to give it another week or two and monitor the trend.
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, see portfolio graphic for stop loss.
If you like the trade setups you have been receiving and you are on a free trial then now is the time to subscribe. Don't wait until you miss a newsletter to decide you want to take the plunge.
Prices Quoted in Newsletter
At Option Investor we have a long-standing policy prohibiting the editors and staff from actually trading the individual recommendations in order to conform to SEC rules concerning trades.
The prices quoted in the newsletter are the end of day prices in most cases.
When discussing fills or stops the prices quoted are the bid/ask at the time the entry trigger or exit stop is hit. This is NOT a price that someone on staff actually got using a live order.
For entry/exit points at the market open the prices quoted will be the opening print. The majority of the time readers are able to get a better fill than the opening print because of market maker bias at the open.
For trades with an opening qualification the prices quoted will be the bid/ask at the time the qualification was met.
All of these rules normally produce worse prices than an active trader would normally get. Because they are standardized there may be some cases where a price quoted was better than an actual fill. If you received a price that was dramatically different than what was quoted please let us know.