MORNING BID – Herbalife and the options market

Jul 28, 2014 15:59 UTC

One of the market’s more well known short bets, Herbalife, reports earnings after the close on Monday. The company is most notable as the target of activist investor Bill Ackman, who has had plenty of choice words for the company and yet has not been able to make good on his short position just yet, despite his fervent belief it is defrauding investors and taking advantage of poor people.

That’s a hefty set of accusations for anyone to deal with, but the stock’s 25 percent one-day surge last week just after Ackman’s presentation turned into a big loser for folks who were betting on big declines by the end of last week.

Ackman, from what we’re aware of, has big positions in put options expiring in January – so it’s a long view he’s taken, and if he took it at the right time, it’s not necessarily a loser just yet. (The options rose in value for the first few months of this year, so it’s possible Ackman got out in time – given his presentations, though, he’s clearly got a position somewhere.)

If that’s the case, he’s currently losing money, and today’s earnings report – and subsequent activity – will be another test of his staying power. Now, he’s said he’s prepared to go to the ends of the earth for this short position, but there are limits to everything, and it’s worth looking at just what the bet is like right now.

There are huge, huge amounts of outstanding contracts in various put options expiring in January – about 220,000 contracts across a swathe of nine different strike prices, to say nothing of a bunch of other less popular strikes.

Most of these big positions are currently not profitable, and are actually worth less than what they’ve been worth over the last several months.

If Ackman did his buying in chunks, a good spot to examine is in the $50 put option contracts expiring in January – a bet the stock will fall below $50 by that time. There was a hell of a lot of volume in these options in January 2014 – on January 9, volume in the $50 strike contracts came to 25,000 contracts and on January 10 volume of 20,759 contracts.

On those days, the stock was trading around $81 a share, so if Ackman is behind these purchases, it means he thought that was an opportune time to buy those puts, which cost $7.25 and $7.45 on average that day, according to Thomson Reuters data.

If he doesn’t hold those options anymore, he may have sold them at a profit, but currently those options are a loser, and as long as the stock keeps rising, they will continue to erode in value.

Doing the math, it shakes out like this – at 25,000 contracts at $7.25 each (x 100 because each contract is 100 shares of stock), those would have cost $18.125 million. The other group would cost $15.465 million, for a total cost of about $33.6 million.

Right now, those options would be worth about $18.9 million, so that’s a 40 percent loss, and that’s just for the $50 strike, never mind all of the other strikes. This of course may not be his position, but whomever took these positions, be it one person or several, is not in a happy place.

What matters is this: Since the first day the $50 strikes expiring in January 2015 started trading (back in Oct 2013), this strike has never been worth less than it is now.

If he’s holding the options now that he bought at just about any time between Oct ’13 and now, he’s losing money. Of course, given these are options, he’s easily able to keep rolling down and buying another money and selling these, but eventually, if the stock doesn’t do what he wants, he’ll be losing a ton of money. He’s got a lot of money, but how much pain can he endure? That’s a real question.

MORNING BID – Waiting on volatility

Jul 24, 2014 12:36 UTC

The day brings another run of earnings reports in what’s overall been a steady and admittedly staid earnings season – many of the high-fliers that investors counted on for volatile trading post-earnings haven’t delivered on that promise, an angle we’ll be exploring in more detail later in the day. Facebook went out with results that weren’t terrible or even all that amazing and shares meandered their way to a 2 percent gain in post-close trading Wednesday (it has since risen and is up 8 percent in premarket action Thursday, so that one has at least panned out for some). Shares of Gilead Sciences bucked the trend among more volatile biotechnology shares and really didn’t do all that much at all.

The big-cap stocks have been similarly unexciting, and the equity market gets a ton of them before and after on Thursday, including heavy equipment giant Caterpillar, the two car companies (Ford and General Motors). There’s also Post-It maker 3M, online retailer Amazon, payment processor Visa – another good consumer spending barometer, and the likes of PulteGroup and DR Horton, a pair of larger homebuilder stocks.

Headed into Wednesday evening’s results, the year-over-year earnings growth was 5.4 percent, or 7.1 percent when removing Citigroup, which had some seriously weird charges this quarter. That still makes things good for a high beat rate of 68.5 percent thus far, and overall companies are surprising by 2.4 percent per Thomson data (again, include Citi, and it’s a -0.2 percent result). So the overall foundation of earnings has generally been strong with few real surprises, helping keep a bit of a lid on volatility in general.

Looking at the names on the docket for today, there are a few that stand out in terms of bettors hoping for wild swings one way or another. Pandora Media looks like a candidate for some volatility, with options types banking on a 9.7 percent move in shares one way or another through Friday, while expectations for Amazon are for a more subdued 6 percent move. That’s relatively quiet for names of that type though Amazon has become something akin to the “old tech” names, with reduced volatility and high share repurchases than anything else.

MORNING BID – The consumer outlook, out of earnings

Jul 23, 2014 12:44 UTC

The next several hours will bring a handful of important consumer names that may give investors some idea of the progress the consumer economy is making. This only works as a barometer to some degree. Sales at S&P 500 companies far outpace the growth of the overall economy, which in part explains why the market itself is doing as well as it is (we’re in the 1980s now on the S&P, so crank up the Def Leppard) and the rest of the economy is lagging behind.

And mass market consumer-facing names like McDonald’s and Coca-Cola disappointed investors with their results on Tuesday, so it will be interesting to see whether others, like Whirlpool – which has tended to buck the general trend – will fare a bit better with their results. (Whirlpool, for its part, cut its outlook amid weak results, but North American sales were up 4 percent excluding currency effects, so score that one on the positive side of the ledger.)

Another consumer name that would lend some credence to the idea that Container Store and Lumber Liquidators put forth – that the U.S. economy remains in a funk – would be Ethan Allen Interiors. The furniture retailer actually comes in as undervalued, per StarMine expectations for growth in the coming decade, and it, too, has managed to steadily increase profit margins.

The company’s valuations compare favorably with those of its competitors: A lower forward price-to-earnings ratio than the likes of Haverty Furniture, Laz-E-Boy, and Leggett & Platt – and while it’s not the biggest of bellwethers (it’s a $659 million company, putting it in the S&P small caps), it has a certain cachet that puts it squarely in the mass market luxury area.

Again, it’s not a perfect barometer, but if it’s doing well along with the cable companies, media names that supply premium content, it points to higher-end retailer outperformance (though nobody has told Harley-Davidson or Michael Kors, both high-end companies that have struggled). If it sinks, it validates the “we’re in a funk” thesis.

The S&P’s global luxury retail index has posted annualized returns of about 25.5 percent in the last five years, outdoing the overall retail index (averaging 25.1 percent annualized in the last five years) and the consumer staples stocks (+16.7 percent).

The auto companies come a day later – Ford and General Motors – but the two U.S. automaking giants are buried under a lot of issues involving recalls, particularly GM.

Notably June auto sales came in at their best levels in about eight years, with GM showing a 1 percent increase in sales while Ford sales were down 5 percent for the month, though still ahead of forecasts.
Either way, the overall level of sales suggested some strength in the second quarter, with the primary questions being how much those companies will be hit by further recall-linked issues.

MORNING BID – The quiet days for Apple

Jul 22, 2014 12:59 UTC

Apple’s been the two-ton behemoth of the stock market for so long that it is going to be surprising, in a way, to see that the company isn’t really pulling its weight anymore when it comes to its percentage of S&P 500 earnings. This sort of thing can be a bit silly, but Howard Silverblatt, the index guru over at S&P Dow Jones, points out that Apple right now is about 3.2 percent of the total market value of the S&P while at the same time accounting for an expected 2.8 percent of earnings in the S&P – the first time since 2008 that Apple hasn’t delivered a percentage of S&P earnings equivalent to its market value.

In the past few years, Apple has tended to carry much of the S&P on its back, such as in the fourth quarter of 2011 and first quarter of 2012, when it accounted for 6 percent and 5.2 percent of the index’s earnings – compared with accounting for about 4.4 percent of the market’s value at that time. In the last quarter of 2012 the stock was 6.3 percent of the market’s earnings and was less than 4 percent of its market value.

Of course you wouldn’t expect that to be the case now – the second and third quarters are the relative dead period when it comes to Apple, given people are generally waiting for the next round of Apple innovations at the end of the year, be it a new phone or what-have-you.

This time through won’t be all that different – with the only real issue being just how solid the growth is for the quarter and whether the stock begins one of its patented run-up-to-the-new-phone rallies that we’ve seen in past years that lasts through the end of the calendar year. Notably, Samsung’s Galaxy S5 came out and face-planted, and that’s either the result of just being a lousy product or competition from China, so it’ll be interesting to see whether upstarts out of China are starting to take share from everybody, or if the Samsung problems auger in general for better things for Apple, as tech editor Eddie Chan points out.

In the last five years, the period beginning July 1 has been the most fruitful for holders of Apple shares, with an average price gain of about 22.5 percent, compared with the relatively unexciting 11 percent gains seen in the first half of the last five years (for Apple, that is, for many companies, 11 percent is fantastic).

The stock has been basically flat since the beginning of this month, but it’s early in the “best six months” period for the iPad giant, so we’ll see where it goes from here. Starmine still puts the stock as undervalued, saying it should trade around $104 a share rather than the $94 where it stands now. The forward P/E ratio of about 13.7 is far short of its 10-year historic mean of about 20.7, and the stock’s price has traded around or below its book value for most of the last four years now. We’ll be looking a bit more as well at the idea that there are fund managers that are shunning shares in a way that they hadn’t in the past – not seeing the kind of value that they feel has been offered in other years, perhaps in part as the expected growth rate for the company slows with all of the additional competition.

MORNING BID – Hewlett-Packard and the declining sales

May 23, 2014 12:58 UTC

Shares of Hewlett-Packard fell late in Thursday’s session after the company inadvertently released results just before the closing bell, but the year hasn’t been so bad for HPQ at least where its stock is concerned – shares are up about 13.6 percent so far in 2014, part of solid performance by a group of stocks Goldman Sachs identifies as “weak balance sheet” companies, the kind of phenomena that occurs when the economy seems to be in recovery and financial conditions are favorable, which they are right now – low rates, high levels of borrowing, reduced covenants in loans and further appetite for risk.

That may change as financial conditions tighten -if Treasury rates start to rise, for instance, or if banks throttle back on lending – but at least HPQ has something going for it right now. The company is cutting 16,000 jobs as it tries to revive its moribund profit margins and reverse what is now 11 straight quarters of sales declines. Companies with weak balance sheets in Goldman’s screen such as HPQ, Time Warner, Norfolk Southern and Delta Airlines generally post lower per-share earnings growth and weak sales growth – often companies in more mature industries or that find themselves left behind one way or another.

So why do those names do well at times like this? Because companies with stronger balance sheets have the ability to adjust more in weaker periods – companies like Salesforce managed to weather the 2008-2009 downturn in a way that tech names during the 2000 bubble did not, because they didn’t have a sustained way to bring in sales the way the cloud software name does.

Improving growth also helps the weaker balance sheet companies like HPQ – though financial conditions, if they tighten, will make the company’s ability to improve margins that much harder. With these job cuts it brings the total job cuts to about 50,000, and as RBC analyst Amit Daryanani said, “you do worry if there’s a finality to this process, or if it’s an ongoing thing that may affect morale at the end of the day. So far the trend has been worrisome.”

MORNING BID – There’s A Sale at Penney’s!

May 14, 2014 12:51 UTC

We come not to bury J.C. Penney, because everyone else has done that a few times over already.

Headed into the last gasps of earnings season, overall earnings growth for the quarter is currently 5.5 percent – much better than the 2 percent expected at the outset of reporting season and trending back in the direction of what had been expected Jan. 1 before, well, before anybody knew anything at all.

Any chance the S&P 500 has to see earnings jump above 6 percent growth depends largely on consumer stocks; there’s Lowe’s, Home Depot, Wal-Mart and a few others that, if estimates turn out better than expected, will result in bottom-line growth coming out better than expected. That would be a welcome development even though overall revenue growth seems to be hovering around 3 percent for the S&P 500.

The question is whether those earnings reports would be enough to realize some kind of shift back to the more growth-oriented names, as consumer discretionary shares have been relative underperformers of late, along with other growth brethren like the small-caps. The latter has been a severe point of weakness in the last few months as well, giving rise to concerns that it will pull the market lower with it.

On to J.C. Penney, then, current title holder of the overused phrase “struggling retailer,” having inherited it from Circuit City and Linens ‘N Things.

Options activity hasn’t been as negative as in the past, with Schaeffer’s Investment Research’s open interest indicator showing 1.37 puts to calls, which ranks higher than 58 percent of readings in the past year, but well off the high of 2.49 reached in the summer of last year.

That kind of thing changes rapidly with the likes of JC Penney, though, given that it’s still a company with very high short interest – about 30 percent of the outstanding float, which puts it in the lowest percentile among both retailers and the overall U.S., according to StarMine data.

This of course also puts it at great risk for a short squeeze should it surprise on its numbers in one way or another, which could happen, one supposes; stocks like this are often very volatile because there’s no telling what they’re going to come out with, making a calculation of their real value very difficult.

It’s a $9 stock right now, which assumes a certain level of liquidation value (it has a price-to-forward cash flow estimate of 44.2, which basically just says when it comes to cash flow, they’re a little shaky, as in, they ain’t got any).

MORNING BID – Stability, earnings, and Russia

Apr 25, 2014 12:43 UTC

The S&P 500 heads into the last session of the week less than 1 percent from an all-time closing high, corporate credit spreads have generally continued to shrink or at least stay stable, and overall investors remain enamored of riskier assets even though the momentum crowd has had its head handed to it for the better part of two months now.

Volatility is low overall, and while earnings estimates are coming down for the second quarter, they’re doing so at a pretty slow pace – with the second quarter expected to come in at 8.1 percent from 8.4 percent estimated on April 1. That’s pretty tolerable, though of course we’ve still got more than half of the earnings season left to get through.

There’s a lot of concern right now around the global growth outlook, though earnings from the likes of United Technology, General Motors and a few others have assuaged concerns about China’s lackluster demand – it hasn’t hit corporate profits all that much, at least.

The market’s signals are rather healthy right now, with Credit Suisse noting recent rebounds in global emerging markets and strength in other “cyclical” trades such as higher prices for iron ore and industrial metals and the improved performance overall in value stocks as well. Energy and health care names have been strong of late. Old technology giants like Microsoft run on and on, and it’s notable that investors took the early rally in the momentum stocks on Thursday as a chance to sell those names into the ground while Apple managed its best one-day percentage gain in about two years.

If there are places to be worried, well, revenue beats haven’t been all that special. Just 55 percent of companies surpassed revenue expectations, short of the historic average around 61 percent, though just a few extra beats would move that needle a bit. While growth of 2.9 percent in earnings for the quarter isn’t all that special (and it was much worse before Apple’s beat on results) there’s again still hope going forward.

And then of course there’s Russia. Standard & Poor’s cut its rating on the country to BBB- with a negative outlook that triggered a rate hike from the central bank and has increased pressure on Russian bonds and the ruble. Russia remains the ultimate wildcard right now. Sure, its exposure to the United States mostly amounts to raw materials and a chunk of Pepsico’s income, but hiccups certainly may be a reason to back away from speculative excess.

MORNING BID – Microsoft, up from the ashes

Apr 24, 2014 13:22 UTC

Microsoft heads into tonight’s earnings report coming in on a high, having recently breached the $40 threshold for the first time in forever (it’s all Frozen references this week, folks). The company pushed past $40 a share in early April for the first time in nearly 14 years, and spent most of that time ensconced in a tight range between about $22 and $35 a share, depending on what the overall market was doing. It tanked in 2008 with everything else, and then spent the 2010-2012 period putting together a cumulative 13 percent price loss in the midst of a raging bull market, if evidence of its sad-sack status couldn’t be more apparent.

This year, though, the company’s been the beneficiary (along with the other “horsemen,” Cisco, Intel and Oracle) of a shift away from overvalued momentum-driven stocks towards cyclical technology stories. These are the types of companies that produce steady revenues even if they’re not doing anything but collecting on consistent upgrades of stuff that everybody needs and doesn’t really like. And really, the company had a stranglehold over PC operating systems that it defended aggressively, let’s not kid ourselves.

For what seems like the better part of a decade, the company has also been talking about how it plans on getting ahead for the next technological leap happening around it. Personal computer sales are bound to be slack, because people aren’t buying those and they’re now buying tablets. But hope springs: CEO Satya Nadella plans on taking analyst questions on the conference call, which isn’t the usual thing for Microsoft.

Sometimes changes in strategic direction mean something for real, and even though analysts at times are overly obsequious and eager to please their corporate overlords (“Congrats on the quarter, guys”), they’re still the voice of someone outside the company and therefore aren’t as likely to be blowing smoke. The company’s planning on focusing more on mobile apps and cloud computing in coming years – probably the right choice, given the trend in computer technology at the moment – but the question is whether they can truly capitalize or not.

News from March showed the firm plans on debuting an Office version for the iPad. That put a charge into the stock and would be something of a game-changer; the stock is now the fourth-best in the Dow this year, up 6.8 percent. Starmine’s earnings quality score has been pretty darned high for the company for three years running.

Free cash flow is generally increasing, it’s been paying more and more dividends every year, and they even think the company’s being underestimated by the market, with the $40 or so price assuming a 4.4 percent annual growth rate over the next decade, whereas Starmine sees growth at 6.6 percent, in line with the five-year historical average – which should make it worth nearly $48 a share.

Again, though, that implies an avenue for growth. The Windows division isn’t it. This mega-division posted between $18.68 billion and $18.84 billion in revenue every year for four years running, falling from 30 percent of overall revenue to 24 percent (and that’ll keep shrinking). Again, something to be said for consistency here (for you dividend folk), but that isn’t “growth.” (It’s not “shrinking,” either, so there’s that, too.) Business solutions carries about 1/3 of revenue – and that’s been steady. But the gains may be more likely in the server/tools division, or entertainment/devices for any real traction to be gained. So look to the cloud, Microsoft.

MORNING BID – Volatility, or lack thereof

Apr 23, 2014 13:06 UTC

It was another disappointing night for those looking for heavy volatility out of those reporting earnings – the trio of biotech stocks many were looking at, Gilead, Illumina and Amgen, had varying results, but they didn’t show the kind of bounce that some people were expecting.

In after-hours action Illumina was moving around 7 percent, short of the 11 to 12 percent move the options market was looking for, and Gilead was up around 3 to 4 percent, less than the six percent gain that the options market had factored in. Following the disappointment among those betting on volatility post Netflix-earnings — and the stock still moved a lot, just nowhere near as much as expected — it raises questions about whether some investors might start to temper expectations when it comes to overall volatility, because putting down money on a big swing has been a bit of a loser so far.

The earnings season is young, of course, so there’s still time and lots of momentum stocks out there that can surprise on the upside or downside, so there’s lots to come. The most notable, of course, is Apple, due out after Wednesday’s close. Some positive analyst revision activity of late suggests that the company’s results could surprise on the upside, even if this quarter is generally a transition one for the most valuable U.S. company because it’s a time when it is gearing up for new products later in the year.
What will be notable to watch are the parade of results that lean on the snow as a crutch for an overall poor performance.

Embattled retailer bebe showed some of that with their warning on Tuesday. While weather may have had something to do with it, it’s more notable that the retailer has posted losses for six straight quarters and their EBIT margins are of course negative when lots of their peers are still doing relatively well – be it Ann Taylor, the Body Shop, L Group, or what-have-you.

The myopic expectation that companies will get away with saying the snow is the cause of all their problems is on a par with Olaf, the snowman from Frozen, and his optimistic expectations for what life would be like for a snowman in summer. (Let it go, folks. Let it go.)

Meanwhile, several sectors including industrials and transports are hitting all-time highs again. It appears to be only a matter of time before the S&P 500 rebounds to its all-time high and puts it in striking distance of moving past 1900, a sign of health in the economy even as there are concerns about China’s growth percolating within the likes of IBM’s report and next week’s US GDP figure isn’t going to come in all that great either.

Where’s the juice coming from? As Reuters correspondent Caroline Humer pointed out in a story overnight, for health care names it’s from M&A activity that culminated in the Valeant bid for Allergan, one that Mike O’Rourke of JonesTrading compared unfavorably to the MCI/WorldCom deal all those years ago that represented the apex (and the nadir, really) of the telecom M&A boom of the late 1990s.

Big-cap pharma has been left behind a bit when compared with biotech – the biotech names are up about 125 percent in the last two-plus years even with the recent selloff, while the pharma giants have gained about 55 percent. The thing is, the latter gain is still pretty solid, so there’s that.

MORNING BID – Biotech swings into earnings

Apr 22, 2014 12:48 UTC

Earnings get a bit less boring with a slew of biotechnology and medical device names out Tuesday, most of them after the closing bell.

Among those that will be most watched are Gilead Sciences, sort of the linchpin of this whole selloff the market’s been dealing with in the last several weeks, Illumina, one of the market’s biggest high-flyers in the last couple of years, and Amgen, which compared with these biotechnology names might as well be a telephone company in terms of volatility and overall sex appeal.

The declines in Gilead and other biotech names have been striking, as the stocks have underperformed the S&P 500 by double-digit levels since the full-scale run out of these names began late in February. Unfortunately the options market suggests the action after the closing bell (or even through the end of the week) might be a bit underwhelming. Ryan Detrick of Schaeffer’s Investment Research notes that the amount of bullish call buying compared with put-buying (bearish bets) in both Amgen and Gilead ranks at about the 55th percentile over the past year.

For Gilead, that means over the last 10 days we’ve seen about 218 call options written for every 100 put options, a healthy but unspectacular bit of action that points to generally bullish tidings. It’s certainly not something that suggests worry among investors after Gilead has been one of the market’s duds since late February, and especially since mid-March when lawmakers asked the company to justify its $90-gazillion price tag for its hepatitis C drug.

The at-the-money straddles (buying a call and put option at the strike price closest to the current price) suggest a move of about 5 to 6 percent by the end of the week, which also isn’t that exciting (this is biotech we’re talking about).

The more interesting action looks like it’s coming out of Illumina Pharmaceuticals, which has been basically hammered since it started to sell off with the rest of the momentum names in February – so much so that Goldman Sachs says their underperformance compared with the S&P 500 is enough to warrant a look as they might end up exceeding estimates. That would certainly put a spring in the stock’s step.

Parsing out what the options are saying here is a bit more difficult; Illumina doesn’t have any weekly options, so you’ve got to judge by the monthly contracts that expire in mid-May. Those are real bearish – Schaeffer’s shows a 10-day put-to-call ratio that’s more bearish than 98 percent of readings over the last year, so people clearly aren’t enamored of the selloff in this name and are protecting themselves against more hell to pay in this one.

The mid-May straddles suggest a move of 13 percent by the middle of next month, so that’s not all that reliable a guide for what’s going to happen this week, unfortunately; it just suggest more volatility.

“You can almost say Illumina is a typical biotech; Gilead is in the middle, a little more established, and then Amgen which does not really have a biotech tone to it with the option premium,” said William Lefkowitz, chief options strategist at vFinance Investments. (Amgen’s a pretty staid one in terms of options. The move expected is 3.4 percent by the end of this week, and it hasn’t been crushed the way other names have been, plus, its an $89 billion market cap company, or four times the size of Illumina).

  • # Editors & Key Contributors