Yesterday CSCO announced a well telegraphed and a well needed plan to restructure the company in effort to better “streamline operations”… or whatever. It’s all a bunch of mumbo jumbo in my opinion, and any organizational changes will take quarters to really affect the bottom line, unless they announce some mass layoffs, and soon.
-The news of restructuring doesn’t change the fact that the company’s core router and switching business that represents about 1/2 their sales and almost three quarters of their operating income is facing massive pricing pressures and market share declines. So any effort by the company to maintain market share comes at the cost of gross margins and thus earnings……..they are in a battle to avoid the likely result of finding their core business in commoditized hell while desperately searching for growth.
-The analyst community generally took the news as neutral to positive but most agree that it is necessary for a new operational plan and now view as a show me story. Street is fairly mixed on the name with 23 buys, 22 holds and 2 sells.
EVENT: FY Q3’11 earnings report May 11th (after the close)
-the options market is currently implying about a 6% move vs the 8 qtr avg move of ~6.5% and the average over the last 4 qtrs of ~11%.
MY VIEW
After reading through the company’s press release regarding the restructuring, and Wall Street’s read through I see little to get excited about in the near term.
-While expectations are very low heading into the April qtr, many see the July qtr consensus estimates as overly optimistic and likely to cause the company to again lower the out qtr guidance.
-Big question in my mind is whether or not management will just “kitchen sink” the balance of the year and possibly take down longer term growth targets in an effort to establish a series of beats to co-inside with their expected restructuring milestones in the quarters to come??? If they do this you could see one more flush lower to the ~$14-15.00 area which marks the lows from early 2009 and levels not see before that since 2002.
-I think it is a hard short to press at this time especially when you consider managements new found focus on righting the ship……The risk reward at these levels is probably down $2.5 to up $5-7 if business environment turns around along side operating improvements.
A FEW WAYS TO PLAY FROM THE LONG SIDE:
As we noted last Friday in a post titled ” CSCO Catch Up Play: Potentially Add 6.5% Yield By June Expiration For Next To Nothing” there are ways to add yield to an existing long with out adding risk, See below:
3rd TRADE EXAMPLE AGAINST A LONG POSITION:
-Long CSCO at 17.48
-Buy 1 June 19 call for .24 and
-Sell 2 of the June 20 calls for a total of .22 (.11 each)
(In this example the CSCO JUN 1×2 Call Spread costs you .02)
Break-Evens on June Expiration:
Downside: If the stock is below 17.48 you suffer loses as you would if you were just long the stock, plus the loss of the .02 in premium that you paid for the call spread.
Upside:-Between 17.50 and 20 you make the gains of your long stock
Between 19 and 20 you can make up to .98 plus the gains in your stock.
-Best case scenario the stock closes at 20 (up ~14% ) and you would make 2.52 in your stock and .98 in the call spread (or nearly an extra 5.5% yield from the options overlay).
-Stock above 20 on June expiration your long stock is called away up 14% and your call spread expires worth .98, so you have effectively made ~20%.
TRADE RATIONALE: If you are long and not going to sell, but think the stock could have a relief rally if the company was able to beat earnings estimates and maintain or even raise next quarter guidance, it may make sense to consider a strategy like this to help add some yield to your long, with only adding a small premium outlay, which happens to be the only added risk.
There is always the risk that the stock rips and you have essentially given it away at 20. But you would be selling your long at 20.98 (up ~21%) on June expiration (consider that you are long at 17.48 and you wrote one June 20 call against your long position and then you own a June 19/20 call spread that you can make maximum of .98. So effectively you have made 2.52 on your overwrite that is called away and then .98 on your call spread.)
In my opinion, the likelihood of a rally much above 20.98 by June expiration is not great