New Trade – $PG: Cresting?

by Enis October 31, 2013 2:07 pm • Commentary

Procter and Gamble is old school Americana, one the largest consumer staples companies in the world.  The stock has had a nice run in 2013, up 20%, which is quite large for a boring old staples company.

Dan mentioned PG in his Confession post yesterday.  This is a company that is expected to earn $4.04 per share in 2013, compared to $3.76 per share in 2009.  Essentially no earnings growth in the past 4 years.  The stock has appreciated due to a rising-tide-lifts-all-boats market – it is up from below $50 in 2009 to above $80 today.

The stock is valued at around 20x P/E, which is not unreasonable when you look at its 10 year P/E history:  

[caption id="attachment_32031" align="alignnone" width="499"]Trailing 12 month P/E for PG, Courtesy of Bloomberg Trailing 12 month P/E for PG, Courtesy of Bloomberg[/caption]

BUT, the stock was growing earnings 10-15% per year in the 2003-2007 period, while it has grown earnings at 0-5% in the past few years.  Projected earnings growth is at 10% over the next 2 years, but PG hasn’t grown earnings at that rate in more than 5 years.  Analysts seem a bit too optimistic in their projections.  The stock’s multiple given that pitiful growth is certainly high vs. history.

The chart shows that the bulk of PG’s move in 2013 came early in the year when it broke out above its prior all-time highs, set in 2007:

[caption id="attachment_32033" align="alignnone" width="600"]Screen Shot 2013-10-31 at 1.22.52 PM PG weekly chart, Courtesy of Bloomberg[/caption]

The $75 breakout level has acted as strong support ever since.  Looking at the daily chart, we can see that the stock has not been able to get above the $82.5 level on 4 separate occasions in the past 6 months, including earlier this week, after a minor new all-time high:

[caption id="attachment_32034" align="alignnone" width="600"]PG daily, 50 day ma in pink, 200 day ma in black, Courtesy of Bloomberg PG daily, 50 day ma in pink, 200 day ma in black, Courtesy of Bloomberg[/caption]

The $82.50 is more important than ever after this week’s rejection.  On the downside, the $78-78.50 area is where the 50 day and 200 day ma’s have converged, and the $75 is more crucial long-term support.

Given the fundamental overvaluation, and the short-term technical picture that shows the stock vulnerable to a pullback, we like this structure:

TRADE: PG ($81.30) Buy Dec 20th 82.5/77.5/72.5 Put Fly for $1.30
  • Buy 1 Dec 82.5 Put for 2.20
  • Sell 2 Dec 77.5 Puts at 0.55 each, for 1.10 total
  • Buy 1 Dec 72.5 Put for 0.20

Break-Even on Dec Expiration:

Profits: Between 73.80 and 81.20, make up to $3.70, with max profit of $3.70 at 77.50

Losses: Up to $1.30 between 72.50 and 73.80, and between 81.20 and 82.50, with max loss of $1.30 below 72.50 and above 82.50.

Trade Rationale:  If PG does retrace here after this week’s failed breakout, we’d expect a move back down to near $78, which would be close to the mid of this put fly.  That would be the spot to exit this trade.  If the retracement does not occur immediately, this put fly has the advantage that it does not decay.  It’s also a trade that should likely be exited for a small loss on a clean breakout to new highs