Name That Trade – $SLB: Schlumber Party

by Enis June 30, 2014 12:04 pm • Commentary

Schlumberger hit a new all-time high last week on massive volume after very bullish analyst meetings where the company laid out guidance all the way to 2017 (guiding $9-$10 per share)  in a major show of confidence in its business.  Management was quite optimistic about the current analyst projections of 15-20% EPS growth, and analysts couldn’t outdo themselves in talking positively about the analyst meetings.  SLB currently has 37 buys, 3 holds, and 0 sells, and a 12 month price target of $128.

The stock’s move above the Oct. 2007 high of $114.84 happened in a flash last week, on the highest weekly volume since April 2013:

SLB weekly chart, Courtesy of Bloomberg
SLB weekly chart, Courtesy of Bloomberg

The breakout has followed a very strong run in the first half of 2014, and SLB is now up 30% year-to-date, making it the best performing mega cap stock in the S&P top 50 stocks by market cap.  

The chart looks quite impressive as long as SLB holds that breakout near $115, especially given the elevated volume last week.

On the fundamental side, I had identified HAL and SLB in a Macro Wrap as two stocks in the energy sector that looked attractive on valuation back in April, but sadly, I did not execute any trade as I waited for a better entry:

With that in mind, I took a closer look at individual stocks in the energy sector for those that looked appealing both fundamentally and technically.  First off, the two major services behemoths, SLB and HAL, have been stellar performers so far in 2014, both up more than 10%.  Moreover, their earnings growth prospects are much higher than the stalwart conglomerates like XOM, CVX, and COP.  Analysts have modeled in 5-10% sales growth and 15-25% earnings growth for both SLB and HAL over the next 3 years, which would be especially impressive considering that SLB is already a $130 billion market cap company, and HAL is around $50 billion in value.

On valuation, HAL and SLB are both trading around a 20 P/E multiple, which is quite cheap vs. the broader market if those analyst estimates come to fruition in the next few years.  HAL reported earnings this morning, and beat both earnings and sales expectations.  Business trends look solid, with a diversified order book globally, and second half strength expected in the U.S.  SLB reported a decent number on Thursday morning, though management disappointed the market a bit on its guidance.  Nonetheless, both of these stocks are on our radar for further outperformance in the months ahead.

At this juncture, the rally in HAL and SLB over the past couple of months makes the valuation argument much less appealing, though the technical argument looks stronger above the $115 breakout level.  Implied volatility has risen from a 2 year low along with the breakout, and earnings approaching in mid-July:

[caption id="attachment_42335" align="alignnone" width="600"]SLB 30 day implied volatility, Courtesy of Bloomberg SLB 30 day implied volatility, Courtesy of Bloomberg[/caption]

Given that the analyst meetings last week likely took out some of the uncertainty surrounding July’s earnings report, we like the idea of selling July options to buy August options as a potential way to play for a breakout or failed breakout in the next 6 weeks, while reducing the cost by selling the Jul19th options that capture an earnings event that could be less impactful than usual.

With that in mind, this trade looks interesting, though we haven’t pulled the trigger yet:

Hypothetical Trade:  Buy the SLB ($117.40) Jul19th / Aug16th 115/120 Strangle Swap for $2.00

-Sell 1 Jul19th 115 put at 1.30

-Sell 1 Jul19th 120 call at 1.20

-Buy 1 Aug16th 115 put for 2.30

-Buy 1 Aug16th 120 call for 2.20

Break-even on Jul19th expiration:

This trade is essentially long a Jul19th/Aug16th 115 put calendar AND long a Jul19th/Aug16th 120 call calendar, so the best case scenario is for SLB to close on Jul expiration close to either 115 or 120 (and better if above 115 and below 120).  At that point, we’d be long the Aug 115/120 strangle for $2.00

Rationale:  This trade structure anticipates a continued breakout or breakdown in SLB, but only after the mid-July earnings event.  We might look to initiate this type of position closer to the earnings report.