Chart of the Day – $CBS: The Big Hang Theory

by Enis September 24, 2014 1:03 pm • Chart of the Day• Commentary

CBS bounced at a very important technical level yesterday, as I noted in this morning’s Notable Options post:

5.  CBS – Buyer of 20k of the Mar 57.5 / 67.5 call spread for 2.47 to open.  CBS bounced right around the $55 support level of the past year yesterday, and is at a critical technical juncture.  The stock is down 13.7% year-to-date.  It has struggled ever since the long-anticipated spin-off of CBS Outdoor in March.

Today, the stock is back below $55, though you could give CBS the benefit of the doubt at the moment:

CBS daily chart, 200 day ma in yellow, courtesy of Bloomberg
CBS daily chart, 200 day ma in yellow, courtesy of Bloomberg

On a longer-term timeframe, the $54-$56 area has been important from a historical perspective.  Here is the monthly chart:

CBS monthly chart, courtesy of Bloomberg
CBS monthly chart, courtesy of Bloomberg

CBS made a high of $55.975 in mid-2000, and the breakout above that level in late 2013 has generally held until now.

Given the bullish options trade in CBS yesterday, what’s the bullish and bearish case for the stock at this technical inflection point?

In my deep dive into the fundamentals of CBS in May, I noted that CBS was one of those large cap stocks that has only been able to achieve EPS growth through financial maneuvering rather than underlying business growth:

While the entertainment divisions are well known, one of the main catalysts for the stock in 2014 was the spin-off and IPO of CBS Outdoor (ticker CBSO), which started trading publicly as a standalone company on March 28, 2014.  In January, the parent company CBS borrowed $1.6 billion against the CBS Outdoor business, and promptly used those proceeds to execute an accelerated repurchase of its own CBS shares.  In fact, a big part of the bull argument for CBS over the past 5 years has been the declining share count.  Sales have only grown 15% in that time, while EPS has gone from around 0.50 to around 3.00.

Analyst expect more of the same going forward.  Sales growth projections for 2014 and 2015 are around 1%, while EPS growth projections are 15-20%.

One concern on companies that generate EPS growth through buybacks and corporate actions rather than growing sales and improving margins is that the first method is at immediate risk if overall market sentiment turns.  But more importantly, it’s an indication that the business itself is struggling to compete effectively, or that the competitive backdrop is unfavorable.  If sentiment turns or the business runs into issues, the stock could be in for a nasty re-pricing.

CBS actually happens to be on the better end of this type of story.  The bullish case of a continued, aggressive buyback, strong free cash flow generation, and relatively cheap valuation (17x P/E vs. expected EPS growth of 10-20%) is a stronger case than can be made for most stocks with relatively flat sales vs. growing EPS over the past 5 years.

With the bullish and bearish sides laid out, I think the crux of the debate in CBS should be the overall trend in the Entertainment division.  Even as its share has declined in the past year, that segment still accounts for around 60% of total revenues at CBS.  If the segment cannot handle the increasingly competitive landscape as online media continues to encroach on traditional media’s turf, then even more buybacks are not going to keep the stock from falling.  If CBS management is able to nimbly adapt to the changes in the industry (likely with selling strong content across more platforms as key), then the buybacks will be icing on the cake.

I don’t have a strong directional bias myself, but the earnings event in early November is likely to be key for CBS given the various push/pull factors impacting the stock.  Implied volatility is still relatively low since earnings is not for another 6 weeks:

30 day implied volatility in CBS, courtesy of Bloomberg
30 day implied volatility in CBS, courtesy of Bloomberg

My hunch is that options would get much more active if CBS does handily break down below $54 in the coming weeks, as the long-term breakout would be a failure.  Regardless, the resolution of the technical cliffhanger is coming soon in CBS.