New Trade – DE In Headlights

by Dan May 26, 2015 11:43 am • Commentary

Friday, shares of Deere (DE) gained 4.35% after reporting fiscal Q2 sales that declined 18% year over year and eps down 30% year over year (which to be fair was much better than expected.) DE today is making a new 52 week high, despite the dollar’s strength wreaking havoc on most U.S. multinationals:

DE 1yr chart from Bloomberg
DE 1yr chart from Bloomberg

What’s interesting about the DE price action is that the stock is being rewarded despite any signs of earnings and sales headwinds abating, nor dollar strength, crop price declines or weak overseas demand.  The company is aggressively cutting costs, production and buying back stock. DE trades at 17x fiscal 2015 earnings that are expected to decline 35%, and analyst don’t expect this year to be the trough with consensus calling for a 4% decline in 2016.  

While the long term technical picture clearly looks constructive, with the 5 year chart below showing the building tension that is likely to resolve itself in a big way one way or the other. A failure here at $94 could send the stock back towards $90 for further consolidation prior to a meaningful breakout or breakdown:

[caption id="attachment_53926" align="aligncenter" width="600"]DE 5yr chart from Bloomberg DE 5yr chart from Bloomberg[/caption]

I would add one point though, the stock is up at 52 week highs despite Wall Street analysts being very lukewarm on the stock with only 4 Buy ratings, 12 Holds and 7 Sells with an average 12 month price target of $88, or 6.5% below where the stock is currently trading.

With an active share repurchase and a dividend that yields 2.55% investors probably see DE as a better bet here than competitor Caterpillar (CAT) who has 55% revenue exposure outside North America vs 35% for DE.

My sense is that for the near term a lot of good news could be in DE shares, despite what appears to be continued weak sentiment.  For the time being the best trade maybe to play for consolidation.

TRADE – Buy the DE ($94.10) June 95/91/87 put fly for 1.10

– Buy 1 June 95 put for 1.95

– Sell 2 June 91 puts at .50 (1.00 total)

– Buy 1 June 87 put for .15

Breakevens on June expiration:

-Losses of up to 1.10 above 93.90 with total loss of 1.10 above 94. Losses of up to 1.10 below 88.10 with total loss of 1.10 below 87.

-Gains of up to 2.90 between 88.10 and 93.90 with max gain of 2.90 at 91.

Rationale: Recent gaps in similar stocks have failed and consolidation has been common. This trade essentially targets a modest consolidation following the gap higher and does so with very little premium risk as the breakeven on the upside is close to where the stock is currently trading.