We have been picking on Procter & Gamble (PG) all year. We’ve done it near its all time highs in January when the stock was just shy of $90 (read here) and most recently prior to the stock’s poor Q2 results reported last week when the stock was in the low $80s (read here). The bearish thesis has been simple for us, significant exposure to dollar strength with the backdrop of weak global growth. Oh, and the stock was, and remains expensive, trading well above a market multiple despite very modest growth expectations.
Back in January investors had yet to fully weigh the potential for negative earnings revisions, but now after two consecutive misses and guide downs, the stock has declined nearly 20% from its 52 week and all time highs made in late December to yesterday’s fresh 52 week lows:
The price action in 2015 is an undeniable train-wreck, down 16.5%, especially when you consider the relative out-performance of peer Colgate (CL) which also has considerable EM and dollar exposure, but is unchanged on the year, has a far worse dividend yield (2.2% vs PG’s 3.5%) a higher earnings multiple and equally lame growth expectations:
As it relates to PG, the million question is whether or not expectations are now low enough where the company can start to meet expectations as they are in the midst of a massive restructuring and having just last week announced the appointment of a new CEO (takes over Nov. 1).
PG is approaching massive long term support at $75, a level it must hold in the near term, as there is little technical support until $70:[caption id="attachment_55921" align="aligncenter" width="600"] PG 5yr chart from Bloomberg[/caption]
As the stock has declined, in an environment where interest rates remain low, the stock’s 3.5% dividend yield looks fat! If you are of the mindset that the Fed will not raise rates in 2015, stocks like PG that have been beaten up could catch a bid as investors look for defensive yielders. Aside from macro movements that have been weighing on PG, the next identifiable catalyst will be the company’s fiscal Q1 results due in late Oct and then the new CEO transition.
Short dated options prices look fair, to possibly cheap, especially when you consider the stock’s recent under-performance, and the fact it is just above important technical support, where a break could catalyze a sharp move lower, or possibly provide the support needed to re-trace the earnings gap. With 30 day at the money implied vol at just 12.6%, risk is likely a few handles lower,but could remain low over the balance of the summer:[caption id="attachment_55922" align="aligncenter" width="600"] PG 1yr chart of 30 day at the money IV from Bloomberg[/caption]
Despite short dated options being reasonably priced, I think it makes sense to figure out how to bide some time in a low vol name that may remain range-bound until we get closer to potential catalysts.
Trade: Buy 100 shares PG for $76, Sell to Open 1 Oct 80 call at 40 cents
Break-Even on Oct Expiration:
Profits: gains of stock between 76 and 80 of up to $4, if the stock is below $80 you receive the 40 cents premium for selling the Oct 80 calls. But the stock will also trade ex-dividend 5 days after Oct expiration (66 cents a share) so between now and the ex-date you will have a $1.06 buffer to the downside, at the important support level listed below.
Losses: below $76, and I would consider selling stock and covering call on a break below that
Rationale: While options prices are not expensive, I would not expect them to rise much in the near term. The stock should find support in and around these levels, and if it does it could be a good candidate to keep selling upside calls against, while also collecting the quarterly dividend.