$TMUS #RealityCheck

by Dan March 14, 2016 3:23 pm • Commentary• Trade Ideas

U.S. Telecom Service providers are deemed defensive from an investment standpoint due to their utility/consumer staple status, their lack of exposure to currency swings given their reliance on U.S. consumers, and lastly their commitment to capital return. With AT&T and Verizon both very near their 52 week highs, up 25% and 35% respectively from their 52 week lows, the companies’ dividend yields are more than double that of the S&P 500 at 5% and 4.3% respectively.  Given the strength of the dollar, the uncertainty about global growth and a brutal sovereign yield environment, these two stocks have been treated like growth stocks in 2016, up 11% and 13.5% respectively.  The only problem is there is little organic growth with AT&T expected to have mid single digits (largely the result of their DTV acquisition) and VZ expected sales and earnings to be flat in 2016.  Both stocks trade about 13.5x expected 2016 eps, which is starting to look a bit hefty, especially at a time when eps growth is plateauing at a peak, and upstarts like T-Mobile (TMUS) are doing their best to kill wireless data pricing, which much like wireless and long distance calling in decades past, will be a long race the to the bottom.

TMUS had been making some healthy gains on subscriber additions as the number three wireless carrier, with the most impact at AT&T. In 2015 TMUS gained 4.5 million net post paid subscribers, and the stock reflected that momentum, with the stock rising nearly 50% in 2015.  TMUS is now off 15% from its 52 week highs made in September, and in what appears to be a well defined downtrend:

TMUS 1yr chart from Bloomberg
TMUS 1yr chart from Bloomberg

One cause for investor concern was the net add guidance given on their fiscal Q4 call on Feb 16th when the company guided 2016 to 2.4 to 3.4 million subs, at the mid point down 35% from 2015.

If you thought that the company’s Q1 results expected in late April could cause the stock to re-test the low end of the trend channel, then the following trade could be a way to make a long premium directional bet that is structured to help mitigate decay in the meantime.  

We don’t have enough conviction in the fundamental set up at the moment, so we are not trading, but we like the risk reward of this trade if we did think that the lack of subscriber gains in Q1 could lead to further pricing pressure in the industry:

TMUS ($37.20) Buy May 37/33/29 Put Fly for 90 cents
  • Buy to open 1 May 37 put for 2.10
  • Sell to open two May 33 puts at 75 cents each (1.50 total)
  • Buy to open 1 May 29 put for 30 cents

Break-Even on May Expiration:

Profits: between 36.10 and 29.90 with max gain of 3.10 at $33

Losses: of up to 90 between 29 and 29.90 & between 36.10 and 37, with max loss of 90 cents below 29 and above 37

Rationale: This fly has a long time to play out so mark to market it is unlikely to see big P&L swings in the short term. What it does do is target a move back to the lower end of the channel to play out over the next 2 months for as little premium outlay as possible.