As we get close to launching a new version of RiskReversal in the coming weeks, we wanted to preview some new content you’ll be seeing from, Mike Khouw, who you know as my co-panelist on CNBC’s Options Action and his partner Mark Guthner. Mike and Mark have generously offered to contribute some of their informative, in-depth and exclusive trade ideas in single stocks and etf, both from a fundamental, technical and mathematical standpoint. They do great work and we look forward to their contributions to RiskReversal. Mike and Mark are also the co-authors of The Options Edge (available on Amazon) which is a great read. – Dan
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Intel Corporation (INTC) is one of the most, if not the most, important hardware companies in the digital world. It is best known for its microprocessors, which became famous with the “Intel Inside” commercials. These are the brains found in computers, servers and personal devices like tablets and smart phones. The company also designs and manufactures server mother boards, PC chipsets, which send data between the microprocessor and input, display, and storage devices, such as keyboards, mouse, monitors, memory chips, hard drives, etc. They also compete in the communication and connectivity segments, offering baseband processors, and radio frequency transceivers. It goes without saying that without INTEL the digital world would not be what it is today.
Many investors have lost their enthusiasm for Intel. Their biggest moneymaker has been microprocessors designed to drive PCs, laptops and servers. These end markets stopped growing a few years ago and the desktop computer market has been shrinking at the margin. This is a big driver of pessimism or at least lack of enthusiasm for the company’s shares. To those paying attention however, INTEL continues to innovate. To help shrink the consumer products that are becoming a part of our everyday lives, they offer system-on-chip products that integrate its central processing units with other system components onto a single chip. They have also developed power management integrated circuits for these electronic devices as well
The trading dynamics of the stock are quite interesting. On a long-term basis, the share price is moving higher at a steady pace in a defined channel. On a shorter time scale, the share price has trended sideways bumping against near term resistance at the $38. Unlike many stocks since the election, INTC has pulled back, giving us a chance to “buy the dip.” On a short-term basis, the share price found support at the 40 week (200 day) moving average. The MACD is signaling that positive momentum is building and the RSI tells us the shares are neither over bought nor oversold. This suggests the bullish near term price trend is intact. Put this together and the technical picture suggests it is just a matter of time before the shares move to all time new highs.
Valuation is supportive of the bullish case. The company’s shares trade at a PE multiple of about 17.5 times the last 12 months earnings, a 25% discount to the median stock in the S&P500. The forward PE, based on analysts’ expectations of earnings over the next 12 months earnings is about 13. In addition, EV/EBITDA is a modest 8.0 and the company generates a 17% return on book capital. The one issue holding the share price back is top line growth. Revenues did not grow in 2015 and earnings were flat as well. Our expectation going forward is that revenue and earnings will grow at about 5% for calendar year 2016, and at the nominal rate of GDP of 3% to 5% in 2017 assuming it accelerates.
Make no mistake, investors assign a below market PE multiple to INTC as computer sales are slowly falling as some consumers move from desk tops or laptops to tablets or other portable devices. These products need microprocessors, communication devices and chips sets as well. Intel is a continuous innovator and we believe they will continue to compete successfully. The company generates about $8 to $10 billion in free cash flow after CapEx. This allows them to pay an attractive dividend and buy back a few billion dollars in stock every year, providing some support to the share price.
Ultimately we suspect any surprises will be to the upside. And for those buying the shares here at $36.27. A stop at the lower trend line or about $30 for long term investors makes sense, and a break of the 40 week moving average (currently around $34) for short-term traders.
But as an alternative to taking a position in the stock, one can use options, with a risk-reversal as a stock replacement strategy. With the stock trading at $36.27, the following does just that:
To initiate this trade, the investor will collect a nominal $49 up front per contract/risk-reversal ($.49 per share, and each contract represents 100 shares). We selected the June 2017 (regular) expiration providing ample time for our thesis to develop and capturing several upcoming catalysts including CES later this week, earnings January 26th and April 18th, the February 9th investor meeting where we believe the company will demonstrate their relevance and ability to generate copious free cash flow for the foreseeable future. The downside breakeven level (at expiration) of $34.51 is 6% below the current price. An agnostic efficient market hypothesis suggests there is a 59% chance of success on this trade, which is consistent with our view. While, we expect INTC to breakout to higher prices at any time, this structure allows us to participate in that upside, but we will not be hurt if the price of INTC shares marks time for the next few months, and reduces the immediate downside exposure in the event that the market which has clearly bought the Donald Trump rumor, begins to sell the news as inauguration day approaches.
Michael Khouw is a 20 year veteran of the financial services industry with broad experience as a strategist, analyst, portfolio manager and proprietary trader of equities, commodities and equity and index derivatives for both buy-side and sell-side firms. (follow on Twitter)
Mark W. Guthner is a veteran of the financial services industry. His skills and experience stretch across multiple disciplines including trading, portfolio and risk management, securities analysis and valuation, investment banking and financial technology as well. (follow on Twitter)