Daniel Jones’ trade of the week is covered calls on NVLS. Here’s his reasoning… courtesy of Daniel at OptionsNotions.com
This week’s pick is a buy / write. We’re going hunting in the technology sector, and we found a company we’ve followed for quite some time that lends itself well to covered call writing. It’s a company in the chip equipment space, which can be a counter-cyclical economic play sometimes. When times are slow in the chip sector, chip makers have to gear up for the next up cycle or face a disadvantage in the technology curve. There are always advances in the reduction in widths between transistors on a chip, and with each improvement, new fabrication facilities have to be constructed, or at least the old ones have to be updated. Our options pick this week is Novellus Systems. Enjoy!
The Chart above shows the six month chart for Novellus Systems (NVLS). The stock has bottomed out around $19 a share, and has now moved back up to the $22 – $23 range. We think the Moving Average Convergence / Divergence line (MACD) is looking strong, and the Relative Strength Index (RSI) has also recovered nicely. It’s well positioned for a buy / write opportunity.
NVLS Fundamentals:
Current Price: $22.60
Shares Outstanding: 99.1 million
Market Cap: $2.2 billion
Forward Price / Earnings (avg. Est):24.3x
PEG Ratio (5 Year Expected): 5.2x
Price / Book: 1.6x
Novellus last came out with an earnings release in Mid-July 2008, at which time they really kind of missed just about every target analysts had for them. Instead of posting an earnings of 6 cents per share, the firm lost $0.12 per share, and went on to discuss a fairly tough business environment. Turns out that the memory chip makers have been impacted by a pretty significant price decline in their products, which in turn has caused them to reduce capital outlays, and plans for future capital outlays, in new technology for their chipmaking.
That impacts NVLS pretty directly, and in the ensuing few weeks we’ve also seen Applied Materials and other chip equipment makers also missing their earnings results. Interestingly enough, though, the stocks have rallied, coming off the bottoms of their respective trading ranges as analysts have at least come out and made predictions that the worst is behind us in this industry. Perhaps it’s becoming "less bearish" in a way that has led the thinking on investing in these stocks.
We are of the opinion that being less bearish is fine, but we’d also like to take some of the options premiums off the table associated with this company. There is a mid-quarter update due from NVLS on 28 August 2008 as well – we will get a look into the firm’s 3rd quarter results – which could be good or bad – but then again the options volatility components are reflecting that uncertainty.
For the third quarter, the average earnings estimate of analysts that follow NVLS is presently in the range of $0.04 per share. On an annual basis, NVLS is expected to earn around $0.33 per share this year (2008 average estimate of 20 analysts) although this number has been reduced lately from a target of $0.46 per share ninety days ago. Next year’s estimates (2009’s) have also been cut from a level of nearly $1.19 per share to a standing $0.92 average expectation now. Those are pretty serious cuts, but the company’s relative valuation to ’09 earnings seems compelling at this point.
NVLS’s balance sheet has some strength to it, with a cash pile of $428 million on hand at present. That is offset by only $154 million in long term debts. In the space of chip equipment makers, NVLS’s $2.2 billion market cap is more or less "tiny" – the big brother in the sector is Applied Materials (AMAT) which tips the scales at $24.5 billion presently. AMAT trades at similar valuation levels with NVLS, and has $2.3 billion in cash on its balance sheets, so there may be a potential for industry consolidation here. That is a little beyond the scope of this report, but it’s been highlighted here just for relative valuation appraisal purposes.
INVESTMENT RECOMMENDATION:
We recommend that investors create a covered call position by buying NVLS stock at the present $22.60 level, and writing the December 2008 $22.50 strike price call for $2.30. The maximum profitability of this trade is $2.20 per contract if NVLS is trading above $22.50 per share at December’s expiration, which would result in the shares being called away. This is a gain of just over 10% for the four-month holding period.
Current UPS Stock Price: $22.60
