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To state that Pitney Bowes (PBI) has taken a beating would be the understatement of the year. It has shed over 68% of its value in the past five years and every single attempt at establishing a bottom has failed. It finally looked like it might have bottomed out when it repeatedly tested the $12.90-$13.00 ranges and managed to hold above this level for the past 6 months without breaking down. However, this level was decisively taken out the 2nd of November. One could argue that the overall weakness in the market helped propel it below this key level. This is a valid argument as many former heavy weights such as McDonald's (MCD), 3M Co (MMM), Abbott Labs (ABT), etc. have also experienced strong pullbacks. If this argument holds true, then the stock should start to trend higher once the markets have bottomed out. The market tends to generally rally toward the end of the year (Santa Claus rally) and this should help the stock trend higher.

What is rather compelling is that the short ratio continues to increase even when the stock has shed so much of its former value and is now trading in the extremely oversold ranges. Bulls and bears win sometimes, but pigs almost always get slaughtered. It looks like the bears have turned into pigs and are trying to squeeze out every single drop of profit out of this stock. The percentage short of float now stands at a 33.9%. It has risen almost two full percentage points since the 10th of October. This is a very high figure and makes this stock a perfect candidate for a short squeeze. From a contrarian perspective, this is a pretty good reason to consider opening up a long position, but there is always the chance that things may not work out as planned and that is where the bull put spread comes into play. You simultaneously sell one out of the money put and purchase one put that is farther out of the money for a net credit. The maximum gain is achieved if the price of the stock trades at or above the highest strike price. Your total risk is equivalent to the spread between the two strike prices. This would only occur if the stock closed at or below the lower strike price.

Benefits of a bull put spread

1. It limits your losses if the stock suddenly plunges. Your loss is limited to the total differences between the strike prices of your short put (the put you sold) and long put (the put you purchased).

2. The ability to profit even if the stock barely budges in price.

3. The risk is significantly lower than writing a naked put as your maximum downside is limited by the put option you purchased.

4. The capital requirements are significantly less. With a cash secured put you would need to have enough cash in your account to back the sale of the put. If you sold a put with a strike at $65, you would need to have $6500 in the account. With the bull put spread, your capital requirement is limited to the spread between the two strike prices.

5. In the event the stock declines, an investor can buy to close the short put position and continue to lock in gains from the long put as the price of the underlying stock drops.

Reasons to Consider Pitney Bowes:

  • The percentage short of float stands at 33.9%. This is a very large number, which makes it an ideal candidate for a short squeeze.
  • The technique we are going to use today strictly limits your downside but provides you with the option of locking in rather lucrative gains over a short period of time.
  • The stock is extremely oversold and could experience a nice relief rally once the general markets start to rally.
  • Despite the beating the stock has taken over the past few years, it is a true dividend champion as it has consecutively raised its dividend for over 30 years.
  • Its sports an incredibly high yield of 12.6%
  • It has a low forward P/E ratio of 6.3.
  • Institutions still have a very large stake in the company. Percentage of shares held by institutions is over 97%.
  • It has a manageable payout ratio of 51%, which means it still has plenty of room to raise its dividends in the years to come.

Technical outlook

The short trend is still down as a key level of support ($1.290-$13.00) was just recently taken out. The volume after initially spiking up has been dropping over the past few days and this could be taken as a sign that the selling pressure is easing. One positive sign would be for the stock to trade to a new low but to end the day on a positive note. If it closed today at $11.96 or better, it would achieve this as it traded down to a new low of $11.78 before moving up. Secondly, the stock needs to close above $12.00 on a weekly basis to indicate that the selling pressure has eased otherwise it could trade down to the $10.50-$11.00 ranges before bottoming out. As the short term trend is down, and the overall market is in a corrective phase, there is a pretty decent chance that the stock could test the $11.00 ranges before attempting to trend higher. We would wait for the stock to test $11.00 before putting this strategy into play.

Charts and data of value

The orange line represents the valuation growth rate line. Generally speaking, when a stock is trading below this line and in the shaded green area, it represents a good long term entry point. Pitney Bowes is trading well below this line, so based on this relationship it could make for a good long-term play. However, based on the table below, $100K invested 10 years ago would have shrunk to 58.7K. We simply multiplied the starting value of $1k with 100 to arrive at our answer. Thus based on this data, it would be prudent to take small bites as opposed to deploying a huge chunk of money into this play based on the rather tempting yield.

A look at Pitney Bowes' competition

Its gross and operating margins are much higher than the industry average of 0.34 and 0.08. Despite the challenges it's facing, it is still generating a positive levered free cash flow of $452 million and sports a decent interest coverage ratio of 3.80.

PBI

(SI)

(XRX)

Industry

Quarterly revenue growth

-0.07

0.07

-0.03

0.08

Revenue

5.06B

101.37B

22.43B

860.62M

Gross Margin

0.50

0.28

0.32

0.34

EBITDA

1.00B

12.67B

3.11B

98.58M

Operating Margin

0.15

0.09

0.08

0.08

Net Income

364.67M

6.54B

1.21B

N/A

EPS

2.95

6.53

0.90

0.04

P/E

4.05

15.45

7.10

13.51

PEG (5 yr expected)

-3.62

0.23

4.65

1.47

P/S

0.47

0.85

0.36

0.63

M= Millions B = Billions

Bull Put Spread

The April 2013, 11 put is trading in the $0.95-$1.10 ranges. If the stock pulls back to the $10.50-$11.00 ranges, these options should trade in the $1.55-$1.65 ranges. We will assume that they can be sold at $1.55 or better.

The April 2013, 9 puts are trading in the $0.30-$0.40 ranges. If the stock pulls back to the stated ranges these options should trade in the $0.55-$0.65 ranges. We will assume that these puts can be purchased at $0.65 or better.

Two other interesting plays are Duke Energy (DUK) and Southern Company (SO). These two stocks will appeal to dividend investors looking for companies that are less volatile but have solid dividend histories. They both offer good yields of 4.9% (Duke Energy) and 4.6% (Southern Company) respectively. Duke has been paying dividends since 1926, has a five dividend growth rate of 2.66%, and has a strong quarterly revenue growth rate of 73%, a healthy quarterly earnings growth rate of 25% and a decent interest coverage ratio of 3.10. Southern Company has been paying dividends since 1948, has consecutively raised its dividend for over 10 years, a five-year dividend growth rate of 4.00%, a 3 year return of 51%, a current ratio of 1.00, a good interest rate coverage of 4.5 and a quarterly earnings growth rate of 6.6%.

Transaction Details

  1. After the sale and purchase of the respective puts you will have a net credit of $90.00.
  2. Your maximum risk is $110 (the spread of $200 is subtracted from the credit of $90).
  3. Your maximum profit is $90 per spread for a possible return of 81%.
  4. Your breakeven point is $10.10

Risks associated with this strategy

The main risk is that you over leverage yourself because the capital requirements are so small. If the shares are put to your account and you have insufficient funds, you could be in a world of trouble. If the shares are put to your account, you could always turn around and sell them, provided you had the funds in place to cover the initial purchase.

The net credit you get from the trade is usually much smaller than the maximum amount of money you could lose from the trade. Thus, it would be wise to close the short option out before your position hits the maximum loss point. Professionals generally take this route when the short option is at or slightly in the money.

Conclusion

The stock is trading below key support levels ($12.90-$13.00) and the short term trend is still down. As the overall market is still in a corrective phase, there is a good chance that the stock could trade down to the $10.50-$11.00 ranges. We would wait for a test of these ranges before committing fresh money to this stock or before putting this strategy into play.

The very high short interest ratio makes this stock a very good candidate for a short squeeze. This strategy provides you with a low-risk option to lock in sizable gains without having to tie up a large amount of capital. However, we would not abuse this strategy as there is always a chance the shares could be put to your account if the stock trades below the strike price you sold the puts at. You can always turn around and sell the shares if they are assigned to your account, but you will need to have the money in place to cover the cost of buying these shares before you can sell them.

If the stock is trading at or slightly below your breakeven point, consider closing the position out or rolling the put you sold. To do this you would simply purchase the put you sold and then sell new out of the money puts. If you closed the position out, you can always write a new bull Put spread. Your breakeven point is $10.10.

Options tables sourced from yahoofinance.com. Option profit loss tables sourced from poweropt.com.

Disclaimer

It is imperative that you do your due diligence and then determine if the above strategy meets with your risk tolerance levels. The Latin maxim caveat emptor applies-let the buyer beware.

Source: Pitney Bowes: Is It Now A Compelling Play?