Bucyrus: Significantly Undervalued

Bucyrus (BUCY) serves the surface and underground mining industries through design and manufacture of draglines, electric shovels, rotary blasthole drills and underground coal mining systems. It also supplies replacement parts and service worldwide.

When the commodities boom was in effect, these shares were among the 'market darlings' with BUCY shares running up to $79.50 this past June. While hard asset prices (and the shares) have fallen back since then, the company's sales and earnings continue to hit record high levels. Since its IPO in mid-2004, growth has been spectacular.

At Monday's close of $19, these shares now trade at just 6.13x actual trailing earnings of $3.10/share and under 5x consensus estimates of $3.85 – 3.97 for 2009. Here are the per share numbers as reported by Value Line since they came public in July 2004. Data for 2008 includes estimates for Q4 (ending this month).

Year …… Sales ….. C/F ….. EPS …... Div …... B/V …... Avg. P/E

2004 …… 7.53 …... 0.42 …. 0.23 ….. 0.02 …. 2.77 …… 47.1x

2005 …… 9.31 …. . 1.10 …. 0.86 ….. 0.08 …. 3.58 …… 15.9x

2006 …… 11.69 …. 1.36 …. 1.12 ….. 0.10 …. 4.69 …… 20.7x

2007 …… 21.50 …. 2.57 …. 1.93 ….. 0.10 ….10.80 …... 17.5x

2008 …… 32.80 …. 3.95 …. 3.15 ….. 0.10 ….13.35 …... 13.1x

The balance sheet looks good with total interest coverage of 9.3x and almost no debt maturing in the next five years. The dividend payout ratio is only 3% leaving plenty of free cash flow for both cap ex and future expansion.

There have been three open market purchases of BUCY shares in recent months versus no insider sales. On September 12 – 550 shares @ $49.90, October 28 – 10,000 shares @ $18.60 and November 19 – 400 shares @ $19.72.

Even eight times expected 2009 earnings of $3.85 would brings these shares back to $30.80 or plus 62% from the current quote.

Is that a reasonable target price? BUCY shares hit peak prices of $30.40, $52.20 and $79.50 in 2006-2007-2008 when fundamentals were much less favorable than they are now.

For those of you comfortable with options, here is an option combination that makes sense to me:

………………………………….……...... Cash Outflow ……….. Cash Inflow

Buy 1000 BUCY @ $19 ……….……….... $19,000

Sell 10 Jan. 2010 $20 calls @ $6.70 …………………….……… $6,700

Sell 10 Jan. 2010 $20 puts @ $7.60 ……………………….……. $7,600

Net Out-of-Pocket Cash ………………….. $4,700

If BUCY shares are above $20 [+ 5.3% from today's price] on expiration date (Jan. 15, 2009):

• Your $20 puts will expire worthless [a good thing for you- the seller].
• You will own no shares and have no further option obligations.

• Your $20 calls will be exercised.
• You will deliver your 1000 shares and collect $20,000.
• You will hold $20,000 for your original cash outlay of $4,700.

If Bucyrus shares are below $20 on expiration date, your puts would be exercised and you will be forced to buy an additional 1000 shares for a net cost of the $20 strike price less the $7.60 'put' premium = $12.40/share.

What's your break-even point on the whole transaction?

On the shares you bought to start, it's the original price of $19 less the $6.70 'call' premium = $12.30/share. On the second 1000 shares it the previously noted $12.40/share. You average net cost basis is thus $12.35/share or 35% below the price on the day you started this whole transaction.

Summary: A 5.3% (or greater) share price increase over the next 13 months would allow for the maximum profit on this combination. Even a 35% share price decline would not result in a loss.

Disclosure: Author is long Bucyrus shares and short Bucyrus options.

Comments

[claudio.lan...:]

I have put Paul on my alert list for his articles. I must say everytime I read a new post he makes good common sense on taking a position and the trade. Thank you for you posts and sharing your knowledge.

2008 Dec 17 09:40 AM

[SJD:]

Paul's option plays could get capped on a run up, but the rates of return and the fact that at some point volatility will go down (which favors option writers) are compelling.

2008 Dec 17 10:31 AM

[Glen Bradford:]

Paul, you're stock choice here in BUCY is great. Why are you capping your gains and minimizing your downside? Look, I'm going to be honest, I read your articles and also have you in my favorites. I would like for you to shoot me an email or contact me so we could discuss the stocks your interested in and have you look through mine.

My only complaint with your strategy is that you find great companies at a great price and limit your upside. Meanwhile... you should be advocating things like: Only buying calls, Only buying the stock, Buying the stock and the calls, or buying the stock on margin.

When you find great companies at huge price discounts, like BUCY trading down 50% YOY and it's backlog increasing and PE of 7 and it should be 20 because of Global Demand for their stuff.

Come On! Break out the Bull talk.

I'll tell you what, BUCY is one of my favorite stocks at these prices. I guarantee 1 year from now, buying this stock right now at $21.84 will outperform your strategy.

Here's an article that is worth your time.

www.gurufocus.com/news...

You can find my contact information on my website.

2008 Dec 17 12:42 PM

[Paul Price:]

Glen,

I agree that BUCY has very big upside and it might be better to wait in writing any calls until the share price is higher.

That said, when I write up a combination play here I like to show a complete trade that is actually available at the time I am posting. The cash-on-cash return in the example I gave would be a profit of $15,300 on an outlay of $4,700 - a gain of 325% (if the shares finish above $20 at expiration).

That's as good percentage-wise as a $62 share price on a straight purchase would have been with that $19 entry point.

Thanks for your comments. The format here is somewhat limiting.

2008 Dec 17 02:35 PM

[Glen Bradford:]

Paul,

Thanks for the write back. As it stands, I don't own the BUCY calls. They're too expensive for my taste. Sorry about coming off so negative --- but I've learned that to get the initial hook you sometimes have to come off strong.

Did you read that article I listed?

I think your strategy is really good actually. Capitalizing on the expected volatility. This is huge returns that are pretty much in the bag. And honestly one of the best article I've read as far as a good idea in ... say... 10 months.

2008 Dec 17 06:29 PM

[Peter D:]

Paul,

Thanks for the very good article. I think you've forgot to include the margin requirement for the naked PUT sold. It could be up to 20% of the underlying price, plus the value of the naked PUT, i.e. typical margin requirement of 20% of $19 (stock price) plus $7.6 is about $11.4. So the cash outlay is $19,000 - $6,700 = 12,300 for the Covered Call, and $3,800 in margin for the naked PUT. The account would be credited $7,600 from the naked PUT, plus an additional $3,800 is hold as collateral. So the net cash outlay is $12,300 + $3,800 = $16,100. We can make a maximum of $14,300 from the call and put sold, which is 89%. In fact, the margin requirement for the stock is usually 33%-50%, so the profit can be higher.

One of the risk is that the naked PUT margin requirement increases as the price does down, so we might need more margin to cover this combination.

2008 Dec 19 09:07 PM

[Paul Price:]

I didn't forget the margin requirement on the naked puts. That can be met simply by having other paid-up equity positions (or even t-bills) in the same account.

I simply stated the cash-on-cash return if the puts go unexercised over the full course of the transaction period. In that case there will never be any further cash actually deployed.

Figuring ROI on short options is never an exact calculation as you can't predict in advance whether calls or puts will be exercised or when that might happen. After the transaction is complete you can get a better feel for the annualized return.

Not knowing in advance what the ROI will be is neither good, nor bad, by itself. You just have to like the prospects for the trade based on your projected price for the shares and let things play out.

2008 Dec 21 09:41 AM

[Peter D:]

Paul,

Your answer left me speechless. Your cash-on-cash return calculation is incorrect, even if we have other paid up equity positions in the account. The risk is that people could get into the Margin Call using these trades with the naked short PUT.

For example, if BUCY drops to $5 in the next two months, then the Jan 2010 $20 PUT would be worth approximately $17 ($15 intrinsic and at least $2 extrinsic). The margin requirement is suddenly $17 plus 20% of stock price of $5 = $18. We got $7.6 credit when sold the naked PUT, and now needs the extra $10.4 in the account as margin/collateral. If we don't have the extra cash, we'll get a Margin Call. Even if BUCY bounce back to over $20, the Margin Call can hurt and force people to sell at a low.

I strongly suggest you to modify all your calculation on naked PUT for other stock recommendations to accommodate the margin requirement of the PUT. Imagine if a person acted on all your Covered Call and naked PUT strategies, they can easily get a margin call when the market drops 5-10% from here. That is dangerous and we should at least warn people on the risk.

2008 Dec 21 05:39 PM

[Paul Price:]

Peter,

I never said there was no further MARGIN REQUIREMENT for the puts. Just that anyone with a decent size margin type account could use the paid-up equity to write against, rather than needing cash in the account per se.

If you have a $50 M or $100M or $1 MM dollar equity value account without current margin debt then you have plenty of put writing capacity that does not require more cash unless the puts are exercised. Even the you would have the choice of going "on margin" if you were willing to hold the shares via that route.

My cash-on-cash returns are exaxctly accurate if the combination works out where the puts go unexercised as clearfly noted in the theoretical "what if" scenarios.

I have also noted the obligation to buy a second equal share position if the stock is below the puts' exercise price.

Options use should only be done by those who understand how they work and how option margin requirements are calculated.

It is imposssible to figure ROI or ROE in advance as it is never predictable whether a particular put or call will be exercisable in the future.

That doesn't make it a bad strategy. You can't predict the ROI on a straight stock purchase until you know at what price you will finally sell it.

All my cash-on-cash projections are clearly the "Best Case" scenarios.

I always put in the "break-even" point on the whole trade to indicate the price at which the investor placing the trade would start to lose money.

In the BUCY example (above) the shares could drop up to 35% from their starting price before a loss would occur.

If you are not a believer that BUCY shares will hold at that level or above you should not do this trade.

2008 Dec 25 06:30 AM