Jacobs Engineering Group (NYSE:JEC) provides engineering, procurement, construction, and maintenance services to a wide range of customers, including oil and gas, chemical, pharmaceutical companies as well as for U.S. federal government agencies. Most work takes place in the USA, U.K. and Ireland.
Jacobs has had an enviable long-term record of increasing sales, earnings and book value. It has done this all with internally generated funds. As of June 30th, the company held $1.059 billion in cash against less than $48 million in total debt.
Here are its per share (split adjusted) numbers as reported by Value Line:
FY (end Sep.)
Zacks sees FY 2009 and FY 2010 EPS at $3.26 and $2.98, respectively. That takes into account both the slow economy as well as the less than robust market conditions in the oil and gas industry. That puts the trailing multiple at about 13.7x and the forward year’s P/E at less than 15x. Compare those with the historical P/E valuations in the prior 7 years from the chart above. A return to about 17 times what should be cyclically low FY 2010 earnings would bring these shares back to over $50 again.
Value Line projects EPS of $4.60 over the next 3 - 5 years, and Morningstar has assigned a current ‘fair value’ of $53 /share. Standard and Poors assigns JEC its highest (5-Star) rating and carries a 12-month price target of $57 /share. Value Line also notes that Jacobs Engineering has 90th percentile rankings in both ‘price growth persistence’ and ‘earnings predictability’ (with 100th being best).
How can you best play a high-quality stock like Jacobs when you feel the year-ahead earnings will be lower? Consider buying the shares and selling LEAP options for 2012.
Why so long? By then earnings should be picking up with the broader economy. If you leave both the shares and the options alone through their early 2012 expiration (if things go as expected) you will get tax deferment on the gains until you file your tax-year 2012 Schedule D in April 2013.
Jacobs has a fairly high (1.45) Beta making options premiums quite attractive for sellers. Here’s a play that looks quite good to me right now:
Buy 1000 JEC @$44.60 /share
Sell 10 Jan. 2012 $50 calls @$10.30 /sh.
Sell 10 Jan. 2012 $50 puts @$14.30/sh.
Net Cash Out-of-Pocket
If Jacobs Engineering rises to at least $50 (+12.1%) by the Jan. 2012 expiration date:
- The $50 calls will be exercised.
- You will sell your shares for $50,000.
- The $50 puts will expire worthless.
- You will have no further option obligations.
- You will end up with no shares and $50,000 cash.
That would be a best-case scenario gain of $30,000/$50,000, or 150% profit
on shares that only needed to rise by 12.1% over the 27-month term of this trade.
That’s a very nice annualized return.
What’s the risk?
If JEC fails to rise to $50 by expiration date in Jan. 2012:
- The $50 calls will expire worthless.
- The $50 puts will be exercised.
- You will be forced to buy another 1000 JEC shares.
- You will need to lay out an additional $50,000 in cash.
- You will end up with 2000 shares of JEC.
What’s the break-even point on the whole trade?
On the original 1000 shares, it’s their $44.60 /share purchase price less the $10.30 /share call premium = $34.30 /share.
On the ‘put’ shares it’s the $50 strike price less the $14.30 /share put premium = $35.70 /share.
You average cost would be $35.00 /share.
JEC could drop by as much as $9.60 /share or (-21.5%) without causing a loss on this trade. While it’s not impossible that Jacobs could be that low it seems unlikely. The absolute lows in calendar 2006 and 2007 were $33.60 and $38.30, respectively, on EPS of $1.64 and $2.35. Book Value has increased about 80% since 2006 and EPS by almost 99%.
Disclosure: Author is long JEC shares and short JEC options.