Safeway, Illumina: Abnormal Options Activity Catching My Attention

Includes: ILMN, SWY
by: Brian Gorban

There are many indicators I use when analyzing a stock. One indicator I look for are relatively cheap dividend stocks. Another strong indicator is insider buying, such as the ones described here. Finally, another indicator is looking at unusual option activity, as I recently brought up here, while these two on Oct. 7 caught my eye:

1. Safeway (NYSE:SWY) together with its subsidiaries, operates as a food and drug retailer in North America. On Oct. 7, there was extreme option activity, specifically with the Oct. 2011 $17 puts trading over 16,600 contracts, indicating strong bearishness. However, while I see some reason to be short due to the stock chart showing no support as it's plunged the last few months approximately 30% and formed a head and shoulders at the $18 price level, I don't see much reason fundamentally which is more the logic I use in making investment decisions. It trades at 12x P/E, .25x EV/S, and a 3.3% dividend yield that looks real secure at a 36% payout ratio.

On the other hand, the stock has a massive debt load near $5B and a negative net cash position of approximately $4.5B which can be a cause of concern. Much are the same valuations with one of its big competitors, Kroger (NYSE:KR), which has favorable valuations at an 11.7x P/E, .2x EV/S, and 2.1% dividend yield, while having a negative net cash position of approximately $6.7B.

If I was going to own a grocer, I'd rather own Wal-Mart (NYSE:WMT) or Costco (NASDAQ:COST). WMT trades at 11.4x P/E, .5x EV/S, 2.8% dividend yield, and while it has a big debt load and sizeable negative cash load as well, this has a far more diverse revenue stream and approximately $11B in FCF that came in last year alone. Moreover, COST has a very diverse revenue stream, trades at .35x EV/S, 1.2% dividend yield, and while it trades at a much richer 24.7x P/E, it actually has a strong $4B positive net cash position and over $1.5B in FCF that came in last year.

2. Illumina (NASDAQ:ILMN) develops, manufactures, and markets integrated systems for the analysis of genetic variation and biological function. The stock got crushed on Oct. 7 after a disappointing earnings report, and options activity was very strong in the Oct. 2011 $37 and $35 puts indicating bearishness.

The stock now trades at approximately 25x P/E, 4.2x EV/S, 14x EV/EBITDA, and has a balance sheet with over $400M in net cash. Looking at close competitors Affymetrix (NASDAQ:AFFX) and Life Technologies (NASDAQ:LIFE), I don't see ILMN being much over-priced and if anything, cheaper now after this big plunge.

AFFX trades at 271x P/E and forward P/E of 68x, 1.4x EV/S, 11.5x EV/EBITDA, and a negative cash position of just over $20M. While LIFE trades at 19x P/E, 2.6x EV/S, 8.4x EV/EBITDA, and big debt load with approximately $2.2B in negative net cash. I wouldn't short any of these stocks at these levels.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in WMT, COST over the next 72 hours.