Arch Coal: Lock In 30% In Extra Gains Or A Lower Entry Price

Jun.19.12 | About: Arch Coal (ACIIQ)

The coal sector has taken a beating, and early birds could be rewarded for taking the plunge into this sector. Last year the U.S. exported 40 million tonnes of coal and by 2015, this figure is projected to top the 56 million tonne mark. A 750 million tonnes plus market exists outside the U.S., which can probably absorb any slack in demand back home. With sea freight prices at historic lows it makes it more affordable to ship this commodity overseas. Since 2005, U.S. coal exports have increased by almost 120%. China continues to import coal at a voracious rate and Japan with its nuclear industry all shot up has stepped up its coal purchases. 90 gigawatts of new coal-fired plants are scheduled to come online soon; that means an additional 300 million tonnes of coal will be needed.

Selling Puts is a great way to purchase shares in companies you like at a predetermined price. In essence, you are getting paid to put in a "limit order."

An investor usually sells a put option if his/her outlook on the underlying security is bullish. The buyer of the put option pays the seller a premium for the right to sell the shares at an agreed-upon price. If the stock does not trade at or below the agreed-upon price (strike price), the seller gets to keep the premium.

Benefits associated with selling puts

  1. In essence, you get paid for entering a "limit order" for a stock or stocks you would not mind owning.
  2. It allows one to generate income in a neutral or rising market.
  3. When you sell a naked put you are in a way acting like an insurance agent. The Seller of the option agrees to buy the stock in the future if it drops to a certain level before the option expires. For this, you (the seller) are paid a premium upfront. If this strategy is repeated over and over again these premiums can really help boost you returns over time.
  4. Acquiring stocks via short puts is a widely used strategy by many retail traders and is considered to be one of the most conservative option strategies. This strategy is very similar to the covered call strategy.
  5. The safest option is to make sure the put is "cash secured." This simply means that you have enough cash in the account to purchase that specific stock if it trades below the strike price. Your final price would be a tad bit lower when you add the premium you were paid up front into the equation. For example, if you sold a put at a strike of 20 with two months of time left on it for $2.50; $250 per contract would be deposited in your account.
  6. Most put options expire worthless and time is on your side. Every day you profit via time decay as long as the stock price does not drop significantly. In the event it does drop below the strike you sold the put at; you get to buy a stock you like at the price you wanted. Time decay is the greatest in the front month.

The majority of traders opt to close the put out prior to expiration if they have the chance of buying it back at much lower price. For example, selling the put at $2.50 and buying it back at $0.50

Reasons to be bullish on Arch Coal Inc (ACI):

  • Strong institution support: Percentage held by Institutions = 79%
  • Net income is trending upwards for the past three years even though it dropped in 2011 it is still almost over 100 million higher than it was back in 2009. In 2009, it stood at $42 million in contrast to $142 in million in 2011.
  • EBOTDA has increased from $450 million in 2009 to $824 million in 2011.
  • Cash flow has increased from $2.41 in 2009 to $3.14 in 2011
  • A decent quarterly earnings growth rate of 19%
  • An operating margin of 9.44%
  • A yield of 2.00%
  • Percentage short of float is an astounding 24.3%, making it a perfect candidate for a short squeeze.
  • A good current ratio of 1.55
  • A free cash flow yield of 5.05%
  • A 3-5 year projected EPS growth of 11.8%
  • A five-year sales growth of 11%

Suggested put Strategy for Arch Coal

It is trying to put in a bottom in the 5.60-6.00 ranges. A stock usually tests its recent lows and ends the week on a higher note as a sign that a tradable bottom is in place. Investors should consider waiting for a re test of the 5.60-5.80 ranges before jumping in.

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The Jan 2014, 5 puts are trading in the 1.29-1.34 ranges. If the stock trades down to the suggested ranges, these puts should rise in value by roughly 25 cents. For this example, we will assume that the puts can be sold for 1.50. For each contract sold $150 will be deposited in your account.

Advantages of this strategy

If the stock trades below the strike price, the shares could be assigned to your account, and your final cost will be $3.50 (5.00-1.50), which could be viewed as a great long-term entry point for those willing to take on a bit of risk. On the other hand, if the stock does not trade below the strike price, you get to walk away with a splendid gain of 30%.

Disadvantage

As long as you are bullish on the stock, there is no real disadvantage. The only risk factor is that the shares are assigned to your account, but as you were bullish on the stock to begin with this should not be a big issue.

Company: Arch Coal Inc

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Basic overview

1. Percentage held by Institutions = 79%

2. Operating margin= 9.44

3. Quarterly revenue growth rate = 19.10%

4. Beta = 2.29

Growth

1. Net Income ($mil) 12/2011 = 142

2. Net Income ($mil) 12/2010 = 159

3. Net Income ($mil) 12/2009 = 42

4. EBITDA ($mil) 12/2011 = 824

5. EBITDA ($mil) 12/2010 = 731

6. EBITDA ($mil) 12/2009 = 459

7. Net Income Reported Quarterly ($mil) = 1

8. Cash Flow ($/share) 12/2011 = 3.14

9. Cash Flow ($/share) 12/2010 = 3.67

10. Cash Flow ($/share) 12/2009 = 2.41

11. Sales ($mil) 12/2011 = 4286

12. Sales ($mil) 12/2010 = 3186

13. Sales ($mil) 12/2009 = 2576

14. Annual EPS before NRI 12/2007 = 1.21

15. Annual EPS before NRI 12/2008 = 2.45

16. Annual EPS before NRI 12/2009 = 0.42

17. Annual EPS before NRI 12/2010 = 1.14

18. Annual EPS before NRI 12/2011 = 1.07

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Dividend history

1. Dividend Yield = 2.00

2. Dividend Yield 5-Year Average = 1.61

3. Dividend 5-year Growth = 10.2

Dividend sustainability

1. Payout Ratio 09/2011 = 0.57

2. Payout Ratio 5 Year Average 12/2011 = 0.4

Performance

1. Next 3-5 Year Estimate EPS Growth rate = 11.8

2. 5-Year History EPS Growth 12/2011 = -11.8

3. ROE 5 Year Average 12/2011 = 10.76

4. Current Ratio 12/2011 = 1.55

5. Current Ratio 5 Year Average = 1.27

6. Quick Ratio = 0.79

7. Cash Ratio = 0.33

8. Interest Coverage Quarterly = 0.74

Related companies

For investors looking for other ideas some data has been provided on two additional companies to get you started. Investors looking for other ideas might find this article to be of interest Philip Morris: Time To Take A Closer Look But Don't jump before pullback

Company: Peabody Energy (BTU)

Levered free cash flow= $142 million

Basic overview

1. Cash Flow 5-year Average = 4.11

2. Dividend Yield 5-Year Average = 0.65

3. Quarterly revenue growth 17%

4. Profit margins = 11.54%

5. Beta= 1.92

6. Percentage held by institutions= 75%

7. Short percentage of float= 3.10%

8. Five-year sales growth rate= 9.75

Growth

1. Net Income ($mil) 12/2011 = 958

2. Net Income ($mil) 12/2010 = 774

3. Net Income ($mil) 12/2009 = 448

4. Net Income Reported Quarterly ($mil) = 173

5. EBITDA ($mil) 12/2011 = 2095

6. EBITDA ($mil) 12/2010 = 1801

7. EBITDA ($mil) 12/2009 = 1231

8. Cash Flow ($/share) 12/2011 = 5.97

9. Cash Flow ($/share) 12/2010 = 4.68

10. Cash Flow ($/share) 12/2009 = 3.43

11. Sales ($mil) 12/2011 = 7974

12. Sales ($mil) 12/2010 = 6860

13. Sales ($mil) 12/2009 = 6012

14. Annual EPS before NRI 12/2007 = 1.56

15. Annual EPS before NRI 12/2008 = 3.63

16. Annual EPS before NRI 12/2009 = 1.92

17. Annual EPS before NRI 12/2010 = 3.05

18. Annual EPS before NRI 12/2011 = 4.17

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Dividend history

1. Dividend Yield = 1.4

2. Dividend Yield 5-Year Average = 0.65

3. Dividend 5-year Growth = 10.01

Dividend sustainability

1. Payout Ratio = 0.09

2. Payout Ratio 5-Year Average = 0.11

3. Change in Payout Ratio = -0.02

Performance

1. Next 3-5 Year Estimate EPS Growth rate = 10.27

2. 5-Year History EPS Growth = 16.38

3. ROE 5-Year Average = 21.18

4. Return on Investment = 10.88

5. Current Ratio = 1.86

6. Current Ratio 5-Year Average = 1.49

7. Quick Ratio = 1.4

8. Cash Ratio = 0.9

9. Interest Coverage Quarterly = 3.51

10. Strong retention rate of 91%

Company: Alpha Natural resources (ANR)

Basic overview

1. Percentage held by Institutions = 79%

2. Levered free cash flow of $454 million

3. Operating margin= 6%

4. Quarterly revenue growth rate = 71%

5. Beta = 2.69

Growth

1. Net Income ($mil) 12/2011 = -677

2. Net Income ($mil) 12/2010 = 96

3. Net Income ($mil) 12/2009 = 58

4. EBITDA ($mil) 12/2011 = 899

5. EBITDA ($mil) 12/2010 = 809

6. EBITDA ($mil) 12/2009 = 526

7. Net Income Reported Quarterly ($mil) = -29

8. Cash Flow ($/share) 12/2011 = 8.01

9. Cash Flow ($/share) 12/2010 = 7.46

10. Cash Flow ($/share) 12/2009 = 4.91

11. Sales ($mil) 12/2011 = 7109

12. Sales ($mil) 12/2010 = 3917

13. Sales ($mil) 12/2009 = 2496

14. Annual EPS before NRI 12/2007 = 0.45

15. Annual EPS before NRI 12/2008 = 2.63

16. Annual EPS before NRI 12/2009 = 1.98

17. Annual EPS before NRI 12/2010 = 2.17

18. Annual EPS before NRI 12/2011 = 1.57

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Performance

1. Next 3-5 Year Estimate EPS Growth rate = 5

2. 5-Year History EPS Growth = 23.94

3. ROE 5-Year Average = 12.81

4. Current Ratio = 1.47

5. Current Ratio 5-Year Average = 2.38

6. Quick Ratio = 1.13

7. Cash Ratio = 0.76

8. Interest Coverage Quarterly = N/A

9. Book Value Quarterly = 33.72

Conclusion

Only put this strategy to use if you are bullish on the stock, for there is a chance that the shares could be assigned to your account if the stock trades below the strike price. This usually takes place on the expiration day as most option players are in the game to make money and not to force the seller of the option to purchase the shares.

EPS and Price Vs industry charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com. Options tables sourced from money.msn.com.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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