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On the 1st of June, we wrote an article that was bullish on Enterprise products Partners (NYSE:EPD) and provided over a dozen reasons to support this outlook. Since then the stock has had a nice run and as of late has been unable to hold onto its gains after trading past $54.50. Invariably, the stock always pulls back either on the same day or 1-2 days later. This has been the case since the 20th of July. At this point, we think it would be best to either bank your profits or put one of the following strategies we will discuss later in this article into play. We will provide reasons from a fundamental and technical perspective as to why we think it might make sense to bank some of your profits now.

The Technical Picture

The stock has put in a double top formation, and one could even argue that it has put in a triple top formation. Both double top and triple top formations are bearish developments. Triple tops are generally more bearish in nature. When a stock cannot trade past a specific point after repeatedly trying to, it is a warning sign that lower prices are in store. The stock has a pretty decent level of support at $52. If it closes below this level on a weekly basis, there is a very good chance it could end up trading well below $45.00. It would need to close above $56 on a weekly basis to indicate that it was ready to trend significantly higher. Given its inability to hold onto its gains after trading past $54.50, it seems more likely that the stock will be trading in the $40-$45 ranges than in the $56 plus ranges in the short to intermediate time frames. Consider putting one of the following strategies described a bit later into play.

The fundamental outlook

  • The demand for ethane has been adversely affected during the first half of 2012. The environment for natural-gas liquids {NGLS} is not too favorable right now. There appears to be an oversupply of NGLS in the market and this is having a negative impact on prices.

The "NGL bloodbath," as it was dubbed by Tudor, Pickering, Holt & Co. last month, is rippling across the oil and gas industry as explorers cut production and reduce cash flow projections, service companies forecast lower demand for drilling rigs, and pipeline partnerships suffer falling revenue for their gas liquids processing plants. The price of an ethane-propane NGL mix was down 58 percent yesterday from a high in January, outpacing the 19 percent drop in crude from a February peak.

  • Lower commodity prices and lower volumes could negatively impact earnings in the short term.
  • A slowdown in economic growth and activity could have an impact on the demand and subsequently, the price of crude oil. This in turn could hurt the company's margins in its natural gas and NGLS businesses.

We would like to stress that our long-term outlook is still bullish, but we feel that in the short term the stock is overbought and facing a lot of resistance and is more likely to correct than rally.

Alternative investment ideas

If you bank your profits now, there are many other good plays out there you could put your money into.

Southern Company (NYSE:SO) is a great example. It is one of the largest and best managed utility companies in the United States. Its rate of return is among the highest in the industry, and it is one of the best managed energy firms servicing the Southeast market. It is a low-cost provider of electricity and continues to generate returns that are among the highest in the industry. Southern also offers a very nice yield of 4.3%, and it has consecutively increased its dividend for 11 years in a row.

Linn Energy (NASDAQ:LINE) is another example of a good play. It sports a top-notch management, which increased production in 2011 by 30% and has set a target of increasing production by another 40% for 2012. The company has a great commodity hedging program in place. Natural gas production is hedged for six years through 2017, and expected oil production is hedged for five years through 2016. Management wants to double natural-gas production to over 800 million cubic feet of gas equivalent per day. It has a strong quarterly revenue growth rate of 18% and has a solid yield of 7.10%.

Suggested Strategies

  1. Bank your profits and close the position immediately. If you are bullish on the long-term prospects of the stock, then consider selling naked puts when and if the stock trades down to the $45-$47.00 ranges. You could aim for the March 2013, 45 puts, which could trade in the $2.20-$2.40 ranges depending on how much time they have left on them when this comes to pass. If they do not have enough time, you could always aim for the June 2013 or Jan 2014 contracts. If you are looking for a way to benefit from a potential decline in the price of the stock, then use some of the profits to purchase a few puts. If you owned 200 shares, consider purchasing 2 and most 3 contracts. For example, you could purchase the March 2013, 50 or March 2013, 45 puts. These puts are trading in the $0.40-$0.60 and $1.40-$1.55 ranges respectively.
  2. If you do not want to sell your shares because you are holding onto significant capital gains, then as a hedge you should seriously consider buying some puts as protection. The number of contracts you purchase should correspond roughly to the number of shares you own. For example, if you own 500 shares, then purchase 5 contracts.
  3. You could sell covered calls and then use the proceeds from the calls to purchase puts to hedge your position. For example, if you own 500 shares, you could sell 5 covered calls and then purchase 5 puts. The March 2013, 55 calls are trading in the $0.80-$0.90 ranges. You could sell them for $0.80 cents or better. Use the proceeds to purchase March 2013, 45 puts, which are trading in the $0.45-$0.60 ranges. If you put a little extra money and can purchase the puts at $0.50 or better, you could purchase 2 puts for each call sold. If your long-term outlook on the stock is bullish, then consider selling puts as outlined in step 1 above.
  4. Finally, the most aggressive strategy and this is more speculative in nature, would be to sell naked calls. You would then use the proceeds to purchase the puts outlined in the step above. Note when you sell naked calls, you take on an unlimited amount of risk because technically there is no limit to how high the stock could trade. However, one way to mitigate this would be to roll the call if the stock starts to trade above the strike price you sold the calls at.

Conclusion

As the stock is overbought and has put in a double top and possibly a triple top formation, investors should consider putting one of the above-described strategies into play. Our suggestion is to consider strategies 1-3 and avoid number 4, which entails the selling of naked calls as it is speculative in nature. Only investors willing to speculate and take on extra risk should consider this strategy. If you purchased puts, consider closing the position out once the puts are showing gains in the 60%-100% ranges.

Some of the research/historical data used in this article were obtained from zacks.com.

Disclaimer

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

Source: Enterprise Products Partners: Bank Your Profits And Wait For A Better Buying Opportunity