- Although guidance has been scrapped for the second quarter, the firm's valuation remains compelling.
- Buybacks have been suspended to protect the dividend.
- We will wait until the stock bottoms. Looking to put the odds in our favor as much as possible.
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As I write (May 4th), the S&P 500 has dropped below 2800. This means as we outlined in a recent video that the odds are now very high that the main equity indices such as the S&P 500 are dropping into a daily cycle low. The reason being is that Monday, the 4th is the 29th day of this daily cycle. Therefore, considering how far we remain off this daily cycle highs (close to 150 handles) and the duration of same, we maintain lower prices remain ahead of us over the next two to three weeks.
If we get a violent downturn, we will see much higher VIX prices. In fact, due to sustained selling in recent sessions, the VIX has already bounced from a low of just over 31 last Wednesday to now trading back up around 40.
A higher VIX benefits options sellers as higher premiums can be extracted. Before we get into potential trading strategies at the next DCL, let's delve into the underlying Hewlett Packard Enterprise Company (NYSE:HPE) which we have been focusing on. HPE which incidentally has lost close to 50% of its market-cap over the past 6 months alone is now trading under $10 a share. This brings distinct advantages when it comes to trading this stock. First though, before we get into strategy, let's look at how some key financials have been trending, its dividend as well as the valuation of HPE.
Firstly, if we look at the chart above, we can see that we are seeing bullish signals on the RSI momentum indicator. Remember, we believe that all known fundamentals reflect themselves in the technical chart. This leads us to believe that HPE may bottom here ahead of the market in earnest.
From a value perspective, HPE looks very cheap at present as we can see below.
Price To Earnings
Price To Book
Price To Sales
Price To Cash-Flow
Many firms are cheap because of earnings difficulties but this is not the present situation with HPE. Its EBITDA margin for example comes in at just over 18% over a trailing twelve-month average and its return on common equity comes in at 6.8%. These numbers are well north of the averages in this sector.
From a shareholder's perspective, the company recently declared a $0.12 quarterly dividend which was in line with previous. This means that the dividend yield based off the current share price comes in at 5.1%. Although the firm has been burning cash in recent times, this has been due to aggressive stock repurchases which still totaled $1.64 billion over the past four quarters. In early April though, the company put a stop to this by suspending its buyback program as well as pulling guidance.
Even when we include recent buybacks however, free cash flow has been still covering the dividend. Over the past four quarters, free cash flow amounted to $841 million whereas the dividend payouts amounted to $607 million. Suspending the buybacks therefore should mean that there will be ample cash flow to cover the dividend over the next few quarters. Furthermore, the debt to equity ratio as well as the interest coverage ratio remain in good stead. The encouraging trends in these metrics will also buy the firm time to come through this.
Analysts who follow this company expect $0.31 in earnings per share in the second quarter of this fiscal year. Two months ago, this estimation was well over $0.40 per share so we are seeing a sizable drop already. In fact, due to how projections have declined in recent weeks, the forward earnings multiple of HPE at present is under 6. This number looks really compelling compared to the sector at large.
The strategy we will be looking at will be to sell a cash-secured put whilst at the same time, buy an out of the money call option. We will be looking if the sale of the put covers the price of the call purchase. If we can achieve this, this "set-up" in essence gives us a free trade to the upside. With this strategy, HPE brings distinct advantages to the table in that shares are liquid and it is a low-priced stock (> $10)
Therefore, to sum up, the pending decline into a daily cycle low in the S&P 500 should increase the value of the VIX over the next few weeks. This decline coincides nicely with the fact that HPE is expected to announce its second quarter numbers at the back-end of this month. Therefore, we should also see a steady rise in the HPE's own implied volatility. This company's valuation and profitability metrics remain compelling. We will look to put long deltas to work in here before long.
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