Amazon’s Holiday Results Raise Questions

Amazon.com, Inc. (NDAQ: AMZN) is one company that tends to profit when others in its industry do poorly. The retail industry has been crippled by sharply lower consumer spending and higher costs, which has begun to shift the trend towards online retailers like Amazon.com. The book store turned everything store recently reported its best Christmas ever in a recent press release.

The press release drew some criticism from the investment community as it lacks some key facts. CNBC’s Fast Money noted that it contained a lot of “black holes” with no mention of “margins” and “promotional activities”. The market reacted by opening higher and then falling all the way until the close while selling continued into today’s session.

The concern is that Amazon.com’s margins may have been hurt while trying to boost its sales. The factors behind the higher shipment numbers may have more to do with tax savings, bad weather, comparison shopping and discounted prices. As a result, the actual impact of the higher top-line sales on bottom-line results remains to be seen.

So, how can investors bullish on Amazon.com participate in the stock’s upside without taking the risk of stock ownership. One way is to purchase long-term options called LEAPS or long-term equity anticipation securities. These options allow investors to purchase the rights to shares over one or two years time at a fraction of the cost of underlying stock ownership.

Currently, investors can purchase $40 January 2011 LEAPS call for just $21.85 per contract compared to $49.50 per regular share. As a result, investors can spend $2,185 for the right to buy 100 shares anytime during the next 753 days versus spending $4,950 to purchase 100 shares of the underlying stock. Investors looking for a lower breakeven and shorter timeframe can also look at the January 2010 calls.

See “Using LEAPS as a Stock Substitute” for more information or check out our Tools & Products section to find more ways to profit using LEAPS.

Hedge Your Bets on Target with LEAPS

Target Corporation (NYSE: TGT) may be hurting from lower retail sales, but at least one investor has found value in the stock. Pershing Square’s Bill Ackman believes that the real estate under Target’s stores could be worth much more than its current market capitalization. As a result, the activist investor proposed spinning off the land into an REIT that would lease it back to unlock value.

The problem with the plan is that it is seen by Target as being risky in today’s environment. The new REIT may have a great renter and properties collateralized by hundreds of millions of dollars in buildings, but the retailer that is left over may be left in a weaker position. As a result, Pershing Square opted to wait until after the holiday season was over before resuming discussions.

The season is now over and investors are left with a predicament. The retail sector is expected to have one of the worst holiday seasons ever, which has pushed down shares of all retailers. However, Pershing Square’s analysis has clearly shown substantial value in Target’s real estates. So, how can investors get exposure to Target while reducing the risk of further declines in retailers?

The answer is simple: Hedge your bets using broad industry indexes! The Retail HOLDRs (NYSE: RTH) exchange traded fund is considered to be the best retail industry index. Investors looking to hedge against a decline over the long run may want to purchase LEAPS puts to hedge out their retail exposure. Currently, the $70 January 2011 LEAPS puts are trading for just $14.90 per contract. This means that investors can purchase roughly 100 contracts to offset every 200 shares of Target.

The resulting position is one that is hedged against a decline in the retail sector. As a result, investors can only make money when Target outperforms the retail sector as a whole and lose money when Target underperforms the retail sector as a whole. Since Target’s real estate is undervalued, this outperformance will occur when the value is unlocked over the next two years.

See “Using LEAPS as a Hedge” for more information on this strategy or take a look at our Tools & Products for more ways to make money!

Brooks Automation Seen as Undervalued

Brooks Automation (NDAQ: BRKS) shares have recovered from their lows, but many value investors insist that the stock remains undervalued. David Nierenberg of D3 Family Funds is one of these investors that first made a case for the stock at this year’s New York Value Investing Congress. Despite the compelling arguments, Brooks’ stock continued to slide to their current levels.

Brooks Automation is now trading for roughly its net asset value, which makes it an attractive stock in the eyes of Jonathan Heller of Value Investing Congress. The CPA noted in the organization’s blog that buying the stock at its current price of $5.10 is like buying $2.25 in cash, $1.17 in other assets, and getting an additional $5.11 in long-term assets, $1.82of which are PP&E and LT marketable securities.

Despite the deep value, many investors are concerned about Brooks Automation’s recent earnings. The company reported progressively worse earnings throughout 2008 and is expected to report growing losses into the third quarter of 2009 before things begin turning around. This cash burn could end up reducing the amount of cash on the books and deteriorating the value of the stock.

The bright side of the situation is that Brooks Automation has accrued more than $114 million in net operating loss carry-forwards to offset taxes on future income. Moreover, the company has no debt on its books and a strong capital position, which means it would likely have no problems if it were to obtain debt to pay its bills and use the cash to unlock value through a buyback or other action.

So, how can investors take advantage of this steep discount while committing less capital upfront? One way may be to use long-term options. While there are no LEAPS available on the stock, investors can purchase options with an expiration date set in April of 2009. Currently, the $2.50 April 2009 call options are trading for $2.60 per contract. This means investors can purchase the right to 100 shares at $2.50 anytime over the next 115 days for just $260 versus $510 purchasing the underlying stock.

See “Using LEAPS as a Stock Substitute” for more information or check out our e-book “Trend Trading on Steroids” for a more comprehensive strategy.

CVS Remains Strong, Could Benefit from Acquisition

CVS Caremark Corporation (NYSE: CVS) may have dropped on lower earnings over at Walgreen Company (NYSE: WAG), but a closer look at the earnings report may not justify the move downwards. Walgreens reported profits that fell 10 percent in its fiscal first quarter, but the lower results were primarily attributed to costs to open more than 200 new stores.

Prescriptions, which represent the majority of sales at both CVS and Walgreen’s, are widely expected to be flat in 2009. Walgreen’s reported a 6.2% increase in overall prescription sales, but saw only a 2.6% growth in same-store sales for the segment. Many analysts expect the industry to report a 0.5% drop in prescriptions during the same period, according to IMS Health and Walgreen’s figures.

CVS investors may not have high expectations for prescription sales figures, but will be watching the firm’s acquisition of rival Long’s Drugs very closely. The hotly debated acquisition drew at least one activist who insisted that the acquisition sharply undervalued Long’s real estate portfolio. Investors will be watching how management unlocks this value and leverages its infrastructure to improve the brand.

Activist investor William Ackman’s Pershing Square believed that the real estate under Long’s stores were worth some $1 billion and even found parties willing to pay substantially more than CVS’s $71.50/share offer. CVS also noted that it intends to make money off of these assets by either selling them or generating cash through sale-leaseback transactions. This could spell substantial value for CVS shareholders over the long-run.

Investors looking to take advantage of the long-term prospects for CVS given its low multiple and strong prospects may want to take a look at long-term options called LEAPS – or long-term equity anticipation securities. Currently, investors can purchase $25 January 2011 LEAPS call options for just $8.10 per contract. This would give the holder the right, but not obligation, to purchase 100 shares of CVS at $25 per share anytime during the next 760 days.

See “Using LEAPS as a Stock Substitute” for more information on this strategy.

DryShips Sees Calmer Waters Ahead

DryShips Inc. (NDAQ: DRYS) hasn’t exactly been smooth sailing over the past year, but many experts believe that calmer seas may lie ahead. The commodities shipper has made cuts to its capital expenditures to preserve capital while many iron-ore miners have been selling more on the spot market. Chinese producers have been purchasing more while India’s decision to lower or abolish taxes on ore exports has also increased shipments for the sector.

DryShips also announced that it would be cancelling its proposed acquisition of four panama dry bulk carriers from companies owned by chief executive George Economou. The aggregate purchase price of $400 million would have represented a significant cash outflow given the significant deterioration of the dry bulk market since the time the agreements were made. However, the company was able to convert its down payments that would have been otherwise lost into a one year option to purchase.

Investors are happy to see the contract canceled as it frees up cash flows to support the firm’s strong 7.19 percent dividend yield as dividends are usually the first things to be cut when companies experience a cash crunch. Meanwhile, many traders believe that short sellers are covering their positions, taking profits off the table, and moving to greener pastures. As a result, DryShips shares moved sharply higher over the past week.

Investors interested in leveraging their position in DryShips while reducing risk may want to take a look at long-term options called LEAPS (long-term equity anticipation securities. Currently, investors can purchase $10 January 2011 call options for just $6.20 per contract. This means that for $620 right now, investors can have the right to 100 shares at $10 anytime over the next 765 days.

Fertilizer Companies See a Greener Future

Potash Corporation of Saskatchewan (NYSE: POT), the Mosaic Company (NYSE: MOS), and Agrium Inc. (NYSE: AGU) may have been popular stocks last year, but they aren’t faring too well in today’s down economy with all three names trading well off of their 52-week highs. However, many investors believe that the trio is overdue for a recover amid continued strength in pricing despite lower volumes.

Demand for the fertilizers made by these three companies is driven by crop prices, which are currently at high levels thanks in part to ethanol production. However, a lack of growth in demand has forced all three companies to make substantial cuts to their 2009 output. Unfortunately, this is bad news for profits if margins remain the same, but the companies are hoping to raise their prices to compensate.

Demand is also expected to pick up in the middle of 2009. Potash CEO Bill Doyle said in a statement that, “We see demand accelerating through the balance of the year as farmers deplete existing stocks and work to rebuild global grain inventories from extremely low levels … We will have the capability to ramp up production in 2009 as necessary to meet demand.”

Potash, Mosaic, and Agrium are also currently in negotiations with China on prices and volumes for 2009. The prices negotiated with their joint international marketing unit, Canpotex Ltd., will help set a expectations for investors going forward. However, shares have already rallied substantially on speculation that the pricing will be higher than the market is expecting.

Investors looking to take advantage of the potential bullish trends in these three stocks may want to take a look at long-term options called LEAPS (or long-term equity anticipation securities). LEAPS work just like a normal stock option, but do not expire for 1 to 2 years out in the future. As a result, long-term investors can pay a fraction of the cost of underlying shares for the rights to buy at a certain price.

See “Using LEAPS as a Stock Substitute” for more information.

Hess Shares Jump, Outlook Improves

Hess Corp. (NYSE: HES) shares moved sharply higher after crude oil futures rallied to near-term highs. The move came after Saudi Arabia – the world’s largest exporter – cut production more than traders and analysts had expected. The kingdom revealed that its output would be 287,000 barrels a day less than estimated in an effort to boost oil prices and its own economy.

Saudi oil minister Ali al-Naimi told the media that he believes $75 a barrel is a fair price for crude oil after it slumped to a low of $40 a barrel on weaker demand. The current prices are too low for Saudi Arabia, who relies heavily on oil to fund many of its social programs. These comments and revelations sparked a 10% pop in crude oil futures contracts during the U.S. trading session.

Analysts have also argued that now is the time to step up and buy oil stocks like Hess. Oppenheimer & Co’s Fadel Gheit said on Tuesday that he expects energy stocks to follow in the direction of crude oil prices, which he predicts will rise in 2009 on reduced supply and in 2010 on increased demand and lower inventories. This sentiment is shared by many other analysts as well who agree now is the time to buy.

Hess Corporation itself is a global integrated energy company that operates in two segments: Exploration and production and marketing and refining. These two businesses profit on both sides of the oil equation. Higher oil prices are good for the production segment as they can sell more while greater demand is good for the refining segment that sells to consumers.

Investors that have a bullish sentiment on Hess and want to leverage their returns with less risk may be interested in purchasing long-term options called LEAPS. Currently, investors can purchase $50 January 2010 LEAPS calls for just $15.20 per contract. This means that investors can acquire the rights to 100 shares at the current market price for just $1,520 versus $4,982 with underlying stock.

See “Using LEAPS as a Stock Substitute” for more information on this strategy.

General Mills Options Present Opportunity

General Mills (NYSE: GIS) has seen its shares fall in recent months as commodity prices have risen higher. Higher raw ingredient costs have put pressure on profit margins while stingy consumers have prevented any price increases. However, General Mill’s strong brand portfolio makes it one of the most resilient companies in its sector that could be poised to rise higher.

Some investors believe that consumers will choose to switch to packaged foods to cut costs in their daily lives. Familiar brands are likely to be the beneficiary of this switch and General Mills is the proud owner of many of these brands, such as Cheerios and Green Giant. Meanwhile, some investors also believe that commodity prices will begin to decline as the dollar continues to move higher.

Analysts are confident that General Mills can improve its long-term profit margins by focusing on things like manufacturing and spending efficiency, global sourcing, and sales mix. The cash flows generated from these initiatives could then be used for share buybacks or special dividends to boost shareholder confidence and deliver value to long-term holders.

Investors looking to purchase a stake in General Mills without taking on as much risk in these troubled times may want to consider long-term options called LEAPS. These options enable investors to purchase the rights to shares at a certain price and range of dates. Currently, long-term investors can purchase $60 January 2010 LEAPS for $8.20 per contract.

This means that investors can pay $820 to purchase rights to 100 shares at $60 per share anytime during the next 400 days. This compares to more than $6,000 required to buy 100 shares of the underlying stock. For more information on this strategy, please see “Using LEAPS as a Stock Substitute”.

James River Rallies on Obama’s Plan

James River Coal Company (NDAQ: JRCC) shares jumped higher as the commodities market rebounded on new plans proposed by president-elect Barack Obama. Over the weekend, Obama proposed an economic stimulus package that would center on building infrastructure at levels not seen in nearly a half-century. Commodities would therefore benefit as the need for raw materials and energy rises.

Coal producers like James River have been struggling with lower coal over the past year as demand from China is projected to slow significantly. Meanwhile, a slowdown in domestic consumption has also put pressure on prices here at home. However, Obama’s new plan calling for massive infrastructure spending could spur this domestic demand and more than offset the Chinese slowdown.

Obama’s proposal calls for the creation of 2.5 million jobs by 2011 using infrastructure projects like building roads, fixing schools and upgrading energy facilities. The size of the bailout remains to be seen, but hints from the president-elect suggest a large number. Speculation from journalists and analysts range anywhere from $500 billion to $1 trillion, but the actual number remains to be seen.

The new proposal could be good news for companies like James River long-term, but some remain bearish on the stock in the short-term. Coal prices may have rebounded in response with many other commodities, but traders were quick to point out that there were very low volumes in the world markets. As a result, the move could be just a short-term bump higher.

However, investors interested in placing bullish bets over the long-term may want to consider long-term options called LEAPS. Unfortunately, there are no LEAPS traded on James River, but there are longer term options. The $10 January 2009 calls are trading at just $4.70 per contract, which means investors could purchase the rights to 100 shares at $10 for just $470 right now.

See “Using LEAPS as a Stock Substitute” for more information.

Philip Morris Stands Strong in Economic Storm

Philip Morris International (NYSE: PM) has benefited from the economic crisis as foreign demand for cigarettes remains strong. The tobacco company reported a 19.2% jump in earnings last quarter as net revenues rose 17.5% over the year. Moreover, the firm reinforced shareholder confidence by upping its quarterly dividend by 17.4% while continuing to buy back shares.

Shares of Philip Morris have fallen nearly 30% from the year’s highs, but continue to outperform the S&P 500. Regardless, many investors are questioning why shares are trading down with double-digit top and bottom line growth along with a growing dividend yield.  The international nature of the firm also eliminates the economic and legal risks associated with the U.S. market.

Disposable consumer income in emerging markets is at record levels while reforms in excise tax systems mean a greater role for specific taxes. This means that revenues should grow while taxes – a large risk for tobacco companies – will be easier to forecast and manage. The second risk of a stronger dollar is also mitigated by the fact that the currency fluctuations are only expected to be temporary.

Philip Morris also has a very appealing balance sheet and ability to generate consistent, predictable and growing discretionary free cash flows. The firm also remains dedicated to delivering shareholder value by boosting its dividend by 17.4% last quarter while remaining committed to a $13 billion two-year repurchase program.

Overall, business fundamentals are strong with an improved infrastructure and brand portfolio to deal with the economic challenges. With the possible exception of Japan, there are no excise tax threats that could disrupt industry dynamics and the firm’s pricing ability remains strong. Meanwhile, large cash flow generation and a strong balance sheet provide the backbone necessary to weather the storm.

Investors interested in leveraging their Philip Morris returns without taking on the extra risks associated with margin buying may want to consider long-term options called LEAPS. Currently, the $40 January 2010 calls are trading for just $8.40 per contract. This means that investors can purchase the rights to 100 shares for just $840 compared to $4,086 purchasing the underlying stock.

See “Using LEAPS as a Stock Substitute” for more information.

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