Crazy for Netflix?

I’m a minerals specialist by profession, so I typically stick to natural resources investments and ideas since that’s my expertise.  However, I think there’s good risk to reward being offered in some of these high flying momentum names.  Netflix (NFLX) is a prime example.  I could write a lengthy article on the fundamentals of NFLX, but I’ll sum it up very simply by saying the following:

NFLX IS EXTREMELY OVERVALUED

I know what you’re thinking, the term “overvalued” is subjective, but look at any metric you like and it’s overvalued compared to it’s peers.  What about Growth?  Well, they sure are growing users, but they aren’t growing cash nor revenue.  In fact, cash from operations has turned extremely negative and it’s my belief that the downside risk is not being priced-in the stock.

So here’s the thesis:

IF equities experience a significant pullback, NFLX will lose approximately 50% of it’s all-time high value.

If equities have hit multi-year highs (which I think they have) and if equities are due for a significant pullback of say around 20% or more (which I think they are), then I think shorting NFLX is the best trade around.  There’s a lot of IF‘s in that statement, but it’s also a really good risk/reward setup.

 

Here’s the Trade:

NFLX had an all-time of $129 (and change) on 8/5/15, that puts my 50% downside target around $65.  At the time of this writing NFLX is around $117.  I’m giving myself a stoploss level at around $119 (not much room I know, but NFLX was at $114 when I started writing this article earlier today- and entered a portion of the trade!).

I’m giving the downside target ($65) until March to play itself out.  Since I’m going to use options I have established target levels at various option expiration dates as follows:

• December 18; Target = $100
• January 15, Target = $85
• March 18, Target = $65

Since it’s moving up so rapidly today, I’m going to enter a very small starter position, and spread the entry as follows:

• Dec 18 expiration, ATM (at the money) puts (strike of 115 when I entered it)
• Dec 18 expiration, strike = 100 puts
• Jan 15 expiration, strike = 85 puts
• Mar 18 expiration, strike = 60 puts

Here’s the trade plan:

• If NFLX trades below $108, I will double my position in each tranche (except the Dec 115’s).
• If NFLX trades below $100, I will roll the Dec 115’s to Jan 15, 100’s (ATM).
• If NFLX trades below $94, I will roll everything that is in the money to ATM January or March expiration (depending on the date)

If NFLX trades above $119, I will cover my small position for a loss and wait for it to reverse (market to exhaust).

Refer to the chart below.  Note the rising trendline that I believe will break, my stoploss areas in red, my “add-to” levels in yellow, and the target boxes at each upcoming option expiration.  The red arrow is my entry today.

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I’ve been handing out free money to iBankCoin readers for the past few weeks and I’d like to summarize my take on the markets and my recommendations up to this point.  This is done in an effort to be transparent with my ideas, calling out my own mistakes and tooting my own horn when I’ve made money.

First of all, if you’re short the Fed Trade School Basket you’re doing very well for yourself, I’ve updated my recommendations below:

Stay short the country basket, Brazil (EWZ), China (FXI), Mexico (EWW), Russia (RSX or ERUS), and Australia (EWA), you should be up on all of these except EWZ, be patient these will continue to work well, especially if you are long some of your favorite US equities as well.

Take some profits on Freeport-McMoran (FCX), you should’ve made some nice gains on this one, personally my options were up around 85% when I took profits on Thursday (too early).  If you’re still short I recommend taking profits and perhaps leaving a piece on, depending on your trading style.

Currencies are still a good play,  although my recommendation was to use Friday’s highs (11/6/15) as a stop loss, you would’ve been stopped out however, I believe these will still work; “Short the Aussie Dollar (FXA), and Short the Canadian Dollar (FXC)”.

Stay short Oil (USO), you’re making a killing here!  No reason to to cover, especially after we had war escalating events over the weekend (Paris attacks) and crude oil was still down today – very bearish.  Perhaps move your stops down depending on your trading style.

From last week’s post, Commodity Not-So Super Cycle you should be short ConocoPhillips (COP).  Depending on your entry you should be doing okay in this one.

Stay short COP, use Wednesday’s (11/11/15) high around $54.75 as a stop.

Finally, my call on coal (perhaps) bottoming in King Coal’s Big Bounce? is still a wait and see event driven idea.

Keep an Eye on ACI, for the signal to buy BTU, when it’s apparent that Arch Coal (ACI) is in fact going bankrupt, depending on the reaction in Peabody Energy’s (BTU) shares, go long BTU for a potential bottom in coal.

I think overall the markets should bounce early in the week and most likely give up those gains by the close on Friday.  The easy trade is to stay short commodity exposure (as described above) and stay long US equities until they break down again.  I personally doubt we’ll see any fireworks until the end of the year.

I’m working on a few ideas for this week, they’ll be associated with transportation (rail) stocks and perhaps THE momentum trade of 2016.

Feel free to comment below, let me know if I’m adding any value here or if you’d rather me go back into my own little trading cave.

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Beginning in around 2002/3 the energy/commodity complex began a magnificent rise as the sleeping Chinese dragon began to awake from its slumber ahead of the Beijing Olympics. The effects were widespread, even in locations that had zero exposure to China, investing capital began to flow into these sectors.  The narrative of the Commodity Super Cycle began to play out and the bobble-heads on financial media all had hard-on’s for any natural resource plays which were going to supply the raw materials for China’s growth.  Commodities, once viewed as speculation only, became the new asset class of choice and the ETF industry eventually took full advantage.

I was in the mining consulting industry during most of these commodity bull years and companies were spending a lot of money.  We were hiring like crazy and there wasn’t enough talent around to finish all of the projects we had.  Production companies were investing in land, transportation infrastructure, exploration, permitting, and equipment.  Rising commodity prices now meant that resources/reserves that were once thought to be economically unfeasible were now “in the money”, so to speak.  Times were good, but it was the classical example of strong demand (and higher prices) leading to over-investment, leading to low oversupply (and lower prices) leading to weak demand.  You don’t need a Harvard Business School degree to recognize what’s happened:

The Boom is now a Bust.

The problem now is figuring out where we are in the cycle.  I think much of the bust has already taken place in regards to commodity prices however, they are mean reverting instruments and will probably overshoot to the downside just like they did on the upside – so stay clear of them in my opinion.  Furthermore, the Fed’s monetary tightening narrative should lead to more commodity downside; read my last article for details: http://ibankcoin.com/dyer440/2015/11/06/fed-trade-school/

Think back to what the world was like in 2002/3, think about the size of the businesses in many of these sectors: energy, mining, chemicals, transportation, etc.  These sectors are going back to at least 2002/3 levels.  Just like the consulting company I used to work for, they will have to shrink.

The interesting thing to note is that all these companies are managed by HBS type personalities, and the hubris at the top is simply incredible.  They should all be scrambling to save their companies but instead they’re missing the writing on the wall – this is especially true in the Oil & Gas industry.  Managers typically have a hard time acting like traders; when we realize a mistake – we get out and cut our losses (at least we should) .  We shouldn’t sit around with our fingers crossed hoping for a rebound.

 

So Here’s the Trade:

I looked for a company with the following attributes:

• Overpriced relative to P/E
• Large Cap
• Tradeable, liquid options
• Large Dividend
• Still has enough meat on the bones to short

The winner is ConocoPhillips (COP).  COP has a forward earnings P/E of around 85, and they are attempting to defend their dividend which is around 7%.  The bullish thesis on COP is “collect 7% while you wait for oil to rebound”.  That is insane.  Last quarter COP generated $1.93 billion in operating cash flow, but spent $2.17 billion in CAPEX and another $920 million on dividends.

The bottom line is they will have to cut their dividend distribution.  That, combined with the commodity price exposure and you have the recipe for a fine-looking short trade.  Use the recent high’s ($57-ish) as a stop loss , and the recent lows ($42-ish) as a price target.

Refer to the COP chart below:

 

 

 

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The picture above is the Pasha Bulker, which ran aground near Newcastle, Australia in 2007.  I’ve been to that beach and what an amazing sight that must have been!  Now that the Fed is going to hike rates in December, I figured it illustrated perfectly what could well be the (continued) fate of many commodities around the globe.  Not to get too “macro” here because academic economists are typically full of it- trying to explain things after the fact- but it should be apparent by now that the US Fed is running a monetary tightening policy whereas the rest of the world’s central banks are easing.

The effects of this are obvious:

1. The US Dollar is going to get stronger relative the rest of the worlds currencies
2. Things prices in US Dollars are therefore going to get weaker
3. Companies that produce and sale things prices in US Dollars will lose income/revenue
4. Countries exposed to exporting things priced in US Dollars are also going to feel the negative effects

See the chart below, Commodities ($GTX) vs the US Dollar (UUP), shown at the bottom:

 

 

Now that this is set to continue, at least until mid-December…

Here’s the Trade:

Countries: Short Brazil (EWZ), Short China (FXI), Short Mexico (EWW), Short Russia (RSX or ERUS), and Short Australia (EWA).  Use their respective recent highs as a stop loss, and use their recent lows as profit targets.

Companies: Short Freeport-McMoran (FCX), use Friday’s high as a stop loss; $11.25.

Currencies: Short the Aussie Dollar (FXA), and Short the Canadian Dollar (FXC), use Friday’s high as a stop loss.

Commodities: Short Crude Oil (USO), and Short Gold (GLD) – only on a break to new lows.

I’ll probably use options for that basket of positions since it’s a fairly short duration trade and I’ll be able to use a minimum amount of cash – allowing me to enter each one.  These trades are not that ingenious, they seem fairly obvious right?  There’s beauty in simplicity, and simple usually makes money.  Key Note: I think this strategy should be closed out by the day of the Fed decision, December 16 – It might self destruct Mission Impossible style, and here’s why I think so:

If they hike rates, the Fed will most likely hint at a “one and done” policy in order to talk the US Dollar back down.  More on this idea to come… but I think Dec. 16 could be the current commodity cycle’s low.  I think the Fed will begin to ‘turn their battleship around’ and start the slow process of changing the narrative back to easy money.  This is of course dependent on how weak the Q4 GDP estimates (and Q3 revisions) come in.   They could be hiking into weakness which is not good.  Furthermore, if you’re a little uneasy about staying long the market after one of the largest monthly rallies ever, the short ideas listed above are a good way to balance (hedge) your portfolio.

Last thing to keep in mind, it doesn’t matter if the Fed actually hike rates, what matters is that the jawboning and the perception of tightening is effectively tightening in and of itself.  That’s why these trades should work.

 

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Let’s be honest about a couple things right from the start:

1. Coal is a dirty word in the investment community, and frankly it’s a dirty fuel.
2. Environmentalists are winning the war against coal, whether you “believe” in global warming or not, rational people would prefer to not live in cities that look like this:

The fact is however, those reasons are not why the coal industry has had the shit kicked out of it. Coal has been bludgeoned by another so-called environmental evil, namely hydraulic fracturing – which has led to epically low natural gas prices. Without the low natural gas prices a significantly higher number of utilities operating coal-fired power plants would have simply upgraded their emissions scrubbing to meet the new EPA mercury standards. Instead, the cost-benefit analysis suggested that switching fuels from coal to natural gas was (and still is) a better option. This outcome has led to lower coal demand, lower coal prices, and lower earnings for coal producers.

In addition to fracking, the ineptitude of management and the lack of foresight led to some poorly timed decisions by a few major coal producers in the US – specifically, the purchase of metallurgical coal properties at the top of the Chinese led, so-called commodity super cycle. I’m referring to Alpha’s acquisition of Massey, and Arch’s acquisition of International Coal Group, which both occurred in June 2011. Alpha Natural Resources (ACI) has already filed for bankruptcy, and I’d currently give Arch Coal only a 20% chance of avoiding the same fate (their bond prices imply worse odds than that).

So from now on let’s put aside the environmental aspect from the coal theme, all it does is create a smog of negativity which prevents us from useful analysis of the sector. The bottom line is that the companies that survive this downturn will see huge returns simply due to the extreme negative valuations currently being applied. Eventually, the bankruptcies will result in closures of enough marginal and/or risky coal mines that the production will reach demand equilibrium. The result will be more efficient operations, less exposure to environmental liabilities, and (eventually) improved balance sheets.

For example, Peabody Energy (BTU) has a balance sheet that appears highly levered however, 85% of FY16 production is locked-in at relatively good long term price contracts and they have access to a committed credit facility that doesn’t expire until August 2018. Comparing Peabody’s operations to their bankrupt (or near-bankrupt) cohort leads me to believe they have superior assets due to less exposure to the Appalachian and metallurgical coal markets, as well as a globally diverse presence. If you believe global coal use is not going to die, then Peabody is arguably the best of breed pure play on coal to use as an investment vehicle.

Here’s the Trade:
It’s all about Arch Coal earnings and probable bankruptcy. Arch is the number two US coal producer behind Peabody and I believe the Arch bankruptcy will mark a bottom in the coal sector. Arch is set to release earnings the morning of Monday, November 9. The release and subsequent conference call will likely yield a deep drop in Arch share prices. The key here is the reaction to Peabody shares; if Peabody shares also drop and hold their recent lows of $11.75 I will be deploying approximately half a position long (I’ll probably do it through options). Use the $11.75 level as a stop loss and add the second half on a closing basis above $16.35 (I always add to strength as opposed to averaging down).  Alternatively, if Peabody’s stock is up on the Arch news I will deploy a full position immediately and use a 5% stop loss channel, calculated daily, until a close above $16.35 (then use that level). I’ll assume you can manage your own profits from there as the sector rebounds.

Keep in mind, this is pure speculation – not value investing. Peabody is down over 90% in the past 52 weeks; this is simply a structured and opportunistic bet on a bounce with the added benefit that it has the potential to be long lasting and provide many multiples of returns on capital.  If you prefer a less risky route, simply watch the reaction to Peabody shares whenever it becomes blatantly clear that Arch will file for bankruptcy protection (that could be Nov. 9, or it could be sometime later this year).  Then, simply go long whenever you feel comfortable that a bottom is playing out; you may miss the first 25%, but there is much more upside that awaits.

There are a lot of sub-plots which I could add to the bullish coal narrative: George Soros, a potential republican POTUS, natural gas producers running out of money (another possible bottom), macroeconomic headwinds turning into tailwinds, etc.  But I would prefer some feedback before I go further down the rabbit hole.

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