LUV: Buy; PT $44; Q215 Update

LUV: 7/30/15; $36.31

From Thomson Reuters I/B/E/S Estimates:

Forward Earnings: 3.34

Forward PE: 10.87

Earnings Growth Rate (EGR): 22.5%

PEG Ratio: .48

S&P Forward PE: 17.82
S&P EGR: 7.12%



LUV reported its quarterly earnings Thursday, July 23.  The reported revenues and earnings for the previous quarter were slightly above analysts estimates.  LUV is achieving significant growth in its earnings due to drastically lowered fuel costs and through its AirTran acquisition, which occurred in May 2011.  The 43% year-over-year (y-o-y) earnings growth was accomplished with only 2% y-o-y revenue growth.



In addition to the earnings and revenue numbers, two other noteworthy topics were presented in the earnings call.  One was a re-signed agreement with Chase bank for the Rapid Rewards Chase credit card.  The amended agreement will contribute $500 million in yearly revenue, or $125 million a quarter.  This amounts to nearly 2.5% of the revenue reported for the second quarter, which is significant considering revenue grew only 2% y-o-y.  This agreement should continue to support a modest y-o-y revenue growth for Southwest.



Another noteworthy topic is Southwest's share repurchase plan.  LUV has completed $380 million of its current $1.5 billion share repurchase authorization.  The $1.5 billion value amounts to approximately 6.2% of LUV's market capitalization.  This effectively means, if all of the $1.5 billion repurchase allotment is used, LUV will increase its EPS by 6.2% without earning a single dollar more of profit (same profit but less shares to divide into the profit).  In addition, LUV increased its dividend distribution recently and now sports a .84% yield.  Pretty pathetic, but still an indicator of the substantial cash flow LUV is generating.



As far of LUV's current valuation (PE) goes, it seems like LUV is greatly undervalued relative to the S&P index.  Considering the growth rate of 22.5%, LUV also seems to be undervalued using a PEG analysis.  However, while LUV is achieving tremendous growth this year, analysts expect the future consecutive years to grow at low single digits.  For this reason, a lower PE for LUV is likely warranted, as the majority of its growth over the next 5 years will be obtained this year.  Therefore, we need to come up with a more realistic valuation.



Using the 2% revenue growth number reported this quarter, the 22.5% margin reported this quarter, and the 6.2% EPS growth assuming a consistent share repurchase plan, LUV's growth rate can be estimated at 6.65%.  The calculation goes as follows: 2% revenue growth x .225 margin on the revenue growth = .45% (only 22.5% of the revenue growth will turn into profit).  Add in the 6.2% growth from buybacks to the .45% and we get 6.65%.  We can see from the above numbers that the PEG ratio for the S&P is above 2, so we can conservatively choose a fair PEG ratio of 2 for LUV.  This gives us a fair PE of 13.3 (2 x 6.65), or a share price of $44.40 (3.34 future EPS x 13.3 fair PE).  This value obtained through our very rough estimates seems reasonable considering the strong management execution and balance sheet of LUV.



Several other factors could help to support earnings performance relative to estimates.  The persistence of low oil prices may not be assumed by analysts in their current estimates.  Prolonged low oil prices may cause analysts to revise their estimates upwards, which would increase LUV's stock price.  Also, LUV is low-balling a few markets where it is trying to grow rapidly.  Ticket prices will increase once the markets are more established, which will raise revenue and earnings.  In summary, Common Cents maintains that LUV is an attractive buy and would be fairly valued at a share price of $44. 



Common Cents Take: The growth prospects for LUV are unclear after this year.  However, LUV generates a great deal of cash and returns much of it to investors through share buybacks and dividends.  Any persistence of low oil prices will only enhance the growth prospects and return of cash to shareholders.

AAPL Purchase @ "$124"

Common Cents purchased AAPL as it declined to around $122.  The purchase consisted of a call option, which represents the right to buy 100 shares of the stock at a certain price.  More specifically, Common Cents purchased an October 16 call option with a $115 strike price for $9.00.  Common Cents' goal is to sell the option for a minimum of $10.00.

We purchased this call option due to the decline in AAPL's share price since the last quarterly earnings report, which we feel was a stellar report and did not warrant the decline in AAPL's share price.  AAPL's PE multiple is well below that of the S&P and does not reflect the fantastic management execution, future prospects, or balance sheet.

AAPL: Buy; PT $160; 3Q15 Update

AAPL: 7/27/15; $122.66

From Thomson Reuters I/B/E/S Estimates:

Forward Earnings: 9.45

Forward PE: 12.98

Earnings Growth Rate (EGR): ~10%

PEG Ratio: 1.30

S&P Forward PE: 17.82
S&P EGR: 7.16%

AAPL reported earnings on Tuesday, July 21, and...it was another great quarter.  Revenue in China increased over 100% year-over-year (y-o-y), Apple Watch sales exceeded management's expectations (whatever they were), and a staggering amount of iPhones were sold (and at an average price of $100 more than a year ago).  As is customary with AAPL's quarterly reports, it just wasn't quite good enough for the analyst community, and the stock dropped over 5% on the day following the report.

So what was the beef about this time?  iPhone sales in China.  Although iPhone sales increased by 35% relative to the year ago quarter, unit sales did not meet analyst's expectations.  The "miss" was attributed, with no basis that I've come across, to slowing sales in China.  China's stock market has recently suffered a pretty significant decline, and fear is that potential iPhone buyers have lost a significant amount of spending money due to this decline.  Apple CEO Tim Cook had this to say during the quarter:

"Nothing that's happened has changed our fundamental view that China will be Apple's largest market at some point in the future...I think this is a major point that many people miss, the LTE penetration in China is only at 12%.  And China doesn't possess the level of fiber that some other countries do...Also, and I can't overstate this, the rise of the middle class there is continuing, and it is transforming China.  McKinsey, I saw a recent study from McKinsey that's projecting the upper middle class to grow from 14% to 54% of households over the ten-year period from 2012 to 2022."

The China worry has some logic to it.  Even though their market is up 90% over the last year and 20% year-to-date, volatility can create a lot of losses for the buy-high-sell-low crowd.  However, smartphones have become more of a necessity than a luxury these days.  People will find a way to buy an iPhone if they are in the market for it.  Also, as Tim Cook points out, China has enormous growth ahead of it in the smartphone market, as most of the China network does not have LTE capabilities.  The long-term prospects for Apple in China far outweigh any near-term concerns, at least that's Common Cents's opinion.

China concerns aside, gosh what an awesome quarter.  And AAPL is valued below the average S&P company?!  We still maintain that AAPL's earnings will more likely accelerate than decelerate.  And so far, 33% y-o-y revenue growth and 45% y-o-y profit growth flies in the face of the "law of large numbers" theory.

Common Cents maintains that Apple is an attractive buy and would be fairly valued at a share price of $160, assuming a PE ratio of 17.0 is conservative given the great culture, long-term track record, potential for major breakthroughs in growth, and ability to return cash to shareholders if growth slows.  The assumed PE is below the current high-17 PE of the S&P, as we see the potential for a "correction" (sell-off) of the overall market after its extended duration of growth.  In addition, the lower assumed PE of AAPL is warranted given the polarizing nature of this position with investors.

Going forward, I hope to sell part of Common Cents's position to reduce the position to its target allocation when the share price nears $140.  Any pull-backs to $121 or below will create an attractive opportunity to trade an options contract.

Common Cents Take: Apple crushed this quarter.  Any China worries represent short-term thinking that does not consider the long-term growth prospects.  It is hard to argue that Apple is worse than the average company in the S&P, especially considering the 30%+ growth shown this quarter, which is what its current PE multiple suggests.

BP Purchase @ $36

Common Cents purchased shares of BP at $36.00 on a gradual decline related to the falling price of oil.  Based on oil supply reports, oil is currently in a glut, which is causing the price to continually decline.  The low oil prices will hurt BP's earnings; however, BP management has indicated its commitment to maintaining the dividend through debt, planned asset sales, and lowering capex.  The dividend yield at this purchase price is currently 6.66%.  This purchase increases BP above its target allocation in the Common Cents portfolio; therefore, this purchase will likely be sold if the share price reaches near $40 in the near future.

V Sale @ $76.5

Common Cents sold a portion of its Visa position at $76.5 on a sharp increase related to V's quarterly earnings report.  V was fairly valued prior to the release of the quarterly results, so a portion of the portfolio was trimmed to lock in some profit.  Going forward, the long-term prospects of V are intact, and the business seems to be performing better than expected, especially in a tough global environment.

YTD (2Q15) Performance Update: July 2015

YTD performance (as of 5/31/15): +0.47%

S&P performance (as of 5/31/15): +1.23%

Common Cents Portfolio is down by 0.76%!!

Portfolio Composition by Position:

AAPL:  13%

V:  10%

RH:  9% 

LUV: 7% 

CLNE: 7%

BP:  6% 

AGNC:  5%

T: 5% 

HD:  5% 

GLD:  3%

CASH: 31% 

Portfolio Composition by Sector/Industry (excluding cash):

Retail:  21% 

Technology:  20%

Energy:  17%

Financial Services:  15%

Industrials:  11%

Real Estate:  8%

Communication Services:  8%

2Q15 Review: The second quarter of 2015 was going gangbusters-the Common Cents portfolio was significantly outperforming the S&P.  However, maybe out of greed or boredom, Common Cents purchased call options for CLNE in hopes of making a small quick profit.  The trade immediately turned south and wiped out the majority of the years profits.  In addition, LUV was a significant underperformer due to certain seemingly negative news releases, which amplified the CLNE mistake.

Why is the CLNE option trade a mistake?  Common Cents purchased the options with no other conviction than, "it will probably go up and earn us a quick buck."  While the long-term prospects are still intact, and still speculative, making a "leveraged bet" using options amplified the volatility typical of this position, which exposed the portfolio to a significant amount of risk.  Lesson learned.

The CLNE trade has recouped some of its value but is still highly volatile.  The trade still has potential to regain its value, or even to turn a profit, based on the conservative way in which it was purchased.  However, the short-term headwinds are not in CLNE's favor, and the earnings report on August 5 will be key to exit this trade with minimal detriment to the portfolio.  The good news is, the rest of the portfolio is continuing to perform well. The damage due to the CLNE trade has reached its near-full effect, and performance can only improve from here.

Common Cents Take: The CLNE option trade wiped out the entire half's gains in a matter of a few days.  Options increase the volatility of the portfolio dramatically, especially when purchased for a volatile stock.  These trades should receive increased scrutiny before purchasing for a short profit.

LUV Sale @ $38.5

Common Cents sold a portion of its LUV position at $38.5 on a sharp increase related to its quarterly earnings report today.  The portion sold today was the previous portion bought for the purpose of trading.  The LUV position is now at its target allocation.

HZNP Purchase @ $35.40

Common Cents initiated a position in Horizon Pharma, a company that specializes in pharmaceuticals.  More information will follow in future posts.

AAPL Sale @ "125.12"

Common Cents sold its September 18 $115 call option for $10.12 as the price of AAPL's stock rose to slightly above $122.50.  Common Cents achieved a return of 12.4% on the sale of this option vs. an increase of 2.1% in the price of the actual stock.

Common Cents Take: Ka-Ching

AAPL Purchase @ "124"

Common Cents purchased AAPL as it declined to around $120.  The purchase consisted of a call option, which represents the right to buy 100 shares of the stock at a certain price.

More specifically, Common Cents purchased a September 18 call option with a $115 strike price for $9.00.  Common Cents' goal is to sell the option for a minimum of $10.00.  AAPL will have to increase, at a maximum, 3.3% (or to $124.00) for the option contract to reach $10.00.  More information on options trading will come in a future 101 post.

CLNE: Hold; 1Q15 Update

CLNE reported its first quarter 2015 results on May 11, 2015.  The results indicated that fuel sales are  continuing to increase by 20%+ year-over-year; however, overall revenue decreased relative to 1Q14.  The decrease was attributed to underperformance and deferred (not yet recognized) revenues related to the business segments outside of fuel sales.

The major concern with CLNE is when/if it will achieve profitability.  The main driver of profitability is likely fuel sales, as this aspect is the sustainable and predictable portion of CLNE's revenues.  CLNE has several opportunities to increase fuel sales: freight trucking, the virtual pipeline obtained through investing in NGAdvantage, rail, and marine.  Rail and marine may both be huge opportunities for growth; however, the development of these markets are not yet on the short-term horizon.  Freight trucking has been slow-growing and has not likely accelerated recently.  NGAdvantage's virtual pipeline, however, will likely have a significant impact on the next quarter's results.

CLNE inked a deal with International Paper (IP) to supply a significant amount of natgas to IP's mill in New York.  The deal should increase gallons delivered by nearly 3 million during the next quarter (relative to the first quarter).  The additional 23 accounts signed with NGAdvantage represent a minimum of 5 million gallons per a quarter, of which CLNE claims 51%.  Some or all of the gallons delivered to the remaining accounts may have been included in the previous quarter's gallons and, therefore, may not represent an increase.  There is much potential for increase in gallons delivered related solely to NGAdvantage; this next quarter may provide some clarification.

Common Cents Take: CLNE is developing multiple "shots on goal."  The stock is highly volatile on little news, but the pace seems to be continuing steadily (albeit slowly) with potential for acceleration.  "Adjusted" profitability may be achieved within a year, which will entirely change the game for investors.  Based on the uncertainties, Common Cents does not intend to add to this position in the near future.

BP: Buy; 1Q15 Update

BP reported its Q1 earnings on April 28, 2015 (wow, I'm late on this update).    The main highlights of the quarter were the increase in downstream profits and drastic decrease in upstream profits, which was related to the volatile drop in oil prices during Q1.  Oil prices have rebounded somewhat since; however, they are still down drastically from the $80 - $100 prices during the previous status quo.

The drop in oil prices greatly reduced BP's profits.  However, management has reiterated their commitment to maintaining the dividend, even in this lower oil price environment.  Several opportunities to maintain the dividend, as per management, include reducing exploration expenditure, continuing with the remaining $3 billion in planned asset divestitures, and increasing "gearing" or debt (currently at 18.4% with a management-specified cap at 20.0%).

Recently, an announcement was released that stated BP has come to an agreement to settle the claim with the United States government related to the Deepwater Horizon oil spill .  The settlement totaled $18.7 billion, which will be spread out over 15 - 18 years.  Numerous individual claims against BP have yet to be settled; however, the deadline for filing claims has passed.  Both of these developments clarify BP's exposure to the spill and will allow investors to ease their concerns about the maximum reduction in BP's profits related to the spill litigation.

Common Cents Take: BP is yet another step closer to putting the spill behind it.  The drop in oil prices has hurt BP profits; however, BP has multiple available options to create cash to maintain the dividend during this period.  Being that  Common Cents has invested in BP primarily for the dividend, Common Cents continues to view BP as an attractive Buy.  Going forward, Common Cents would like to purchase more shares when the dividend yields around 6% and at every .5% dividend increment above %6.

LUV Purchase @ $32.5

Common Cents purchased LUV at $32.5 during a steep intraday decline on July 1.  The decline was related to news of a probe into price collusion by the major airlines.

Common Cents Take: LUV just can't win.  Analysts lower earnings estimates on fears that the airline companies will increase competition, which will lower ticket prices and profits.  Then, the Department of Justice (DOJ) announces that it is launching a probe for not lowering ticket prices.  Since when is it a requirement to proactively reduce profits?  Doesn't the market (we ticket buyers) control that?

Going forward, Common Cents will look to sell the recently purchased shares near $35.50, as the position is now larger than the target allocation.

AGNC Sale @ $18.5

Common Cents closed out its position in AGNC on July 1.  The remainder of the position was sold at $18.5 per share.

Common Cents Take: The position should have been closed out earlier (near $21) when it was evident that a fed rate hike would cause the stock to decline.  There were no positive updates on the horizon at the time, and AGNC is going to have a difficult time managing its mortgage portfolio during a rising rate environment.