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Two Pair Trades to Play It Safe - 23692 views
MINNEAPOLIS (Stockpickr) -- I’ve analyzed dozens of companies during the latest earnings season. For the most part, companies beat estimates by a wide margin. As a result, stocks have gained more than 5% so far this year as measured by the S&P 500.
Not even a minor correction can take the enthusiasm out of the market. As if on cue, dollars are finally rotating from safer securities such as Treasuries and into stocks or other more-risky assets. This is exactly what the Federal Reserve was looking for with its essentially free money interest rate policy.
On a stock-by-stock basis, many names have zoomed higher, not just this quarter but over the last two years. Where that puts us today is in a bit of a quandary.
On one hand, we are still early in an economic recovery from a very deep hole. On the other hand, recent gains in stocks lead to valuations that may be a bit ahead of themselves. Earnings estimates for the future are on the rise too. For companies to beat estimates they will be jumping over a higher bar.
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Call me conservative, but I like to make my money when the odds are in my favor. Lately, the odds that corporate earnings continue to blast by estimates are decreasing with every quarter. Thus, I do suggest a more conservative approach when it comes to investing over the coming months.
The recent correction may be merely a taste of what is to come. In order to best protect gains, investors can apply the brakes with a long/short pair-trade strategy. By going long one stock and short another, investors hope to secure gains if stocks continue to rise and to lose less if stocks stumble.
Here are two pair trades to consider to secure gains if stocks continue to rise and to lose less if they stumble.
Long Time Warner/Short New York Times
Media companies have been hurting disproportionately compared with other industries. Heavily reliant on advertising dollars, media companies are particularly vulnerable during a recession. It is always easy to cut marketing dollars when times are tough.
Within the media industry, the print business has been on the decline since the advent of the internet. Although some companies have transitioned to include online advertising, the dollars spent there simply cannot make up for lost print ads. Many print companies have struggled mightily, with some venerable names actually filing for bankruptcy over the last two years.
From an absolute return perspective, long/short investors can play this dichotomy between print and other medium. In particular my thesis would be to suggest that a cable television company, or at least a diversified media company, will fare better than one predominantly based on print.
My picks would be to go long Time Warner (TWX) and sell short New York Times (NYT). With stocks possibly ready for a step back, I would expect New York Times to see more losses than Time Warner. On the upside, well, I’m not sure what the upside is for New York Times other than being possibly bought in an acquisition.
In a recent update, New York Times noted that print ads in February were down in the single digits on a percentage basis. Using a bit of wordsmithery in the release, the company stated this was an improvement over January. So print ads are down -- but just not by that much.
It did say that online ads were higher in the single digits but that they still represent only 15% of total revenue for the company. The company says it will begin charging for content. I’d be skeptical that fees can make up for lower online revenue, but management clearly is hoping they will.
The fact is that pay models on the Internet have proven to be problematic in many ways. The Wall Street Journal seems to pull it off, but will a more liberal audience for The New York Times be receptive to paying for content? I’m not so sure.
From an investing standpoint, the play here is to go with the more stable model, and that would be Time Warner. The cable media company made $2.40 per share in 2010. Analysts expect that number to grow to $2.74 in 2011. At current prices, Time Warner trades for just under 14 times forward earnings estimates.
In contrast, New York Times made 82 cents per share in 2010, but analysts expect that number to slip to 58 cents per share in 2011. Now, things may go differently, but there is simply more risk with New York Times at a time when stocks are not likely to move much higher than current levels.
Irving Kahn's Kahn Brothers increased its stake in NYT by 17.9% in the most-recent period, while Leon Cooperman's Omega Advisors increased its position in Time Warner by 349.6%. TWX is one of TheStreet Ratings' top-rated media stocks.
Long Dollar General/Short Casey’s General
The theme for this pair trade isn't that both names include the word "General"--that's just a coincidence. With oil prices blasting through $100 per barrel, the consumer is once again seeing its budgets tighten. The result will be a continued effort to save money, including figuring out a way to cut back on driving -- and that has me concerned about convenience store Casey’s General Stores (CASY).
The gasoline station and convenience store chain makes its money on volume of customers coming through its doors. Higher gas prices means fewer trips to the station. Fewer customers put future revenue and profit at risk.
On the flip side, where do customers turn when looking for bargains? Dollar General (DG) discount retail model makes it the perfect long compliment to Casey’s General in an environment of higher oil prices.
Dollar General competitor Family Dollar (FDO) recently received -- and rejected an acquisition bid from billionaire investor Nelson Peltz. Dollar General shares jumped by more than $4 following the bid. It follows that investors in Dollar General have the added benefit of a potential acquisition of that company.
From a valuation standpoint, both Casey’s General and Dollar General are priced below their expected growth rates. Dollar General shares are priced at 13 times January 2012 estimated earnings of $2.14 per share. Those earnings represent approximately 18% improvement over the 2011 numbers.
Casey’s General shares are similarly priced. Shares trade for a little more than 12 times April 2012 estimates of $3.30 per share. Assuming the company hits its 2011 number of $2.77 per share, earnings are expected to grow by 19%.
The difference between the two companies is in the assumptions. My belief is that Wall Street has yet to factor in slowing traffic at Casey’s General due to rising oil prices. With gasoline prices already high, imagine where they will be when the summer driving season starts.
I’m all about realistic expectations and rational analysis. In my opinion, investors will see estimates for Casey’s General adjusted lower over coming months, making going long Dollar General and shorting Casey’s General a strong pair trade.
As of the most-recent reporting period, Dollar General was a top holding of Steve Mandel's Lone Pine Capital, which increased its position by 58.8% during the quarter. Lee Ainslie's Maverick Capital boosted its position in Dollar General by 15.4%. Casey's General shows up on a recent list of 21 possible retail M&A deals in 2011 and is one of TheStreet Ratings' top-rated food and staples stocks.
To see these stocks in action, check out the 2 Pair Trades for a Toppy Market portfolio.
At the time of publication, author had no positions in stocks mentioned.
Jamie Dlugosch is a founder and contributor to MainStreet Investor and MainStreet Accredited Investor. Formerly, he was president and CEO of Al Frank Asset Management. He has contributed editorially to The Rational Investor, The Prudent Speculator, Penny Stock Winners and InvestorPlace Media.