Earnings Indicate This Company Might Be an Unbeatable Bargain
If analysts are right, this company is trading at about 5 times earnings. And, stocks with price to earnings (P/E) ratios near 5 are unusual in this market.
Finding deeply undervalued stocks typically means looking in industries that are out of favor. As fears of a recession rise, makers of large consumer goods become an out of favor industry. After all, fewer consumers will be able to buy cars and other big items in an economic down turn.
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This all indicates it could be time to look for bargains among auto makers like Ford or GM. It also means it could be time to look at the companies that supply those large companies.
An Auto Parts Supplier Delivers String Earnings
Adient plc (NYSE: ADNT) is an automotive seating supplier. The company designs, manufactures and markets a range of seating systems and components for passenger cars, commercial vehicles, and light trucks, including vans, pick-up trucks, and sport/crossover utility vehicles.
ADNT also makes instrument panels, floor consoles, door panels, overhead consoles, cockpit systems, decorative trim and other products. The company also supplies various seating systems to the international motorsports industry through its RECARO brand of products.
While it might not be well know, ADNT is a large company. It operates approximately 230 manufacturing or assembly facilities, with operations in over 30 countries.
ADNT recently delivered its latest earnings report and according to ZACKS, the company “reported fourth-quarter fiscal 2018 adjusted earnings per share of $1.30, beating the Zacks Consensus Estimate of $1.26.
The bottom-line figure in the year-ago quarter was $2.32 per share. In fiscal 2018, the company reported adjusted earnings per share of $5.62.
During the quarter under review, Adient reported net sales of $4.15 billion, up 4% from fourth-quarter fiscal 2017. Further, the top line beat the Zacks Consensus Estimate of $4.12 billion.
During the reported quarter, gains generated from the Futuris acquisition and increased volume aided revenue growth. In fiscal 2018, the company reported revenues of $17.4 billion, up from the fiscal 2017 figure of $16.2 billion.
During the quarter under review, net loss attributed to Adient was $1.36 billion against the net income of $344 million in fourth-quarter fiscal 2017.”
Digging Deeper Into the Numbers
Looking at individual segments, the Seating segment of the company reported net sales of $3.75 billion, up from $3.61 billion in fourth-quarter fiscal 2017.
Adjusted EBITDA for this segment amounted to $301 million, down from $403 million in fourth-quarter fiscal 2017.
The Seat Structures & Mechanisms (SS&M) segment reported revenues of $705 million, up from $670 million in the prior-year quarter. Adjusted EBITDA for this segment amounted to negative $34 million against $4 million in fourth-quarter fiscal 2017.
But, perhaps most importantly from a trading perspective, traders seemed pleased with the report.
This could mark the reversal of a down trend.
A Trade for Short Term Bulls
As with the ownership of any stock, buying ADNT could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for ADNT
For ADNT, the December 21 options allow a trader to gain exposure to the stock.
A December 21 $26 call option can be bought for about $1.20 and the December 21 $28 call could be sold for about $0.70. This trade would cost $0.50 to open, or $50 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $50.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in ADNT the maximum gain is $1.50 ($28 – $26 = $2.00; $2.00 – $0.50 = $1.50). This represents $150 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $50 to open this trade.
That is a potential gain of about 200% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.