Earnings Provide A Short Term, High Income Opportunity
LabCorp (NYSE: LH) recently announced results for the second quarter ended June 30, 2019.The stock fell on the news.
Business Wire reported, the company’s Q2 earnings beat estimates, but margins fell.
“Q2 revenue of $2.88 billion, up 0.5% from $2.87 billion last year; excluding the disposition of businesses revenue grew 2.4%. Q2 diluted EPS of $1.93, down 15% from $2.27 last year; Q2 adjusted EPS of $2.93, down 2% from $2.98 last year.
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2019 adjusted EPS guidance of $11.10 to $11.40, up 1% to 3% over 2018.
2019 free cash flow guidance of $950 million to $1.05 billion, up 3% to 13% over 2018
Revenue for the quarter was $2.88 billion, an increase of 0.5% from $2.87 billion in the second quarter of 2018.
The increase in revenue was primarily due to acquisitions of 1.4% and organic growth of 1.7% (which includes the negative impact from PAMA of 0.9%), partially offset by the disposition of businesses of 1.9% and foreign currency translation of 0.7%.
Operating income for the quarter was $335.7 million, or 11.6% of revenue, compared to $369.2 million, or 12.9%, in the second quarter of 2018.
The decrease in operating income and margin was primarily due to lower Medicare and Medicaid pricing as a result of PAMA, higher personnel costs, cybersecurity expenses, and higher special items from acquisition and disposition-related costs, partially offset by increased demand and LaunchPad savings.
The company recorded restructuring charges, special items, and amortization, which together totaled $111.2 million in the quarter, compared to $94.3 million during the same period in 2018.
Adjusted operating income (excluding amortization, restructuring charges, and special items) for the quarter was $446.9 million, or 15.5% of revenue, compared to $463.5 million, or 16.2%, in the second quarter of 2018.
The $16.6 million decline in adjusted operating income from 2018 included the negative impact from PAMA of $27.1 million.
Net earnings in the quarter were $190.4 million, compared to $233.8 million in the second quarter of 2018.
Diluted EPS were $1.93 in the quarter, a decrease of 15.0% compared to $2.27 in the same period in 2018. Adjusted EPS (excluding amortization, restructuring charges, and special items) were $2.93 in the quarter, a decrease of 1.7% compared to $2.98 in the second quarter of 2018.
Operating cash flow for the quarter was $253.5 million, compared to $387.4 million in the second quarter of 2018. The decrease in operating cash flow was primarily due to higher working capital requirements to support growth.
Capital expenditures totaled $85.2 million, compared to $87.2 million a year ago. As a result, free cash flow (operating cash flow less capital expenditures) was $168.3 million, compared to $300.2 million in the second quarter of 2018.”
The stock could be headed lower after failing to challenge its old highs.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.
Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
A Bear Call Spread in LH
For LH, we could sell an August 16 $170 call for about $3.45 and buy an August 16 $175 call for about $1.07. This trade generates a credit of $2.38. which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $238. The credit received when the trade is opened, $238 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $262. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($238).
This trade offers a potential return of about 90% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if LH is below $170 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $262 for this trade in LH.