🗞 Hail Mary?

WHILE YOU POUR THE JOE… ☕️
Back to Back

Remember a few weeks ago when we pitched a strong buy on the 20+ year Treasury Bond ETF (ticket $TLT)? 📈 

Just like that, we ran it from $90 to $101.5 and then Tweeted live to exit it as we saw some seriously aggressive sell orders to absorb any new potential buyers.

Now that bond yields are back up to 4% on the ten-year, the $TLT ETF is beginning to look like a reasonably attractive buy once again 👀.

The initial target is $96 if the price can attract new aggressive buyers to break back above the recent rejection.

If it fails and continues lower, I feel comfortable shorting it down to $94.75. There, I would watch out for new aggressive buyers once again and then flip my book to go long.

Not set in stone, but definitely looks like a gameplan for this week. 🔥 

Speaking of gameplans, let’s get on with today’s email 📧…

A CHANCE AT REDEMPTION
Walgreens Nostalgia

Remember when Carvana was a stock that was essentially going to $0 📉 in early 2023? I mean, it all made sense for it to go bankrupt on a fundamental basis: all the debt, lack of cash flow and earnings, and weakening vehicle market dynamics made it the perfect short.

But

Management had other plans in mind, it proposed a convertible bond for investors at a rate they could not refuse, this essentially did two things:

1. Restructure the company’s capital profile, easing its debt burdens and gauging for interest from markets and their belief as to whether Carvana could make a comeback.

2. As many buyers came in for these convertible bonds, markets realized that there was a lot of upside left in the stock now that management had finally made the right move.

From there, Carvana went on to 20x 💥, one of the biggest trades I never took, but I saw it coming, and that hurts.

Anyway, after being a long-term bear on Walgreens, even calling for it to go to $0 and go bankrupt, I now have reason to believe that it might become another Carvana story.

MIGHT.

First of all, I think the issues stem from the current business model in brick-and-mortar locations, while competitors like CVS are shifting to a more online and flexible model.

Knowing that Walgreens might go out of business if they don’t pivot hard and soon, management pulled a rabbit out of the hat and pitched a solution.

This involves closing down underperforming locations, investing in their digital presence, and doubling down on the pharmacy sales and prescriptions business, which is what actually works.

So far, this shift has created up to $1.6 billion in cost savings 💵 from a decreased need to invest in capital expenditures for physical locations, as well as margin expansion from less overhead as physical locations close.

In addition, they expect to receive $2.1 billion in proceeds from the sale of their Cencora shares.

But here’s why I think there’s still some juice left in the company:

This isn’t new to the markets, but at only 0.6x price-to-book ratios, the discount to the equity left in the business makes this an attractive proposition.

With up to 24% growth in Walgreens’ new digital branch and healthcare programs, which carry little to no overhead costs, I think margins and earnings could start to shift higher as the mix goes away from physical locations and into digital.

There’s just one problem, though. You need to give the business room to breathe while it recovers from whatever disease it contracted, and paying out an 11.5% dividend that costs the business more than a billion per quarter is not the way to do that.

I would be happy to see management postpone the dividend (Even Disney did this) to let the cash flow back into the company and aid in its transformation efforts.

Sure, this might bring a lower stock price, but so be it!

Pain Trade Status

You see that big red bar at the bottom of the Walgreens distribution? That means the most volume traded for the entire year for Walgreens stock was at the current price, or just a tick above.

This is not new selling, as there are a few institutions that decided to plunge into the stock over the past quarter, judging from the 13-F filings reported as of October 2024:

• MassMutual Trust: New position at $50,000

• Central Pacific Bank Trust: $72,000 position

• Czech National Bank: $1.3 million position

Knowing that the most volume seen during the year (at this price) has been mainly occupied by institutions, we expect to see more accumulation in the coming months and some positive headlines after these entities are done buying.

Looking at the options chain, I think the $12.5 level has the most interest 🎯, as it is also at the top of the current volume distribution.

That tells me markets want to see a run from today’s price up to that upper range in the distribution on this new institutional buying, and hitting the $12.5 or higher level would mean a run of over 43% 🔥.

But given that short interest in Walgreens stock is up to 13% of the float, this could easily become a pain trade. The bets are too focused on the short side, and if these bears are proven wrong, the pain is too great to hold the position, creating a massive exit.

When shorts exit, they buy the stock to cover their position, a process known as a short squeeze. This is the same as what happened to Carvana, so of course, we don’t want to go long the stock alone.

Instead, we’re going to consider buying those call options with a $12.5 strike, ideally for the next quarter's expiration, which is January 2025.

These contracts now trade at roughly $40 each, so this would be a massive multi-hundred contract position for us, which is fine considering there are 37.8 thousand contracts liquid.

We’ll Tweet about this position live on our Twitter account, so follow us.

TRADE OF THE WEEK
Long / Short = Bread & Butter

Last week, we posted our breakdown of the manufacturing PMI index, arriving at a long bias for the Computer and electronics industry based on all of the drivers being in expansion, just like the overall index.

But that’s where we stopped, and we promised to go over our stock selection in the following posts as we had already landed on the right industry.

So, as promised:

Long Candidates

Here we go, it is SentinelOne ($S), CyberArk Software ($CYBR), and CoStar Group ($CSGP) that stand out in the following metrics against the industry:

• Forward P/E premiums to the industry and the market ✅ 

• Earnings per share growth above the industry and the market, justifying the premium ✅ 

• PEG2 ratios below the industry and market to show this potential growth is not yet priced into the stock today ✅ 

For these reasons, we keep them as our long candidates, but one metric made us stick with one, and that is the price-to-book (P/B) ratio.

CyberArk trades at the highest premium of 13.6x P/B today, and that, along with a few other statistical tests, keeps us running with this selection for the long leg of the trade.

Fundamentally, here’s what we liked as well:

Double-digit growth 📈 rates across the board, and 90% of the company’s revenue comes from contracts, so the model is pretty stable going into the future.

Here’s my favorite though, operating cash flow jumps..

Going from a $5 million loss in the same quarter last year to a $112.9 million gain this year is enough to send the stock trading at new all-time highs, but since everyone cares about EPS and net income, this buys us enough time before everyone finds out.

That all looks amazing, but is it time to buy?

Yes and no, I’d like to see it come down to the quarterly VPOC level of $272.25 to $275 roughly and find new aggressive buyers come in to support the stock hold that level and rally back.

Short Candidates

For the negative outlier, we found an opportunity in Check Point Software Technologies ($CHKP).

Based on the forward P/E discount, the below-average EPS growth, and the high PEG2, this stock is not only set to underperform but also expensive relative to its prospects today.

The financials look similar to justify this situation:

Nobody said they’re losing money, but they’re definitely not boosting their profits as aggressively and quickly as the long candidate is, and underperformance in today’s mania-driven market is enough to send this stock down 📉.

The chart is almost there as well:

Ideally, we want to see this stock come back to the low-volume area of $195.25 and see further aggressive sellers step onto the plate for a big swing.

From there it’s nothing but air down to the $186.25 area 🎯, where I think we retest and see another potential leg down or recover back to the middle of the range before new buyers come in again.

Trade Set Up

That’s not enough though, as what we’re ideally looking for is the market-neutral nature of these trades, so here’s how quants set this up:

The spread between the two stocks (Price of $CYBR minus price of $CHKP) shows a strong correlation and mean-reversion character.

Under this strategy, we want to buy the spread at a negative deviation (such as today) and take profit back at its mean value.

In this case, based on the highlighted Delta Hedge above, we want to short 2.7 shares of $CHKP for every 1 share we buy in $CYBR.

For easy numbers, think 100 shares long $CYBR, 27 shares short $CHKP, then your position will be market neutral.

As far as expectations, here’s some math to back up our views:

Both an AdFuller and Stationarity test suggest that this spread is stationary up to the 99% confidence interval. This means there’s a very high chance that it will go back to the mean from today’s deviation. ✅ 

Happy trading. 🫰 

NOW GO AND MAKE IT HAPPEN
Welcome To the Future

If all that long/short mean-reversion above confused you, please take this as a wake-up call. In a few years, discretionary trading will be dead, and most of the analysis we currently do by hand in Excel will be automated by Python and C# scripts—most of it already is.

So, you could get the hang of the beast. Today’s book recommendation 📖 does just that. You will gain an insight into some of the most popular algorithmic trading strategies ran at the biggest banks and hedge funds today.

To your success,

G. 🥃