When the market was in freefall in early August,
intrepid investors could score gains by wading into stocks even as
many were pulling out. Sure enough, the market went on to rebound
later in August, but we've hit a rough patch again in early
September. With the market still up from those early August lows,
it may be time to adopt a different posture: use
strategies to eliminate exposure to an up or down market if you
simply lack conviction on how the rest of September -- and 2011 --
will play out.
This makes it a good time to adopt "pair trades," which means
buying (going "long") on one stock in a sector while shorting
(that is, borrowing shares at a certain price in the hopes the
price will go down, thus creating aprofit ) of a less appealing
Here are two pair trades I'm focusing on right now.
Pair Trade No. 1
Long: Exide Technologies (Nasdaq:
Short: A123 Systems (Nasdaq:
In a tough
, riskier business models always get shunned. This is why these two
battery makers may be perceived in a very different light in 2012
and 2013. Exide makes traditional car batteries and should post
decent results as auto makers maintain or even boost sales
from current levels. (Exide also benefits from the increasing
number of aging cars on the road, many of which have deteriorating
electrical systems that go through batteries more quickly than a
A123 Systems, in contrast, needs two things in order to be
successful: Demand for electric vehicles needs to become quite
strong in the next few years to propel orders for the company's
advanced lithium-ion batteries, and it needs to hope rivals don't
flood the market with too many of these state-of-the-art batteries.
It's the latter risk that will likely imperil the
. Asian manufacturers are bringing on so much capacity that the
whole industry may struggle to ever reach profitability as prices
drop. Analysts don't think A123 will turn a
before 2014, and even that forecast relies on fairly optimistic
assumptions about supply and demand. Instead, A123 may never
actually move into the black, setting this stock up to fall to new
lows in coming quarters as forward-looking assumptions get reduced.
Shares of A123 have rebounded nearly 50% since bottoming out in
early August on word that
may look to use its batteries in future vehicles. What's left
unclear is the size of any actual orders and at what price. A123
may find itself yielding to sharp industry pricing pressures and
never make a dime on this contract.
Meanwhile, Exide appears set for a nice rebound. The company has
struggled recently as a spike in lead prices (the company's highest
material expense) was slow to be passed on to customers. Exide
finally put in those price hikes recently, and quarterly results
should start to rebound. After losing money in each of the past two
quarters, Exide is expected to move back into the black this
quarter and see rising profits from there. Taking a broader view,
per share profits are expected to more than double in fiscal
(March) 2012 and rise another 50% to around $1.15 in fiscal 2013.
Shares trade for less than five times that figure.
Pair Trade No. 2
Long: GT Advanced Technologies (Nasdaq:
Short: Rubicon Technologies (Nasdaq:
Both of these firms make furnaces used to cure silicon and
semiconductor wafers used in the solar and chip industries. A quick
review of the order book thus far in 2011 shows two companies
moving in very different directions... GT Advanced has been
signing-up a raft of new customers, building a $1.5 billion
that could take upwards of two years to satisfy. Rubicon has had a
much harder time lining up fresh orders, in large part because GT
Advanced has come up with more advanced equipment and has been
wining on head-to-head bids.
To be sure, both companies are expected to boost sales at a
mid-teen percentage clip in 2012. And Rubicon's lack of recent
fresh orders won't bite for another year as it works through
backlog. But analysts increasingly think GT Advanced is poised for
strong growth in 2013 and beyond, while Rubicon may be hard-pressed
to grow at all due to its lagging technology position. Despite this
backdrop, GT Advanced is actually the less expensive stock, both in
terms of its price-to-earnings (P/E) ratio and enterprise
value-to-sales (EV/sales) ratio.
Shares of GT Advanced had surged from $10 to $17 earlier in the
summer, but the recent market swoon has wiped out almost all of
that gain. Trading at less than seven times next year's profits,
and with an order book that should help boost sales and profits for
the next few years, this stock has become too cheap to ignore and
looks like a much better rebound candidate than Rubicon when the
market finds its footing.
Why do shares of Rubicon look ripe for short sellers? Because the
company's technology platform is not as strong, forcing it to cut
prices to win business. Gross margins, which stood at 63% for the
first six months of 2011, should fall to 40% by the end of this
year, and close to 30% by the end of 2012, according to analysts at
Sterne Agee. As a result,
earnings per share (
should drop sequentially for the next six quarters, and the company
should exit 2012 with an annualized run rate of roughly $0.40 a
share. The stock trades for 30 times that figure.
Risks to consider:
The two long plays, Exide and GT Advanced, are dependent on the
auto, chip and solar industries. If those industries hit an even
deeper slump, then sales and profit forecasts for these firms may
need to eventually be lowered. That said, GT Advanced's strong
backlog and Exide's exposure to the replacement battery market
mitigate a lot of that risk.
Action to Take -->
It's time to stop worrying whether the market will hit an even
deeper rough patch. There are great "longs" to be had in this
market. But if you're still a bit uncertain, you might as well pair
them with the right shorts and protect yourself while still
-- David Sterman
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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