Sold Cash Secured Put + Investment Thesis – Seagate Technology PLC (STX) – $31.00 strike – Aug 18 Expiration

This trade was actually executed on Tuesday 07/25/17. I didn’t get a chance to write about it until today.

Please visit the core philosophies article on my investment thesis process for a deeper explanation of the components of this article.

In case you missed it, I’m making it a point to twitter all my trades when I make them. This was no exception:

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I have updated the portfolio and income tracker pages to reflect this position.

Dividend Cycle

STX has already announced their next ex-div date and it will be September 19, which is about a month after this contract expires, so not too long to wait if assigned, but also enough time to maybe squeeze another contract in if it expires worthless?

The quarterly distribution will be $0.63/share, which is where it’s been since November of 2015. There is one more chance in 2017 for STX to raise the dividend and extend their streak to 7 consecutive years which would maintain their challenger status. I have no idea if they’re going to give a token raise in December or not. Honestly, I wouldn’t be that upset if they froze it, but their cash flow situation is strong enough, there’s plenty of wiggle room to go ahead and raise it a little bit.

The premium from this contract is less than half the quarterly distribution (which says something about the yield). But to be fair the contract is only in force for 24 days.

Investment

# contracts

Strike

Expiration

Total Premium

Days in Force

Annualized Return

Closing Price

Downside Protection

1

$31

08/18/17

$29.20

24

14.33%

$33.20

6.63%

The QC (Quantitative Case)

Payout Ratio – EPS, FCF

103.7%, 51.4%

10 Year Revenue CAGR

-0.18%

10 Year EPS CAGR (5 Year EPS CAGR)

5.58% (-4.95%)

5 Year ave P/E – Current P/E (ttm)

-0.22

5 Year ave Yield – Current Yield  

-3.24%

10 year mean DGR (dividend growth rate)

22.2%

Debt/Market Cap

$5.23B/$9.51B (55%)

Total Cash

$3.03B

Return on Assets

8.68%

Return on Equity

44.24%

Profit Margin

6.61%

EBITDA/Revenue

$1.96B/$11.02B (17.8%)

Reverse DDM Fair Value DGR at Strike

1.87%

Assumed DGR (DDM valuation 10% disc.)

3.0% ($36.00)

DGR Margin of Safety

1.13%

Dividend Cushion Ratio (2.26% DGR)

1.69

Cash from Ops “cushion”

-21.47%

Capex “cushion”

+86.34%

DGR “cushion” (delta)

+20%

Okay so I realize that’s a little bit more red than usual. A few excuses:

  1. Payout ratio of earnings is way less important to me than FCF. Earnings are weird.
  2. Similarly, I care more about historical yield than PE. The PE is pretty close to 5 yr average. Good enough.
  3. 10 yr revenue is basically flat, which isn’t good, but this isn’t a growth story. It’s a “is that ridiculous dividend safe story?”
  4. EPS 10yr CAGR good, 5yr CAGR bad. Reiterate: not really about growth
  5. Market cap changes with stock price. Stock is beaten down, Market cap is wiped out. Most of the time it’s a good indicator of debt level but it’s far from perfect. Div cushion also factors debt situation and that’s very healthy.
  6. ROA goal is +10% or better. +8.68% is pretty close.
  7. This would fail a lot of DGI screeners focused on earnings, and or historical performance. Dividends come from future cash flows, and those actually have a pretty decent buffer, which is surprising considering the yield.

SPL (Strike Price Logic)

There was a pretty big jump in premiums from the $30 to $31 strike price. Seagate announced their earnings at market open on Tuesday July 25 and Mr. Market freaked the fuck out. Right after the opening bell it was down nearly 20%. It recovered a little bit, but it was still a pretty wild ride. The options market doesn’t usually get warmed up until a little later in the morning. Probably because the robots get up to some weird shit first thing in the morning.

Anyway, by the time I sold this it was up to the mid $33s maybe even almost $34. The $31 strike represented pretty substantial downside considering that the price had already cratered.

Implied volatility tends to be a lot higher BEFORE earnings, then once the surprise is out, it all unwinds. So to be able to get this kind of premium still with considerable downside was pretty good. Although I guess that means the market is worried it will keep going.

If it does keep going that far, it will yield over 8%. Which under most circumstances, would be worrisome, but the dividend cushion is a very favorable value. Do I dare say this is a “safe” 8% yield? I mean as “safe” as that sort of thing can be?

QWaF (Qualitative Warm and Fuzzy)

There’s been a lot of consolidation in the Hard Disk Drive (HDD) industry. They went from like 10 different manufacturers to 3, and STX is one of the ones left standing. That’s generally good from a competition and margin support perspective.

HDDs are still the go to storage mechanism for big cloud data storage infrastructure. There’s going to be a lot hard drives built for the cloud in the next however many years, and STX is one of three companies who make them.

CPR (Cold and Prickly Risks)

The problem is that, at least in PCs, Solid State Drive (SSD) technology has historically been so much more expensive than it is today, that it didn’t compete much with HDD. Well it’s been progressively taking away more and more of the PC market share. The PC market has been STX’s bread and butter and it’s shrinking because people would rather have an SSD in their new laptop if it’s not that much more. It isn’t.

Plus there just aren’t as many PCs being made as there used to be. The company has definitely felt the pinch, and there’s no guarantee that the cloud hardware upside is going to be able to offset the PC hardware downside. They’re currently paying an 8% yield though, which means they don’t really have to grow much (market implied DGR of 2% with 10% discount rate), they really just need to maintain.

The healthy dividend cushion ratio suggests to me that they’ll be able to do that, and the fact that 11% of shares outstanding are held by insiders suggests to me that if there’s any way they can maintain the payout, they will.

So let’s do this!

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