It’s Friday. We’re entering the final weekend of February. Next weekend, we’ll be in March; spring will be on the way.
This week in the markets was all about Nvidia (NVDA) and the proposed merger between Capital One (COF) and Discover Financial (DFS). I’m confident in Nvidia’s future. I’m not so sure about regulators letting the merger of two credit card companies stand. I guess we’ll see.
In yesterday's options trading, there were many puts and calls with days to expiration of more than a year -- 36 to be precise. While finding some unusually active options for the long haul from this cohort is tempting, I will go with three options with slightly shorter durations, but all 84 days to expiration or higher.
Have an excellent weekend!
Alight
Alight (ALIT) provides cloud-based human capital management and business solutions software to approximately 70% of Fortune 100 companies. The company’s products and services reach more than 36 million employees of these companies and their dependents.
Over the past three years, Alight has been in the midst of a transformation to create a more growth-oriented and profitable business. For the most part, it's been very successful. On Jan. 1, 2021, it had revenue under contract of $2.1 billion. On Jan. 1, 2024, it was $3.0 billion.
The company’s BPaaS (business process as a service) revenues increased by 29.8% in Q4 2023. They now account for 23.1% of its overall revenue. BPaaS cumulative bookings were $2.2 billion as of Dec. 31, 2023, $700 million higher than its three-year plan.
Equally significant is the profitability improvement. In 2023, its adjusted gross margin improved by 210 basis points to 37.0%, leading to a 21.7% adjusted EBITDA margin. At the same time, it managed to reduce its net leverage ratio to 3.3x in 2023 from 3.9x in 2022.
In 2022, it converted 43% of its EBITDA to operating cash flow. In 2024, it expects to increase that to 60% at the midpoint of its guidance. Further out, it’s targeting 60-80%, leading to higher adjusted net income.
It’s a work in progress.
Interestingly, ALIT had a May 17 $9 call with a Vol/OI ratio of 38.78 on Thursday and a May 17 $9 put. Both are equally interesting. With 84 days to expiration, the former had an ask price of $0.70 for an 8% down payment based on its $8.92 closing price. You can double your money on the call if its share price increases by $1.28 (14.3%) over the next 12 weeks.
However, I like this stock for the long haul. If that happens, you’ll want to exercise your right to buy 100 ALIT shares.
As for the put, its bid price was $0.55, good for a 27% annualized yield. That’s very respectable. Trading slightly in the money, its shares have gained nearly 18% over the past three months. It may deliver a repeat performance over the next three months.
Of the two, the put is the best bet because it gives you a lower entry point on the stock should its share price reverse course.
Starbucks
Starbucks (SBUX) stock is down 7.5% over the past year and 11.3% over the past three years. It’s going through one of those low points that every good company’s stock goes through. Long-time shareholders have little to worry about. In my experience, the company always finds a way to deliver value for shareholders.
Starbucks had six unusually active options on Thursday. The one that caught my attention is the Jan. 17/2025 $130 put with 329 days to expiration. Well, in the money at this point, the $31.50 bid provides an annualized yield of 37% based on its $95.78 closing price and a net price paid of $98.50 should you have to buy the shares at expiry.
If this were an income play only, I would be hesitant about the put because it’s doubtful, given its current slump, that its share price will increase 36% over the next 47 weeks. I hope I'm wrong, but I doubt I will be.
To get there, it needs a catalyst. China is the place to look for growth beyond its traditional stronghold in the U.S.
In January, it reported Q1 2024 results. Its China business hasn’t bounced back as quickly as hoped, sending some investors to the sidelines.
“In China, we remain very confident in the long term,” Investor’s Business Daily reported CEO Laxman Narasimhan’s comments during the Q1 2024 conference call. “The market is going through a transition as we see an increase in mass market competitors, which we believe will shake out over time, and the market will emerge looking fundamentally different than what we see today.”
The company’s guidance called for 5% same-store growth in China at the midpoint. Its Q1 2024 press release tempered its enthusiasm, suggesting same-store sales growth will be in the low single digits.
There is a risk in selling this, should things worsen or not get better. The longer duration is a double-edged sword. On the one hand, it allows enough time to recover in China. On the other hand, three quarters are to be announced before the put expires. If they’re all meh or worse, your downside risk grows exponentially.
I don’t think Starbucks will deliver three straight poor quarters out of China, but that’s out of my control. Long-term, I remain bullish about its future.
UiPath
UiPath (PATH) is a leader in RBA (Robotic Process Automation) and BPA (Business Process Automation) software. Its end-to-end platform software solution enables companies to automate routine and repetitive processes, freeing staff to do more analytical work and adding value to their businesses.
UiPath has integrated AI into its RPA and BPA solutions like most tech companies. AI can more quickly find ways to automate processes that their customers might not have considered in the past. These are called AI solution accelerators. It has 10 for RPA use cases and two for BPA processes.
Its business model is very attractive because of the recurring revenue generated by the company. In Q3 2024, its annualized renewal run rate was $1.38 billion, 24% higher than a year earlier. This means it’s both retaining existing customers and adding new ones.
At the same time, its dollar-based net retention rate was 121%, which means customers of a year or longer are spending 21% more than they did a year earlier. As it continues to add new customers, its profitability will grow.
As tech stocks go, I like it a lot. It’s got a shot to return to $80, where it traded in 2021. It just has to keep adding new customers while keeping long-time customers happy and spending more. It’s not an easy task, but I like its chances.
The option in question is the Aug. 16 $35 call. Expiring in 175 days, the $1.05 ask price is a 3% down payment on its shares. With a delta of 0.22457, you can double your money on the call if the share price increases by $4.68 (20%) over the next 25 weeks.
Based on Thursday’s closing price of $23.42, it’s well out of the money. However, its share price is up 30% over the past three, so it’s capable of generating outsized returns in short order.
Ultimately, the worst-case scenario is that you’re out $105 per contract.
On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
