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Turnaround Candidates?

Richard Croft
March 14, 2011
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Options traders willing to place contrarian bets on companies facing short-term headwinds might consider a couple of Canadian industrials that have seen their share prices slide on what seems simply to be short-term negative sentiment.

SNC-Lavalin Group Inc. (TSX: SNC, Recent price $54.98), the Montréal-based global engineering and construction company, which just happened to have infrastructure projects on the go in strife-torn Libya, including work on airports, waterworks, and prisons. Those projects accounted for some $400 million of SNC’s top-line revenue. Although the company reported a 41% surge in fourth-quarter profits (to $139.2 million) on a 20% increase in revenue (to $1.9 billion), and a 23.5% dividend increase (to an annual $0.68), it offered guidance for only flat growth in 2011. Shares have plummeted more than 10% in the past three weeks as a result.

But the company is notoriously conservative in its earnings guidance projections, and equally aggressive in going after new business. It’s a fair bet that not only will the Libyan business eventually revive under the current or new regime (it doesn’t really matter which), but also that new projects will come on stream to compensate for the (probably temporary) loss of the Libyan income stream.

With that in mind, you might want to look at buying calls on SNC. Premiums are relatively cheap, and with a call, your risk is limited to the price of the option. With SNC, the SNC June 56 calls at $2.30 look interesting.

In the case of Canadian Pacific Railway Ltd. (TSX: CP, $63.03), falling traffic volumes and the departure of Chief Operating Officer Ed Harris have also dragged down its share price about 7.5% over the past month. The company has underperformed in achieving its operating performance targets, a number of analysts have downgraded CP, and the share price has suffered accordingly. Interestingly, we might say the same thing about Canadian industrial in general, as the sector has become oversold on extreme bearish sentiment.

The question is whether the market has taken more than its pound of flesh from the sector and most importantly CP Ltd. You have to think that CP’s large bulk capacity throughout North American and its improving operating efficiency bodes well for business. Particularly if growth in Asian demand for raw materials originating in North America continues.

Technically, the stock has had support around the $62 level. Which might be a decent entry price for investors who think the a turnaround might be overdue. One strategy for CP would be to sell the July 62 puts at $2.75 per share. The sale of the puts obligates you to buy CP at $62 per share anytime between now and the July expiration. Last day of trading for the July option series is July 15th.

If the stock declines by July and the puts are exercised, you will be required to buy the shares at $62. However, you retain the $2.75 premium, which means that your net cost for the shares would be $59.25.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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