Zacks Bull and Bear of the Day Highlights: Suncor Energy, Federated Investors, Cummins, Westport Innovations and Caterpillar

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Jul 12, 2011, 09:30 ET

CHICAGO, July 12, 2011 /PRNewswire/ -- Zacks Equity Research highlights Suncor Energy (NYSE: SU) as the Bull of the Day and Federated Investors, Inc. (NYSE: FII) as the Bear of the Day. In addition, Zacks Equity Research provides analysis Cummins (NYSE: CMI), Westport Innovations (Nasdaq: WPRT) and Caterpillar (NYSE: CAT).

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Full analysis of all these stocks is available at http://at.zacks.com/?id=2678.

Here is a synopsis of all five stocks:

Bull of the Day:

Suncor Energy (NYSE: SU) is one of the best positioned companies to benefit from the oil price recovery over the next several years, in our opinion,. The company's asset base includes substantial conventional reserves and production at offshore Eastern Canada and in the North Sea, which generate strong margins and should provide free cash flow to fund future oil sands expansion.

With a large portfolio of growth opportunities, unique asset base and high return potential in the long run, the company has a competitive edge over its peers. We are also encouraged by Suncor's improving oil sands operational performance and execution of its cost saving initiatives. The company is also getting back on track following its merger with Petro-Canada.

Additionally, given our bullish outlook for the medium-term oil price scenario, we think the company is nicely positioned to benefit from its leverage to commodity prices. Considering these factors, we believe Suncor is well positioned going forward and consider it an attractive investment.

Bear of the Day:

We are downgrading our recommendation on Federated Investors, Inc. (NYSE: FII) to Underperform from Neutral based on expected downward pressure on assets under management (AUM), flows and margins. Regulatory backdrop, waning equity markets and sluggish global economic growth are expected to keep earnings under pressure.

Federated's lowered AUM has resulted in a negative organic growth in the core business as investors are transferring cash from money market funds to higher yielding bank deposits or investments across the fixed income universe and equities. A significant reduction in money market managed assets due to changes in financial markets, including increases in interest rates over a short period of time, considerable deterioration in investor confidence, prolonged periods of historically low short-term interest rates and resulting fee waivers, could have a material adverse effect on Federated's results of operations.

Federated shares currently trade at 14.7x our 2011 earnings estimate, a 7.5% discount to the industry average. Our six-month target price of $22.00 equates to about 13.5x our earnings estimate for 2011.

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I want to re-cap how my two most recent naked put trades have worked out, not simply because they happen to be profitable (not always the case) but also to highlight once again how the strategy works for stocks you are fond of. On June 13 I sold puts against engine makers Cummins (NYSE: CMI) and Westport Innovations (Nasdaq: WPRT) as both stocks had pulled back significantly and I was already eyeing them for long opportunities.

The two companies are in a related business -- natural gas engines -- and actually have a 50:50 joint venture named, of all things, Cummins Westport Inc. I have written many times previously about the potential of natural gas vehicles in providing America some measure of energy independence and I offer a link to one such piece ahead.

Cummins is obviously the bigger, stronger brother of the duo and has been an industrial name to own along with Caterpillar (NYSE: CAT) since 2009, benefiting from global growth in emerging markets and sales in 190 countries. Founded 90 years ago in Indiana, the $20 billion diesel engine giant earned over $1 billion in profits last year on $13.2 billion in revenues. It's 40,000 employees span the globe in over 500 company-owned and independent distributor facilities.

CMI dropped from $120 to $92 in the May-June sell-off, hitting a forward P/E multiple of 11 times for 2011 and 8 times for 2012. On June 2, I looked at the buying opportunity Cummins offered near $100 in the article "Industrial Strength Economics: CAT and CMI." Then on June 10, I focused specifically on the opportunity that Cummins offered as the best way to play the "Alternative Energy Wars," led on one side by billionaire energy man T. Boone Pickens.

Buy the Dominator

Since I had previously highlighted the as-yet-unprofitable Westport as the pure play in the nat gas engine space, I thought investors looking for more conservative exposure might be more comfortable -- and profitable -- going with the proven dominator.

I sold the CMI January 90 puts for $10 and my timing was good as the stock found solid support near $92 and worked its way higher with the broad market rally in late June. That put was trading for as low as $4 when the stock hit $110 last week and I could have bought it back for over a $5 profit if I would have had a resting limit order in on Wednesday when it gapped higher.

The reversal back below $105 doesn't bother me at all though, because CMI is a name I want to own and I am willing to use the capital I have at risk to either buy the stock at an effective price of $80 (put strike price of $90 minus the $10 credit I received up front), or simply pocket the entire premium.

Try the Innovator

My logic for sticking with a dominant company like Cummins doesn't mean we can't occasionally increase our leverage to a new industry by trying a smaller cap up-and-comer. My new way to evaluate these high-growth, higher-risk names is by using the Zacks Rank to gauge the quality of their earnings momentum. In other words, I seek to quantify the story with hard data.

Westport Innovations offered disappointing earnings the week of June 6 and the stock was punished, falling over 15% in one day but finding support just below $20 for the rest of the week. The stock dropped to a Zacks #4 Rank (sell) immediately on analyst downgrades and downward estimate revisions. But on that Friday, new analyst data rolled in that pushed the stock back into a favorable light with a #3 Rank (hold).

Since I liked the longer-term potential of this name, I took the opportunity to get paid for my risk by selling January 20 puts naked for $3.00 per share. This obligated me to buy 100 shares of stock per put contract at $20, if assigned, and I would keep the $3 as long as I held the short position.

WPRT continued to build support near $20 and by the middle of last week, the stock had reached above $25.50. My put contracts fell in value by more than half, meaning that I could have bought them back for under $1.50 per share, thus earning a static return of about 9% in just under a month (using $17 per share as my investment risk since I got paid $3 up front).

Naked Puts As Insurance Swing Plays

I also stayed in the WPRT position because I still like the risk-reward. If the T. Boone's nat gas engine revolution picks up steam later this year (possible if Congress gets the debt ceiling debacle out of the way soon), this company is a good wild card play. And I think analysts could remain positive on the earnings outlook into the company's next quarterly report. I may exit before then if I can buy the put option back for under $1.

And obviously for both of these trades, I always had the chance to take quick profits if prepared. That's the beauty of naked puts. Instead of speculating on upward stock movement by buying calls and taking on the additional risk of evaporating premium before expiration, I take a "surrogate" long position in a stock I am willing to own by getting paid option premium for my risk.

By selling a naked put, preferably below where the stock is trading, I get paid a risk premium up front. Then I win in any one of three ways: First, if the stock goes below the strike price and I am assigned, I get to automatically buy the stock "at a discount" relative to where it may have been trading beforehand and because of the premium I was paid. Second, if the stock goes higher and stays above the strike price, I could also keep the entire premium just for taking the risk of potential assignment.

Finally, as a seller of puts you are also a "writer" of insurance. If you are comfortable taking the risk of buying more of your favorite stocks, you can use naked puts to catch support levels on pullbacks, especially in fear-driven sell-offs when volatility inflates put premiums. If you are right about buyers coming back into your name, then when you reach a certain profit target you like, simply "close the policy" (i.e., buy the put contract back) and keep the difference between the initial premium collected and where you bought it back.

It sounds a little complicated, I know. But even America's favorite plain-spoken investor, Warren Buffett, sells naked puts all the time. Who knew he was so wild? For more on the concept and its risks, see my article "Strategic Put Selling."

[Disclosure: The author of this article is short naked puts in CMI and WPRT.]

Get the full analysis of all these stocks by going to http://at.zacks.com/?id=2649.

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