Wednesday, February 1, 2012

ECL: The Alchemy of Bugs and Grime

Ecolab Inc. (ECL) -- from its name one imagines white-robed scientists delving into the secrets of environmental sustainability and climate moderation. But that's not what the St. Paul, Minnesota company does. Ecolab kills bugs and removes grime.

ECL provides its basic, gotta-have-it services for hospitality, food service, health care and industrial enterprises across the world. It keeps the floors and other surfaces squeaky clean and cockroach free.

No, ECL won't roll back global warming. But it will keep the health inspectors happy as the climate degrades.

ECL had the most bullish chart out of 16 selected at random from 675 large-cap stocks. I describe my screening methods in an essay, "10,000 Charts".

The price suffered a nasty plunge in early August 2011, and from that low of $43.81, has climbed steadily to its high of $61.42 on Jan. 26. Since October 2011 the stock has been trading in blue-sky territory, above all prior prices.

The company has clearly discovered the alchemy of turning grime and cockroaches into gold. I's return on equity is a stunning 23%, debt to equity is on the low side at 0.42, and the institutions love it, owning 78% of the stock and bidding up the price to 2.78 times sales.

Earnings, however, are unstable -- they rise for a few quarters and then fall, and then rinse and repeat. So I conclude that it is a stock better played for the anticipation of earnings rather than for riding it through the announcement and risking an earnings surprise.

Understandably, analysts are on the whole neutral about ECL. They don't see it outperforming the market to any great degree.

The next earnings announcement is Feb. 28 before the open. So the question of whether to trade now comes down to short-term considerations -- how much bump can I get in before exiting the position ahead of earnings.

The hourly chart shows that ECL, after hitting its high of $61.42 on Jan. 26, set a low at $59.55 on Jan. 30, a lower high of $60.79 on Jan. 31, fell to a higher low, and then gapped up to a high of $61.15 today at 10 a.m. Eastern.

That final high, today, is the crux of the problem. It is a lower high compared to Jan. 26, but a higher high compared to Jan. 31. In the subsequent three hours, the price has dropped to fill in the gap, which in classic analysis would indicate a likelihood that the price would reverse and resume its rise.

If I were to play ECL, I would want to see that Jan. 31 high taken out, and even better, the Jan. 26 high. After getting in I would want to see a strong price rise prior to the earnings announcement. If I had some equity behind me at earnings, I might ride it through. If not, then I would exit a couple of days before.

ECL has a moderately OK selection of options -- 10 strikes, with triple-figure open interest on the February at-the-money call. The bid/ask spread is quite reasonable. The implied volatility is way low, at 22%.

Because of the low volatility, I would play it as long calls with as much delta -- price change on the option vs. the stock -- as I could decently purchase.

Decision for my account: I won't buy ECL now. I'll consider a purchase once it clears above $61.42.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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