Matthews International (NASDAQ:MATW), which operates in the basic materials sector, has not had a good year so far, and there might be further weakness in MATW stock during this last quarter. Specifically, there are two bearish plays in MATW that I want to share with you, as each play could lead to impressive profits.
Matthews International, a provider of brand solutions, memorialization and industrial products globally, is a small-cap stock with a market capitalization of $1.5 billion. Although analysts have highlighted its growth potential over the years, investors should pay attention to MATW’s financial health before hitting the buy button in their brokerage account.
The three segments of the company are quite unrelated businesses and management has not been able to organize Matthews International well to run these segments efficiently. MATW serves a plethora of customers, ranging from manufacturers, suppliers and distributors of durable goods, building products, consumer goods and pharmaceuticals. MATW has reported customer service and satisfaction issues that have resulted in the loss of business.
These operational problems have affected MATW stock’s earnings and the outcome for investors has been disappointing with poor quarterly results, accounting anomalies, rising costs with a high debt level of about $1 billion. This debt has mostly been accumulated as a result of Matthews International’s acquisition of 10 companies in the past five years. However, many analysts do not believe these strategic moves have been well structured and they regard at least two of them as failures.
Although being highly leveraged is quite a prevalent feature of most small-cap stocks, in case of a business or general economic downturn, liquidity may easily dry up, making it hard to operate for these small-cap stocks. Basic materials industry tends to be highly cyclical, so when times are tough, it is common for many companies to go bankrupt. Rising energy costs can squeeze margins of basic materials companies like Matthews International. As such, analysts are concerned that MATW cannot continue to service this level of debt with its operating cash.
Year-to-date (YTD), Matthews International stock is down about 12%; the one-year MATW stock price change is a loss of 27%. The technical chart shows no sign of stabilization and of forming a base to support any sustained increase in the stock price.
Investors who pay attention to shorter-term moving averages should note that they are giving a strong “sell,” while the oscillators are giving “oversold” readings. A stock in a definite downtrend, like MATW, can continue to see lower prices despite being oversold. MATW’s stock price has fallen in five of the last 10 days on increasing volume, another sign of bearishness in MATW.
MATW will report earnings on Nov. 15. I expect further volatility and selling in Matthews International stock, especially in October.
MATW stock’s 52-week price range has been $45.72 (Oct. 4, 2018) — $ 64.75 (Oct 10, 2017). Matthews International is likely to see a new 52-week low around the anniversary of last year’s high on Oct. 10. 2017. Short-term support for MATW is ﬁrst at $44.5 and then at $40; meanwhile, short-term resistance in MATW stock is ﬁrst at $48.4 and then at $52. If you also believe that there might be more weakness in Matthews International stock before its earnings call, here are the two trades set up for the stock (prices are based on MATW stock’s closing price of $46.89 on Oct. 5):
Two Bearish Strategies on Matthews International Stock
1. If you already own Matthews International stock, consider using a deep in-the-money (ITM) covered call to protect your portfolio. For every 100 shares of MATW stock you own, sell a MATW 21 Dec $40 call option, which currently trades at $7.85. The $40 option is deep in-the-money (ITM), offering more downside protection in case of volatility and a decline in MATW stock around the earnings call season.
This setup would offer you deep stock protection; if you feel the weakness in MATW stock will continue well into 2019 too, you can consider selling another deep ITM covered call at the expiry of this option.
This call option would stop trading on Dec. 21, 2018 and expire on Dec. 22.
Assuming you would enter this covered call trade at the closing prices on Friday, Oct. 5, at expiry the maximum return would be $96 (i.e., ($7.85 – ($46.89-$40))*100), excluding trading commissions and costs.
An ITM Covered Call’s maximum profit is equal to the extrinsic value of the short call option. The trader realizes this gain as long as the price of MATW stock at expiry remains above the strike price of the call option (i.e., $40).
2. Consider buying a slightly in-the-money (ITM) MATW put option to benefit from a decline in the stock price. The 50-strike put option is ITM because MATW’s current market price of $46.89 is below the strike price of 50.
Therefore, I would consider buying a MATW 21 Dec $50 put option, which currently trades at 4.75.
This put option would stop trading on Dec. 21, 2018 and expire on Dec. 22.
Your maximum risk would be $475 at a stock price of $50 at expiry (excluding trading commissions and costs). As long put options have a limited lifespan, if Matthews International stock were to close above the strike price of the put purchased (i.e., 50), you would lose the entire amount invested in the put.
Your maximum return depends on how far the stock price falls. For example, at expiry, if the MATW stock closed at $35, then your profit potential is: $10.25 (i.e., $50-$35-$4.75), excluding trading commissions and costs.
At expiry, this trade would breakeven at a MATW stock price of $45.25 (i.e., $50-$4.75).
You can close this MATW put option at any time before expiry.
The Bottom Line on Matthews International Stock
I hold a negative evaluation of MATW stock both on fundamental and technical analysis. The stock price is likely to fall further. However, as prudent investors, it is always crucial to maintain a clear risk/return profile. Thus, if the drop does not happen, a move up towards $50 level might be the next leg up.
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.