Are The Chemicals That are Killing You Produced by This Company? (ESI)

Element Solutions Inc. (NYSE:ESI) is a chemical company with great cash flow whose climb of late has come too far, too fast.

And that cash flow will be necessary to cover the company’s substantial debt.

Just last week, ESI shares jumped better than 7% on guidance, and we believe that’s set the stage for a top.

Background

Element Solutions makes chemicals that enhance the performance of a broad variety of communications equipment, mobile devices and electric vehicles.

So business has been strong during the ‘coronal flare’, as robust demand for electronics and communications infrastructure enhanced ESI’s bottom line.

But whether that justifies the stock’s price action of late is a separate issue.

Fundamentally speaking, the stock is overpriced according to traditional metrics, though not wildly so –

• P/E is 33.7,
• Dividend Yield is 1.24%,
• Price to Book is 1.78.
• Debt, as mentioned, presents a problem, with ESI’s Debt/Equity ratio standing at 0.68.  Strong cash flows will eventually pay long term debt, but as of this writing, coverage is wanting.

Have a look now at the daily chart –

ESI’s rise in the last six weeks was a phenomenal 42%.  And that’s what put her on our radar.

Technically –

1. RSI registered overbought just three sessions back (in green),
2. As a single day, 7% price-spike tagged the upper edge of a near parabolic trend channel (in blue).
3. The move left gaps at $15.10 and $11.90 (black arrows), both of which we believe will be filled.
4. Simple Fibonacci retracement calculations offer potential declines to the $12.35 and $9.37 levels (in purple).
5. The longer term moving averages bunch in the $11.00/$11.50 range and are rising, offering a larger likelihood that the decline will carry to roughly $12.00, if not lower – where both the lower gap and the Fib calculation reside.

Now, take a peek at the weekly chart, where both MACD and RSI looked stretched, and an old fashioned GANN pattern appears to point to a top –

Note well: the 90 degree trough-to-peak turns (in red) are not pure predictors, though they offer strong potential top and bottom stopping points.

Here, too, MAs are bunched in the $11.00/$11.50 range, pointing to a likely decline toward that range.

And it’s for that reason we’ve set up the following –

A Jew and His Money recommends you consider the sale of the ESI May 21^st 15.00/17.50 CALL spread for $0.95 (2.20/1.25) and purchase of the ESI May 21^st 17.50 PUT for $2.75.  Total debit on the trade is $1.80.

Rationale:

The stock is high beta, but the spreads on the options are still relatively tight; and we like that.

With the potential for a substantial percentage decline in the offing, we want to own a PUT for as cheap as possible.

The short CALL spread affords us that.

Max loss would be $4.30 and would occur if the stock closed above $17.50 (difference between the CALL strikes plus initial debit).

Max gain is unlimited.

Breakeven on the trade is $15.35 (while current price is $16.08).

With kind regards,

Hugh L. O’Haynew

Follow @HughLOHaynew