Market Overview
For the first time in the new year, the market had a bad week. The declines aren’t terribly surprising or worrisome (for now), as the recent rally had been without much of a pause.
For the week, the S&P lost 1.05%, the Dow was mostly unchanged, and the Nasdaq finally gave back some gains, falling 2.11%.
The Stock – Allegro MicroSystems (ALGM)
Why the Strength
Allegro makes magnetic sensor integrated circuits, power ICs and photonics components, all of which are used in things like eye-friendly lasers and solar panel inverters. But its primary market is automobiles: The first two product segments are seeing strong growth as automakers hunger for more chips needed to power advanced assisted driver systems (ADAS) and chips that can better handle greater electrical demands in electric vehicles.
Allegro’s Q3 sales released two weeks ago showed a 33% year-over-year rise to $249 million, at the high end of management’s guidance. Four-fifths of the growth came from automotive, where the expansion of ADAS features from luxury models to even entry-level models means more sales for chip makers. For instance, a pickup truck model Allegro sells into has tripled the amount of company content in just three years, to $12 a unit – real money considering the scale of production. Such demand has management saying the current fiscal year (ending in March) will produce sales of $970 million, a 26% gain over fiscal 2022.
The longer-term outlook is brightening too, with the company recently winning the rights to supply a steering system for an unnamed U.S. manufacturer’s model and multiple systems for a China EV maker. Big picture, EV growth is key: Allegro sees its addressable market at $90 of component sales per EV produced, and global EV manufacturing is expected to grow 30% over the next year, with growth accelerating in subsequent years.
The company disclosed that large China OEM Geely is a customer, as are a dozen major players including Ford, Tesla and Mercedes. Allegro’s own pandemic supply chain troubles appear behind it and the company is whittling down the sales backlog, lowering lead times for new orders. Wall Street sees only modest growth the next few quarters, but the stock doesn’t believe it.
Technical Analysis
ALGM came public in late 2020 and hit a peak near 35 early the next year; after a correction, shares tested that area in late 2021 before being rejected again. Then came the bear phase last year, but after a low in October near 20, ALGM changed character—shares spiked back toward that old resistance, tightened up for a few weeks and decisively broke out two weeks ago on huge volume. Stop — 34.5
The Covered Call Trade
Buy Allegro Microsystems (ALGM) Stock at 44, Sell to Open March 45 Strike Calls (exp. 3/17/2023) for $1.30, or a Net Price of 42.7 or less
Static Return: $130 per covered call (3.04%)
Breakeven: 42.7
Covered Call Return (if assigned): $230 per covered call (5.38%)
Please note, the stock and options prices will be moving throughout the day, so these prices are simply an approximation of prices that you should be able to achieve.
However, the important component of this equation is that the stock price paid, minus the premium received via the call sale, equals the Net Price, or 42.7 or less. (In this case 44 minus 1.30 = 42.7. Or another example is you could pay 43.75 for the stock and sell the call for 1.05, which also equals 42.7)
For every 100 shares of stock you buy, you can sell 1 call. For every 200 shares of stock you buy, you can sell 2 calls. And so on …
Open Positions
If our stop is hit, I will send an alert giving detailed instructions on how to exit the trade. But don’t get too worried about setting the stop. I will manage that for you.
The next Cabot Profit Booster issue will be published on February 22, 2023.
