Covance [NYSE:CVD] Jan. 21, 2009 close: $37.97
52-week range: $31.43 (Nov. 21, 2008) - $99.08 (Aug. 7, 2008)

Covance is one of the world’s largest Contract Research Organizations. They conduct clinical trials for big pharmaceutical companies on an outsourced basis. Early stage testing represented about 47% with clinical phase II – III contributing another 17% of revenues. Bio-manufacturing, lab services, clinical packaging and other health services make up the remainder of their sales. CVD likely came in with record revenues of about $1.8 billion in 2008 and EPS should also be an all-time high at about $3.02 versus $2.71 in 2007.

Covance is in great financial shape with just $23 million in short term debt coming due and zero long-term obligations. They held $209 million in treasury cash at the end of the September quarter.

Because earnings have grown steadily and dramatically since 2000 Covance has been considered a glamour-type growth stock. The P/E has reflected that with a 10-year median multiple of 26x. The lowest average P/Es on a full year basis occurred in the 2002-2003 bear market at around 18x.

That has changed with the recent market insanity since last August. CVD shares peaked at $99.10 before plummeting to $31.43 at the November nadir. They closed today at $37.97 or just 12.6x 2008’s earnings. Estimates for 2009 have been shaved to $3.08 to reflect the poor economy. Even so that makes the forward multiple just under 12.4x – the lowest ever for this company.

Here are the past eight years numbers are reported by Value Line. 2008 data includes estimates for the soon to be released Q4 results.

Year ….… Sales ….... C/F ……. EPS …... B/V …... Avg. P/E
2001….... 14.29 ….. 1.39 …… 0.58 ….. 5.76 …….. 30.4x
2002 …... 15.27 ….. 1.75 …… 1.03 ….. 7.13 …….. 18.8x
2003 …... 15.53 ….. 1.94 …… 1.21 ….. 8.99 …….. 18.3x
2004 …... 16.34 ….. 2.23 …… 1.52 ….. 9.86 …….. 23.4x
2005 …... 17.41 ….. 2.33 …… 1.94 …..10.19 ……. 24.6x
2006 …... 22.12 ….. 3.18 …… 2.24 …..14.53 ……. 26.8x
2007 .……25.44 ….. 3.78 …... 2.71 …..17.31 .…… 26.1x
2008 .……28.75 ….. 4.20 …... 3.02 …..18.90 ….… 21.2x

Even if Covance only comes back to 15 times the year ahead estimate of $3.08 it will reach $46.20 – up 21.6% from today’s quote but still less than half of last summer’s high.

Value Line gives Covance a financial strength rating of ‘A’ and notes both their ‘Price Growth Persistence” and “Earnings Predictability” are at the 90th percentile mark (100th being best).

Want an even better risk/reward?

Try this combination play:

………………………………........................…………. Cash Outlay …….…..... Cash Inflow
Buy 1000 shares CVD @ $37.97 ….....………….…. $37,970
Sell 10 CVD Jan. 2010 $35 Calls @ $9.50 ……...……………………....………… $9,500
Sell 10 CVD Jan. 2010 $35 Puts @ $7.00 …….…………………….....…………. $7,000
Net Cash Out-of-Pocket …………….......………………………..….. $21,470

On expiration date (Jan. 15, 2010):

If CVD shares are $35 or higher (even less than their current price):

Your $35 calls will be exercised.
Your shares will be sold for $35,000.
Your $35 puts will expire worthless (a good thing for you as a seller).
You will have no further option obligations.

You will have $35,000 cash for a net cash outlay of $21,470.
That’s a $13,530 gain or + 63% cash-on-cash.

This will be achieved if the shares go up, stay unchanged or even if they drop by up to $2.97/share or (-7.8%) over the next year.

What’s your risk?

If Covance shares stay below $35 you will be forced to buy an additional 1000 shares at $35/share for an additional $35,000 cash outlay.

Your break-even price on the original 1000 shares would be their $37.97 cost less the $9.50/share call premium = $28.47/share.

Your break-even on the ‘put’ shares would be the $35 strike price less the $7 put premium = $28.00/ share.

Your overall break-even price would be the average of $28.47 + $28.00 = $28.24 /share. That’s a few bucks below even the panic low hit last fall.

I can’t guarantee that CVD shares will not go below that price. I can tell you that $28.24 is lower than the absolute low share price touched since 2003 when EPS came in at $1.21 - just 40% of today’s trailing earnings.

Disclosure: Author is long shares and short options on CVD.

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