Last week I wrote an article on Cedar Fair LP (FUN) with a recommendation to own this stock for its attractive yield of 6.1%. Since then, Fed Chairman Ben Bernanke sent the markets into a tailspin. As the International Business Times wrote:
The biggest headline from this news conference was Bernanke's announcement that the Fed could begin to reduce its bond-buying program later this year (if the economy continues to improve) and could end its purchases in the middle of 2014.
Is this good or bad for a company like Cedar Fair that depends on discretionary spending by visitors to its theme parks? In the prior article it was noted that the traditional two week vacation had been replaced by staycations for many families as a result of economic uncertainty. In discussing the staycation and the recession, CEO Matt Ouimet said:
...it was an economic disincentive to take a longer trip. You either didn't have overtime, which in the middle-class America is a very important device for the extras if you will, or you didn't feel secure about your jobs so people stayed closer to home and it's certainly must have played out in the Regional Amusement Park business because everybody had record years.
So, if economic uncertainty is good for Cedar Fair, can an improving economy also be good for the company? The Fed's possible tapering of its purchases would indicate a healthier economy, and the possibility of the purchases stopping by mid 2014 means that the Fed has reached its target unemployment rate of 6.5%, a significant improvement from the 7.6% rate posted for May. And if more people are working, then there should be more discretionary dollars available. Could Cedar Fair get a portion of that money, or should investors expect families to resume taking traditional two week vacations?
Ouimet thinks that the staycation due to economic uncertainty isn't the only thing that has affected the traditional vacation. He believes that two week vacation has morphed into the concept of Funcations because families have become overly committed to their children's Summer activities. A two week block of time for a vacation wouldn't fit into a family's schedule. His view is that Cedar Fair is a beneficiary of the "time poverty" faced by these families and calls the Cedar Fair alternative a Funcation (rather than staycation).
As the economy improved, the attendance at Cedar Fair parks set records in 2010 and 2011 before dipping slightly in 2012. 2012 was on pace to set a third consecutive record year until poor October weather hurt late season visits to its Halloween themed events. The improving economy the past three years certainly did not seem to hurt attendance and it seems reasonable to assume that attendance will set a new record in 2013. The company has reported that attendance was already ahead of the early 2012 pace.
It is my view that the improvement in the unemployment rates will help attendance, in addition to any benefits from staycations and Funcations. This, in turn, should make the cash distribution by Cedar Fair more secure.
The market certainly didn't react that way. The shares fell from $41.22 early in the week to $39.11 by Friday. This drove the yield of the $2.50 distribution up to 6.4%, making the investment more attractive. And if the economy shows rapid improvement that $2.50 distribution may take a bigger than expected jump in 2014.
On the other hand, if the price of Cedar Fair is tied closely to the yield, then the drop in the price of the shares could also reflect the market's concern about rising interest rates caused by a more robust economy. If yields on riskless, or less risky, fixed income assets rise, then the yield produced by Cedar Fair's $2.50 distribution becomes comparatively less attractive.
But why worry, or even wait? If all one is looking for is "current" income, there is the opportunity to boost the yield above 6.4% by using options - specifically, covered calls. Selling a covered call gives someone the right, but not the obligation, to buy your shares at a specific price up until the option's expiration. Here's a quick look at what happens with Cedar Fair and its distribution.
The call premium for selling someone the right to buy your shares for $40 between now and September 21st $1.25 Bid, and $1.65 Asked. It has been my experience that one can usually sell the call at prices above the bid and below the mid-point between the Bid and the Asked, but we'll keep this simple and assume one uses the minimum bid of $1.25. Next, we will assume that one will simultaneously buy the stock and sell the call.
First, note that the premium is equal to one half the annual distribution. Second, remember that one could buy the stock at $39.11. So, if one buys the stock and sells the $40 call, and NEVER receives a single distribution because the shares are assigned before the next ex-distribution date (expected to be some time in September), the investor would receive $0.89 capital gain ($40 assignment price less the $39.11 purchase price) plus $1.25 call premium for a total of $2.13 for less than a 3 month investment.
$2.13 of income on a $39.11 investment is a 5.45% gain in three months. Ignoring the effect of compounding, the hypothetical annualized return is 21.8%. But, since one only has to lay out $37.86 to open the position ($39.11 less the $1.25 call premium), selling at $40 in less than 3 months generates a yield that is slightly higher - 22.6%.
If one is permitted to hold the shares for two distributions and they are assigned at expiration on December 21st, the yield is even higher. In that case, the total return would be $1.25 in distributions plus the call premium of $1.25 plus the $0.89 capital gain for a total of $42.50 on a net investment of $37.86 and a gain of 12.26% in six months. The hypothetical annualized yield (without compounding) would be 24.5%.
If the calls are exercised at various other points, the yield could be higher. And, if the calls are never exercised, the investor should have the opportunity to open new call positions at options expiration.
So, what are the risks? The primary one would be the impact of increasing interest rates. Even if Cedar Fair continues to set new records for attendance and revenue, a healthy economy and Fed actions could be expected to drive interest rates higher. That in itself could put pressure on the share price as investors find the current 6.4% yield unacceptable. Or, investors could become concerned about the short term borrowing costs incurred by the company during its annual capital spending cycle. Or investors could become concerned about the cost to refinance some of its long term debt.
I find these risks to be acceptable, expect Cedar Fair to have no problem continuing to pay the current distribution and have expectations of seeing it increase. I have also used the covered call strategy outlined above with Cedar Fair.
I purchased shares last November for less than $37, and simultaneously sold June $40 calls against those shares. I received one dividend of $0.40 and two dividends of $0.625 each, and a call premium of $1.37. I got "lucky" when the market tanked the last few days, and instead of losing the shares, I will be able to sell another call at either the $40 or $45 strike price.
If the shares are assigned - perhaps the biggest risk - I would expect to be able to replicate this strategy and continue to produce current income. It is possible that it would be with Cedar Fair, although it is equally likely that it would be replicated with another company. If the effort to continually search for investment alternatives is too prohibitive for an investor, one can simply sit back and enjoy the 6.4% current income - income that I expect would continue to grow.
Additional disclosure: I have utilized the strategy outlined in this article and expect to sell another round of covered calls in the next few days.