07/01/13 Covered Call Pick: Conagra Foods Inc. (NYSE:CAG)
Conagra Foods Inc. (CAG) is an American packaged foods company that produces shelf-stable and frozen foods, processed meats, retail food, food ingredients, and agricultural products. With recognizable brand names in products ranging from Chef Boyardee and Jiffy Pop, to Hunt's Tomato Sauce and PAM Cooking Spray, it is no wonder that 97% of American households are stocked with one of Conagra's hundreds of products.
Conagra Foods has a market capitalization of $14.56 billion with 416.8 million outstanding shares.
Conagra currently pays a $0.25 quarterly dividend for a current yield of 2.9%.
With a beta of 0.64, CAG currently trades with approximately 35% less volatility than the current market.
Conagra Foods has been a popular food-packaged products company due to its pervasive product line, strong brand recognition, and good dividend. The company's product line is strong, and as we've shown before in our articles on other food companies such as Heinz and Kraft, the strength of the company's brand names means a lot in terms of increasing sales. The company just recently reported quarterly earnings for their financial fourth quarter, beating EPS by $0.01 and slightly missing revenue by $0.02 billion. In the quarter, the company saw 7% organic increase in sales in their Consumer Foods Segment, and a 3% increase in their Commercial Foods Segment. This does NOT count the sales garnered from the acquisition of Ralcorp Holdings this past January, which helped boost overall sales for the past quarter by 33.7%. Operating margins also expanded by 0.2% in the face of rising prices, with operating profit expanding by more than 30%. The Ralcorp acquisition, while expensive for CAG, will elevate their business to the next level in terms of production, and will in the long term greatly benefit the company's penetration in the marketplace.
The stock is currently trading a P/E of 16, a discount to the market's P/E of 18.57. Looking forward to this upcoming year of earnings, the stock has a PEG ratio of 1.23 off of 13% expected increase in earnings, a fine valuation for the 19% ROE and double-digit earnings growth you are purchasing. A metric we mention every week, but one that we feel is even more important at the moment given the current market conditions, is beta. On Friday we talked about how the margin debt levels in the market are at elevated levels similar to those found immediately prior to the financial crisis, and how these margin levels can create a downward spiral of selling that can trigger a market crash. Well as we've explained in our beta article, a stock with a lower beta will move less when compared to the market as a whole. So if the worst would happen and a 40% market crash is triggered like it was during the financial crisis, CAG will pull back only about 26%. In addition, a lower beta stock will have a lower chance of having margin call levels get raised on it by brokerage houses, as they are less volatile, and thus considered less risky. This will help keep funds in the stock as compared to the more volatile investments with higher betas.
For a Covered Call strategy on the stock, we are looking at selling the December 2013 $36 Call. The recent 52-week high for the stock is $36.31, and while the stock had been subject to the recent market pullbacks, we feel that the recent boost it received from its earnings report will help stabilize it around these levels. That is why we are recommending buying CAG and selling the December 2013 $36 Call.
- Buy 100 shares of CAG @ $34.96 = $3,496 + Commission ($12.95) = $3,508.95
- Write 1 CAG December 2013 $36 Call @ $105 - Commission ($8.70) = $96.30
Note: Prices may vary from the time of post. Actual commissions paid will vary returns.
Static Return (Not Called):
(Call + Dividend)/Stock Price X (Days/Year)/Days to Expiration
(0.96 + (2*0.25))/35.09 X (365)/173
= 8.78% Static Return
(Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration
(0.96 + (2*0.25) + 36 - 35.09)/35.09 X (365)/173
= 14.25% If-Called Return
Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarantee the above, or any, result. All investment decisions should be made based upon individual's personal investment goals and risk tolerance.
Disclosure: I am long CAG.
Additional disclosure: As active managers we will continue to add to Conagra and sell covered calls.