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Private Wealth Manager / Securities Expert / Co-host of "Investing and Your Legal Rights" heard monthly on www.KQV.com. Over 33 years in the investment industry, first working at PaineWebber for almost 20 years which included 3 years as a branch manager. Currently have a CRCP... More
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OakTree Investment Advisors
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Covered Call Focus
  • Buy Deere & Co. (DE) And Write A Call  0 comments
    Jan 13, 2014 3:36 PM | about stocks: DE

    01/13/14 Covered Call Pick: Revisiting Deere & Company (NYSE:DE)

    Find our first revisit on Deere & Company here.

    Deere & Company (DE) is the leading manufacturer of agricultural machinery in the world. This American-based multinational company manufactures and distributes tractors, combines, harvesters, sprayers, mower, backhoe loaders, planter/seeders, and a multitude of other farming equipment on both an industrial and consumer scale. The company also produces various construction and forestry equipment as well as ground-care and landscaping equipment.

    Deere & Company have a market capitalization of $33.43 billion with 372.5 million outstanding shares.

    Deere currently pays a $0.51 quarterly dividend for a current yield of 2.3%.

    With a beta of 0.75, DE currently trades with approximately 3/4th the volatility as the current market.

    We first instituted a position in Deer nearly one year ago when we predicted an agricultural bull market and the beginnings of a global economic recovery. While the global economy started a slow recovery, the increased crop size for the year drove food prices slightly lower which caused DE to bounce around for the good portion of the year, with a high of $95.60, and a low of $79.50. With our initial cost basis of $90.10, we re-sold a Covered Call on the stock in June after the first expired, to help regain our initial cost in the stock. In September, that Call expired worthless, and our adjusted cost-basis was reduced to $86.21. At that time, we continued to hold the position, but did not immediately sell another Call to cover it.

    Since then, the stock has climbed a bit to its current price just shy of $90 a share, and we believe is poised for greater gains moving forward due to both fundamental and technical reasons.

    Deere has recently announced an $8 billion share repurchase program last quarter. The company has reduced its outstanding share count by approximately 10% since 2010, spending $1.6 billion annually on buybacks, and generating value accretion due to properly timing the buybacks during low valuation periods. This will continue to drive shareholder value, and will give EPS a boost moving forward.

    The buyback isn't the only reason we're still bullish on DE. They remain the largest global player in the agricultural equipment market, and hold more than 50% market share for the United States. They have also seen great success in their launch of several new tractor products in Brazil, a market traditionally dominated by one of their main global competitors, AGCO. Customer loyalty to the Deere brand and solid dealership network has helped preserve share in the United States, and has led to 10 year average ROIC of 20%. The company also traditionally able to outperform their competitors in up markets, while incurring more moderate income declines during the downturns, which we believe stems from their superb management and the geographically diversified and efficient operations. While analysts believe 2014 will see declining sales for farm equipment due to crop pricing and muted economic sentiment, it is expected DE will see 10% top-line growth for the business with an operating margin target of 9%, above historical averages due to the improved efficiency and an offsetting of raw material cost escalation through continued price increases.

    There is also a technical signal that leads us to put a bullish spin on DE at the moment. The stock chart is currently forming a Cup-and-Handle shape, which occurs when the stock price creates a U-Shape. When the stock price finishes the U-Shape, it can form a handle, which is when investors who bought it at its previous highs sell to regain their initial cost in the investment. This is sometimes followed by the stock taking off, as valuation usually becomes impressive enough to attract buyers to the stock and momentum takes over. Deere is currently forming the handle right now, and while we are unable to be sure the stock will actually take off from this handle (it could just sputter out) we believe that due to the company's long-term macroeconomic tailwind of growing populations in emerging markets, it is worth the bet of grabbing the pop in the stock.

    For a Covered Call on the stock, we want to sell a near-term out-of-the-money Call. The stock's valuation is quite low with a P/E of 10, and a Morningstar Fair Value Estimate of $95 based on discounted cash flow. For this Covered Call strategy, we are looking to the Call to just get a little something extra out of the stock, as we do not want to limit our potential gains we can receive off the Cup-and-Handle formation. If the stock putters off, we're perfectly fine holding the stock for the long term, as we believe the company will continue to be profitable for the reasons mentioned above. If the stock jumps and we get Called away, we grab a wonderful return and are fine buying the stock back later this year if muted sales cause the stock price to lag. That is why we are recommending buying DE and selling the March $95 Call.

    IF BUYING THE STOCK TODAY:

    Scenario:
     

    • Buy 100 shares of DE @ $90.69 = $9,069 + Commission ($12.95) = $9,081.95
    • Write 1 DE March 2014 $95 Call @ $114 - Commission ($8.70) = $105.30

    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

    (1.05 + 0.51)/90.82 X (365)/67

    = 9.36% Static Return


    If-Called Return:
    (Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration

    (1.05 + 0.51 + 95 - 90.82)/90.82 X (365)/67

    = 34.43% If-Called Return


    IF USING THE PREVIOUS HOLDING (BOUGHT 01/14/13):

    Scenario:
     

    • 100 shares of DE @ $89.97 cost basis = $8,997 + Commission ($12.95) = $9,009.95
    • Write 1 DE March 2014 $95 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

    (1.05 + 0.51)/90.10 X (365)/67

    = 9.43% Static Return


    If-Called Return:
    (Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration

    (1.05 + 0.51 + 95 - 90.10)/90.10 X (365)/67

    = 39.06% If-Called Return


    The TOTAL yields for the strategies include ALL the dividends collected, ALL the Call premiums collected, and are calculated over the duration of the ENTIRE strategy (from the inception point of buying the stock to the expiration of the most current Option). We will save you the math at this point and go into it more in depth upon the review of the current Option cycle.

    Total Static Yield = 6.13%

    Total If-Called Yield = 10.73%

    Posted by OaktreeAdvisors at 1/13/2014 11:29 AM
    Categories: Weekly Picks

    Previous Post

    Disclosure: I am long DE, .

    Additional disclosure: As active managers we will increase and decrease positions as markets dictate.

    Themes: Call Options, Writing an Option Stocks: DE
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