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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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Covered Call Focus
  • Go Long Honeywell (HON) And Sell A Covered Call For Additional Income 0 comments
    Jun 2, 2014 2:24 PM | about stocks: HON

    06/02/14 Covered Call Pick: Honeywell International Inc. (NYSE:HON)

    Honeywell Intl Inc. (HON) is an American multinational conglomerate that provides automotive and aerospace products, security technologies, specialty materials, and engine systems to a wide variety of customers including private, corporate, and governments. With over 132,000 employees worldwide, some of the company's more well-known products include its line of rounded home thermostats, and Garrett turbochargers.

    Honeywell has a market capitalization of $72.95 billion with 783.1 million outstanding shares.

    Honeywell currently pays a quarterly dividend of $0.45 for a current yield of 1.93%.

    With a beta of 1.32, HON currently trades with approximately 32% more volatility than the current market.

    Honeywell is not a stranger to this blog, with our last recommendation on the stock coming in last year in May. The company has a strong diversified business and has been becoming increasingly more efficient in their operations over the last several years as management has fallen into swing of the plan for increased productivity improvement through restructuring and the firm wide implementation of the Honeywell Operating System, a production model that helps standardize processes across the firm to allow for quick, efficient operation of business. This has help led to a positive Q1 report this past April.

    On April 17th, the company reported an EPS of $1.28 with a revenue of $9.68 billion. This translates to a GAAP EPS growth of 7% over the prior year, with revenue up 3.8%. These numbers are, in part, a result of Honeywell's diversified product line. While weakness in the aerospace business, resulting a 2% decline over the prior year, threatened to constrain the company's quarterly growth, strength in the automation and controls segments more than made up for the aerospace decline. A resurgence in the company's turbocharger business saw a 9% revenue growth over the prior year, spearheading this quarter's growth. HON exists in a very cyclical industry, as many of their end markets are tied closely to the global economy. Yet by making sure the firm diversifies across both their products and their geographies, HON is able to lessen the fluctuations on revenue caused by the business cycle.

    As we mentioned above, HON has been becoming increasingly more efficient over the past several years, and that has been one of the main drivers for the firms success over that time. One of the largest criticisms over the past couple years when it comes to a company's quarterly reports, is that growth and earnings has stemmed from an increase in efficiency, and not from organic growth - the true growth of the core of a company outside of takeovers, acquisitions, mergers, etc. While there is something to be said about companies that are just focused on increasing efficiency rather than attempting to expand their operations through increasing output and sales, what we see in HON is an intelligent and efficient plan the company has been putting into place that allows them to be strategically ready for the future.

    In the firm's aerospace division, HON has focused solely on business and regional jet aircraft, allowing GE and UTX to fight over wide-body and narrow-body aircraft orders. They also continue to invest in products outside the aircraft, with a focus on next-generation air traffic control systems. With a spotlight shined on the poor aviation infrastructure in the United States, this helps position the company to be a go-to for upgraded systems after the FAA approves its use. Honeywell has also used its strong position in heating and cooling controls to build a strong base in the automation business. They have also created growing strength in the specialty materials market by developing products to help heavy energy users become more energy efficient - an important factor as energy requirement and costs rise. Most importantly, management developed a solid plan, and has stuck to it. This may seem like a simple thing, but being able to properly position a company to take advantage of global trends, while also ensuring that the company continues transforms into the best version of itself is no small task, and one that many less experienced companies flounder with at the first sign of turbulence.

    We have a bullish outlook on HON moving forward, and we're not the only ones. Morningstar analysts raised their fair value price estimate to $105 from $90 back in March, and reaffirmed that number upon the firm's Q1 report and forward guidance this April. More recently, Oppenheimer analysts raised their price target to $110 from $103 this past week with a rating of "Outperform". This follows raises of price targets at firms like Argus and Cohen & Company over the past two months, giving the stock an average rating of "Buy" and a consensus price target of $96.72.

    The stock is currently trading at just near $93, and has been in a technical consolidation range between $90 and $96. For a Covered Call Strategy on the stock, we are looking at the December 2014 $97.50 out-of-the-money Call. This strike price is just over the consensus price target of the averages, and outside the technical resistance level of $96 we see on the stock's graph. While we are making a bullish Call on HON, volatile and uncertain market and economic conditions moving forward into the summer leads us to reap a higher premium now rather than stretch our upside goals. The best case scenario is that the stock trades inside its consolidation range of $90-$96 and our Call expires while we pick up the premium for free. If the stock breaks out to the upside, we receive a nice yield for our time, and will look for a pause in the stock's run to get back in. If the stock breaks out to the downside due to a turn in the global economy or a broad market pullback, we can be sure of our position in a strong, diversified company that will bounce back to its previous levels of profitability over time. That is why we are recommending buying HON and selling the December 2014 $97.50 out-of-the-money Call.

    Scenario:

     

    • Buy 100 shares of HON @ $92.95 = $9,295 + Commission ($12.95) = $9,307.95
    • Write 1 HON December 2014 $97.50 Call @ $224 - Commission ($8.70) = $215.30

    Note: Prices may vary from the time of post. Actual commissions paid will vary returns.


    Static Return (Not Called):
    (Call + Dividends)/Stock Price X (Days/Year)/Days to Expiration

    (2.15 + 2*(0.45))/93.08 X (365)/201

    = 5.95% Static Return


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

    (2.15 + 2*(0.45) + 97.50 - 93.08)/93.08 X (365)/201

    = 14.57% 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.

    Posted by OaktreeAdvisors at 6/2/2014 10:30 AM
    Categories: Weekly Picks

    Previous Post

    Disclosure: I am long HON.

    Additional disclosure: As active managers we may sell or buy additional shares as suitable.

    Themes: Covered Calls, Call Options Stocks: HON
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