I'm as much of a fan of combing the history of my recommendations to present myself in as positive a light as possible as the next Seeking Alpha contributor, and in support of that effort, I want to write about Weis Markets (NYSE:WMK), dear readers. I've written two articles on Weis on this forum, the first of which was bullish. I wrote the second only two months later, where I recommended taking profits on the company, and gave it the incredibly original title "Taking Profits in Weis Markets." The trade worked out well, netting a profit of about 38%. Since publishing that second article nearly three years ago, the shares are flat against a gain of ~41% for the S&P 500. Much has happened since then, obviously, so I thought I'd check in on the name again to see if it's worth buying at current prices. Slightly more important than having my ego stroked is the need to find profitable opportunities, and a profitable dividend payer that's underperformed the overall market may qualify. As is frequently the case, I'll try to determine whether or not it makes sense to buy shares by looking at the financial history here, and by looking at the stock as a thing distinct from the underlying business. A discussion about short put options may also make an appearance.
I'll jump right to the point for those who want more of a summary than was provided in the bullet points above, but are (understandably) unwilling to wade through an entire article. Since 17% of restaurants are closed, grocery stores are obvious beneficiaries. This is evidenced by the fact that Weis has done very well in the age of Covid. In spite of that, the shares remain relatively inexpensive. For that reason, I recommend buying back in. For those who are (probably understandably) worried about a market correction, I think short put options represent an excellent alternative. For my part, I'm going to buy the stock and try to sell the puts described below.
Financial Snapshot
The company's financial performance in the first 39 weeks of 2020 relative to the same period in 2019 has been remarkable. Specifically, revenue was up just under 17%, and income from operations and net income were up 121% and 103% (!), respectively. The firm achieved this remarkable level of profitability in spite of a 16% uptick in cost of sales, a 9% uptick in operating, general and administrative expenses, and a 133% uptick in provision for income tax. A particular standout was the growth in e-commerce, as consumers switched to working from home.
The question is whether this performance can continue, and in my view it can. My investment thesis on that question is fairly straightforward. The working population requires X calories per day, and in the past some percentage of those calories were provided by the restaurant sector. Unfortunately, about 17% of restaurants in the United States are closed either "permanently or long term." The obvious beneficiary of this horrendous trend are grocery stores, and so I think Weis' outsized growth may continue for the foreseeable future.
Given that the payout ratio is at multi-year lows, I think the dividend is particularly well covered at the moment. For that reason, I'd be very happy to own these shares at the right price.
Source: Company filings
The Stock
I can hear some of my regular readers starting to moan. "Here we go" I imagine you saying. "He's going to get us all excited about a wonderful business only to disqualify it from consideration because it's too expensive!" I imagine them girding themselves for another didactic lecture about never overpaying. I'll admit that I do enjoy being a bit preachy about only buying cheap stocks, but I think the performance of this stock itself is the best tool to describe the idea that an investor should never overpay. To pick two dates that happen to support my argument completely at random, imagine one investor bought this stock in early January of 2017, and another investor bought it in early January 2018. The first person is sitting on a 21% loss as of this morning, and the second is sitting on a 26% gain. Not much changed in the narrative from one period to the next, but this investment is "bad" from one person's perspective and "good" from another's. I would rather the investment be "good" for us, dear readers, which is why I'm usually such a downer when it comes to buying expensive stocks.
My regular reader-victims know that I judge whether shares are cheap or not in a few ways, ranging from the simple to the more complex. On the simple side, I look at the ratio of price to some measure of economic value, like earnings, free cash flow, and the like. Ideally, I want to see a stock trading at a discount to both the overall market and its own history. On that basis, I think you'd agree that Weis is fairly cheap, per the following:
Data by YCharts
In addition to looking at the simple relationship between price and some economic value, I like to try to understand that the market is currently "assuming" about a given company's future. My regular reader-victims know that I employ the methodology described by Professor Stephen Penman in his book "Accounting for Value" in order to do this. In his book, Penman describes how an investor can isolate the "g" (growth) variable in a standard finance formula to work out what the market must be assuming about a given company's future. According to this approach, it seems that the market is currently assuming that Weis will be growing at ~1%, which I consider to be extremely pessimistic, which I like a great deal. For these reasons, I'm very comfortable buying in again.
Options As Alternative
I can understand why some investors may be unwilling to put capital to work at the moment, as a strong argument could be made that the market is currently massively overpriced. For such people, I would recommend selling some put options. If the shares remain above the strike price, the investor simply pockets the premium. If the shares drop in price, you're obliged to buy this already cheap stock at an even more attractive price. This is why I consider this approach to be a win-win trade.
In particular, I recommend selling the October puts with a strike of $45. These last traded hands at $2, which I consider to be a reasonable price. The problem is that they are very thinly traded options, so I would recommend putting on a good-till-cancelled order. I consider the $45s a win-win trade because if the shares remain above that price over the next several months, the investor simply pockets the premium. If the shares fall, the investor is obliged to buy at a price of ~$43. To put this in context, the company currently sports a book value per share of about $42 and the (very sustainable) dividend yield at that price would jump to 2.88%.
Now that you're hopefully all excited by the prospects of a win-win trade, dear readers, it's time for me to absolutely obliterate the mood writing about risk. The fact of the matter is that every investment comes with risk, and short puts are no exception. We do our best to navigate the world by exchanging one pair of risk-reward trade-offs for another. For example, holding cash presents the risk of erosion of purchasing power via inflation and the reward of preserving capital at times of extreme volatility. The risks of share ownership should be obvious to readers on this forum.
I think the risks of put options are very similar to those associated with a long stock position. If the shares drop in price, the stockholder loses money, and the short put writer may be obliged to buy the stock. Thus, both long stock and short put investors typically want to see higher stock prices.
Puts are distinct from stocks in that some put writers don't want to actually buy the stock - they simply want to collect premia. Such investors care more about maximizing their income and will, therefore, be less discriminating about which stock they sell puts on. These people don't want to own the underlying security. I like my sleep far too much to play short puts in this way. I'm only willing to sell puts on companies I'm willing to buy at prices I'm willing to pay. For that reason, being exercised isn't the hardship for me that it might be for many other put writers. My advice is that if you are considering this strategy yourself, you would be wise to only ever write puts on companies you'd be happy to own.
In my view, put writers take on risk, but they take on less risk (sometimes significantly less risk) than stock buyers in a critical way. Short put writers generate income simply for taking on the obligation to buy a business that they like at a price that they find attractive. This circumstance is objectively better than simply taking the prevailing market price. This is why I consider the risks of selling puts on a given day to be far lower than the risks associated with simply buying the stock on that day.
I'll conclude this rather long discussion of risks by looking again as the specifics of the trade I'm recommending this morning. I'll be selling the puts described above that have one of two outcomes. Either the shares remain above $45 over the next eight months, at which point I will have generated ~4.4% in that time, which I consider to be acceptable. If the shares fall in price, I will buy the shares at a net price ~20% below the current, already cheap level. Both outcomes are very acceptable in my view, so I consider this trade to be the definition of "risk reducing." That's an ironic way to end a discussion of risk, but it's the truth.
Conclusion
I expect this sector in general and this company in particular to thrive over the next few years. The fact that the shares are trading at multi-year low valuations in spite of this suggests to me that this is a good investment. For those who are (justifiably) worried about a market correction, I think the puts described above represent a decent alternative. For my part, I'll be buying some shares and will attempt to sell these puts. Food is not going out of style anytime soon, and since the restaurant sector is less of a source of calories, companies like Weis are obvious beneficiaries.
