03/18/13 Covered Call Pick: Brown-Forman Corp (BF-B)
Brown-Forman Corp (BF- is an American-based spirits and wine company. Founded in 1870 by George Garvin Brown, Brown-Forman is one of the country's largest spirit producers and distributors with over $3.6 billion in sales for fiscal 2012. The company owns a variety of well-known brand names including Jack Daniel's, Southern Comfort, Finlandia Vodka, Woodford Reserve Bourbon, and Korbel champagne. Brown-Forman Corp has two different types of tradable stock shares, Class A shares, which are voting shares that are thinly traded due to the Brown family's 70% ownership, and Class B shares which are non-voting shares that are frequently traded in the markets.
Brown-Forman Corp has a market capitalization of $14.71 billion with 213 million outstanding shares.
BF-B currently pays a $0.255 quarterly dividend for a current yield of 1.6%.
With a beta of 0.46, BF-B trades with approximately half as much volatility as the market.
The past two weeks we decided to showcase two widely varying Covered Call Strategies. We did a very conservative at-the-money strategy for Comcast (NASDAQ:CMCSA), followed by last week's bullish out-of-the-money strategy on the more volatile Qualcomm (NASDAQ:QCOM). This week, we're back to our more conservative ways with Brown-Forman. This dividend aristocrat has raised its dividend for the past 29 consecutive years, and has been a favorite inclusion in many income-oriented portfolios despite the overall "low-ish" yield. One of the reasons for this is the consistent manner in which BF-B raise their dividend - usually averaging out to about 10% a year - having the dividend follow their annualized EPS growth rate over the past ten years, and causing the dividend to double every seven years. These numbers may seem like they don't really mean all that much, but what is important is that they display consistency in the way the company approaches returning profits to its shareholders and lending conviction that the company will keep its ability to pay and increase its dividend, despite possibly difficult macroeconomic conditions. Stable, continuous income is a goal of many investors, and one of the reasons why people are attracted to our Covered Call Strategy. For this reason, BF-B makes a great target for the strategy.
BF-B is also HUGE. If you haven't noticed yet, we like to focus on the leviathans in each sector when we are looking for investments because they provide the most safety and ability to shrug off the currents of the global economy. Brown-Forman is the largest American-owned liquor and spirits company in the world, despite their focus on providing income to their investors, they have not neglected the chance to continue to grow. They have been able to hold a central place in the global market trends with their notable brand names, namely Jack Daniels, and have recently announced that they will be opening a distribution company in France as of January 2014. Their business in France has grown at a double digit rate for the past seven years as the bourbon market has continued to grow in popularity, and the move to open a distribution hub in the middle of one of their fastest growing regions is smart strategic business.
In terms of valuation, we wouldn't necessarily say BF-B is cheap. The stock is up 7.71% year-to-date, and are poised to take out their 52-week high of $71. The stock sports a trailing P/E of 25 and a PEG of greater than 2. These aren't ridiculously expensive valuations, but like we said, they aren't exactly cheap. Yet it is relatively easy to see why. Investors flock towards safety and consistency in uncertain economic times, and BF-B is an attractive choice given its dividend history, its recent earnings report in which they beat on EPS and met revenue estimates, and the fact the company just raised their guidance for their fiscal 2013. An investment in BF-B at this moment isn't a value play, its a reliability play. We're not going to the car lot hoping to buy a clunker that happens to have Ferrari engine in it, we're buying the pick-up truck that can run for the next 100,000 miles.
For the Covered Call Strategy for BF-B we're going to be choosing the September $70 Call. Why such a short time frame given the long-term stability of an investment like BF-B, and why such a close strike price if the company has positive outlook for the year? It is a simple fact of choices - in terms of options for BF-B there aren't too many of them. We could go for the $75 strike price in September, but the premium is too paltry and there is a possibility of the stock hitting a bit of resistance around its 52-week high. We think it better to just grab the larger premium right now rather than try to reach for the $75 level. That is why we are recommending buying BF-B and selling the September 2013 $70 Call.
- Buy 100 shares of BF-B @ $68.32 = $6,832 + Commission ($12.95) = $6,844.95
- Write 1 BF-B September 2013 $70 Call @ $180 - Commission ($8.70) = $171.30
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
(1.71 + (2*0.255))/68.45 X (365)/189
= 6.26% Static Return
(Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration
(1.71 + (2*0.255) + 70 - 66.67)/66.67 X (365)/189
= 10.64% 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 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 have no positions in any stocks mentioned, but may initiate a long position in BF.B over the next 72 hours.
Additional disclosure: OakTree Investment Advisors manages money for individual and pension plans and may take a position in BF.B