06/24/13 Covered Call Pick: Generac Holdings Inc. (NYSE:GNRC)
Generac Holdings Inc. (GNRC) manufactures standby power generators and generator components for residential, industrial, and commercial markets. Headquartered in Waukesha, Wisconsin, Generac Holdings sell their 800 watt to 9 megawatt generators through independent wholesalers, retailers, and big box stores. These generators are gaseous, diesel, or bio-fueled and are used for everything from RV power generation to life-saving backup power during natural disasters.
Generac Holdings has a market cap of $2.38 billion with 68.4 million outstanding shares.
Generac Holdings currently pays no dividend.
With a beta of 0.85, GNRC trades with approximately 15% less volatility than the current market.
GNRC is a stock that is quite uncharacteristic for our Covered Call recommendations. It is a Mid-Cap stock with less than $10 billion in market capitalization, doesn't pay any current dividend, and has only been trading publicly since 2010. So why are we recommending GNRC since it is so far outside our normal mold?
Well if you haven't noticed, our normal go-to style stocks (the big income yielding dividend plays) have been going on quite a run recently, and are now overvalued in the eyes of many analysts. That really doesn't concern us for the long term, but it does get us to looking at other options that are out there in the market that are mildly eschewed from our regular rank and file.
Generac really hit the mainstream news last year after sales skyrocketed in the aftermath of Superstorm Sandy, where thousands along the East Coast were left without power for days and even weeks. Not only did sales benefit from this horrific event, but more importantly awareness for supplemental power not only for commercial areas, but residential areas, came to the forefront in the media. The shortcomings of our country's utility infrastructure was poignantly highlighted during this tragic time, and many people now understand that they cannot rely on their electric companies to keep the lights on when a natural disaster hits. When people run to Home Depot or Loews to prepare for a coming storm, its the Generac generator that they will end up seeing.
The stock itself has a lot of positive characteristics. With a P/E of 10, it is trading at a good discount to S&P 500's P/E of 18. The ROE is a healthy 36%, with an EPS Growth Rate of 91% over its short tenure on the open markets. The stock has a Daily Graphs Accumulation/Distribution rating of A-, meaning that institutional buy orders far exceed the institutional sell orders over the last 13 weeks. It also has an Up/Down Ratio of 1.7, meaning that investors are more likely to buy and/or hold the stock during up and down days as opposed to selling it.
Yet nothing is perfect, and there are some shortcomings that we see in the stock. Firstly, their cash flow generation is not that strong. Their LTD (long-term debt) to equity level is also high at 172%, but this is not uncharacteristic of industrial equipment companies (in comparison, GE has a higher LTD-Equity ratio). The most troubling thing is the lack of a dividend, which means we're not going to get paid for holding the stock, and with forward earnings for 2014 essentially flat, we want to get paid for holding the stock now in case next year is as disappointing as they are projecting. Luckily, we have Covered Calls to help with all of that.
We're going to look at the November $35 at-the-money Call for GNRC. As you might have noticed, the markets are getting hammered recently, and while there is some great investor support for GNRC, they are not immune to a sell-off. By selling an at-the-money Call we provide ample income from the premium to satisfy the income investor and allow us to get paid for holding the stock during these rough market times, and hopefully use this as a good way to back into the stock at a lower cost basis. There is good technical support level at $30, and by selling the Call we actually put our cost basis just above that level. If the stock ends up getting called away from us, we pick up a nice yield for our time, and can always buy more of the stock if we see the market turn around and get its feet back underneath itself. It is in markets like these you should be thankful you have sold Calls on your positions, as your downside risk across your portfolio is much smaller as compared to the investor that did not sell the Calls. That is why we are recommending buying GNRC and selling the November $35 at-the-money Call.
- Buy 100 shares of GNRC @ $34.92 = $3,492 + Commission ($12.95) = $3,504.95
- Write 1 GNRC November 2013 $35 Call @ $295 - Commission ($8.70) = $286.30
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
(2.86)/35.05 X (365)/145
= 20.54% Static Return
(Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration
(2.86 + 35 - 35.05)/35.05 X (365)/145
= 20.18% 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 GNRC over the next 72 hours.
Additional disclosure: At OakTree we are active managers and will own and continue to add to positions as well as write calls on our long positions.