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Go Long Eastman Chemical Co. (EMN) And Sell A Covered Call

|Includes: Eastman Chemical Co. (EMN)

08/26/13 Covered Call Pick: Eastman Chemical Co. (NYSE:EMN)

Eastman Chemical Co. (EMN) is a United States based chemical company that focuses on the manufacture and sale of specialty polymers, polyethylene, intermediate chemicals, and adhesives for the consumer and industrial markets. Eastman has over 44 manufacturing sites worldwide, employing more than 13,500 people. Spun off from Eastman Kodak in 1994, Eastman Chemical Co. makes specialty chemical and plastics products for a variety of applications, and is a major supplier or both cellulose acetate fibers and PET polymers used in packaging.

Eastman Chemical Co has a market capitalization of $12.28 billion with 154.2 million outstanding shares.

Eastman Chemical currently pays a $0.30 quarterly dividend for a current yield of 1.5%.

With a beta of 1.59, EMN trades with approximately 60% more volatility than the current market.

At the end of last week's review we reported the bullish outlook for a revival in the chemicals industry, especially domestically. If you haven't read Friday's review, you should probably go back and check it out, but here are the cliff notes: the shale gas boom here in the United States has made it exceedingly cheap for chemical companies to produce the polymers that are used in the variety of products they make such as plastics, adhesives, elastics, and coatings. The chemical industry, which had seen a multiple decade decline, is now poised for a revival with the glut of natural gas supplying cheap materials, and economic recoveries around the world starting to form. In the chemical industry, Eastman Chemical is poised to outperform.

Over the past three years the company has seen double-digit revenue growth off the back of strong growth from their plastics, elastics, and adhesives products. This type of growth has carried over into this year with solid performance in the first quarter, and beating both EPS and revenue expectations last month in their Q2 report, causing them to raise EPS guidance for the year up to $6.40-$6.50, or 21% year-over-year. Given this performance and raised guidance, Deutsche Bank raised its price target up to $100 from $85, and Zack's Research firm gives the stock a #2 Buy ranking. Including a B- Accumulation/Distribution Rating and an Up/Down Volume Ratio of 1.3, there is strong support for the stock from institutional investors and analysts alike.

The stock posts an impressive 33% Return on Equity with a strong cash flow of $7.55 per share, and is trading a discount of a 13 P/E ratio and a Forward PEG of 0.62. Because the beta for the stock is higher than normal we have to be careful about getting too greedy with looking for growth on the Covered Call, but we still believe Eastman Chemical will continue to profit despite headwinds in the macroeconomic environment. The stock has a near term support level of $77.79, so we are recommending the December 2013 $85 Covered Call. The premium from this Call gives us enough downside protection to prevent a loss if the stock slips down to that support level, and then some. It also gives us approximately 6% upside potential for the stock alone, not including the premium and dividends, and without weighting for duration. That is why we are recommending buying EMN and selling the December 2013 $85 Covered Call.

Scenario:
 

  • Buy 100 shares of EMN @ $79.30 = $7,930 + Commission ($12.95) = $7,942.95
  • Write 1 EMN December 2013 $85 Call @ $2.30 - Commission ($8.70) = $221.30

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

(2.21 + (2*0.30))/79.43 X (365)/111

= 11.63% Static Return


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

(2.21 + (2*0.30) + 85 - 79.43)/79.43 X (365)/111

=34.69% 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.

Posted by OaktreeAdvisors at 8/26/2013 9:59 AM
Categories: Weekly Picks

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Disclosure: I am long EMN.

Additional disclosure: As active managers we are or may go long EMN and will sell covered calls in accounts when appropriate.