Sold Cash Secured Put + Investment Thesis – The Kroger Company (KR) – $21.00 strike – Sep 15 Expiration

This trade was actually executed on Wednesday 08/16/17. I didn’t get a chance to write about it until today.

Please visit the core philosophies article on my investment thesis process for a deeper explanation of the components of this article. Additionally you might find my rules for trading options helpful in understanding the parameters of the trade.

In case you missed it, I’m making it a point to twitter all my trades as they happen and this was no exception.

 I have updated the portfolio and income tracker pages to reflect this position.

Dividend Cycle

KR just went ex-div a few weeks ago on August 11, so the next opportunity won’t be till November, well after this contract expires. The current quarterly distribution is $0.125/share which reflects the most recent increase of 4.2%. The company has increased the annual distribution for 12 consecutive years which is good for Dividend Contender status. The premium on this contract is 2.3x the quarterly distribution and is only in effect for 30 days

Investment

# contracts

Strike

Expiration

Total Premium

Days in Force

Annualized Return

Closing Price

Downside Protection

1

$21

9/15/17

$28.91

30

16.75%

$23.09

8.7%

The QC (Quantitative Case)

Payout Ratio – EPS, FCF

30.12%, 43.86%

10 Year Revenue CAGR

6.4%

10 Year EPS CAGR (5 Year EPS CAGR)

14.4%

5 Year ave P/E – Current P/E (ttm)

+4.1

5 Year ave Yield – Current Yield  

-0.7%

10 year mean DGR (dividend growth rate)

16.5%

Debt/Market Cap

$13.44B/$20.29B (66.2%)

Total Cash

$356M

Return on Assets

5.51%

Return on Equity

24.78%

Profit Margin

1.35%

EBITDA/Revenue

$5.51B/$117.02B (4.71%)

Reverse DDM Fair Value DGR at Strike

7.6%

Assumed DGR (DDM valuation 10% disc.)

8% max by rule ($25.00)

DGR Margin of Safety

0.4%

Dividend Cushion Ratio (7.79% DGR)

-3.05

Cash from Ops “cushion”

+49.71%

Capex “cushion”

-62.86%

DGR “cushion” (delta)

N/A

Note: Ruh Roh! It seems that there was a mixup with my datascraped watchlist. I’m not too worried about the low ROA or EBIDTA %. That’s the nature of the grocery business.

But the debt situation is no bueno. You see, my watchlist scraped Morningstar’s balance sheet data for “short term debt” and “long term debt”, and came back with zero of each for Kroger. That’s because they don’t call it that on their balance sheet. So the watchlist spreadsheet formula missed the fact that they have $1.85B in current and $11.59B in long term capital leases, which are very much debt. A rose by any other name…

I will be monitoring this position closely, and may close it early if I get lucky enough with a favorable share price move before earnings.

SPL (Strike Price Logic)

Implied volatility is through the roof for the September monthly contracts because KR is set to report earnings the week before on 9/8/15. At the time the $21 strike was a pretty decent amount of downside with a compelling premium return. Share price weakness over the last week has eaten into some of that cushion.

QWaF (Qualitative Warm and Fuzzy)

Kroger is the largest traditional grocery store in the United States by revenue. Their size and position in the market offers them a strong advantage. They are adapting to the digital age as needed (with plans to double their current 640 “click and collect locations”), but also offer compelling reasons for customers to shop the old fashioned way (50% of locations offer gasoline).

CPR (Cold and Prickly Risks)

Amazon just bought whole foods. Aldi and Lidl are coming to America. WalMart and Target aren’t going to give up their efforts to expand in the grocery space. This is an industry already teetering on razor thin margins and all this competition isn’t helping. Amazon and WalMart and Target all sell stuff other than groceries to help drive cash flow. What’s Kroger have other than gasoline?

If they really had zero debt, I would say that they’ll be able to weather the coming retail grocery storm one way or another. Since that’s not the case, I’m not very confident in this trade and will likely be unwinding it at the first good opportunity.

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