Sold Cash Secured Put + Investment Thesis – Hormel Foods Corporation (HRL) – $31.50 strike – March 02 Expiration

This trade was actually executed on Friday 02/02/18. 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

HRL went ex-dividend a month ago on January 11th, which means this contract will expire with over a month before the next ex-div date. That may work out in my favor, opening the possibility of squeezing a second trade in beforehand.

The most recent quarterly distribution was $0.188/share, which represented a 10.6% increase over the previous payout of $0.17. That’s what I like to see, and is a big reason why I’m initiating this position.

However, it’s not much of a surprise, considering HRL is a dividend champion (King actually), boasting 52 consecutive years of dividend increases.

The premium earned from this contract is over 1.5X the quarterly payout and the contract is in force for only a month.

Investment

# contracts

Strike

Expiration

Total Premium

Days in Force

Annualized Return

Closing Price

Downside Protection

1

$31.50

03/02/18

$29.66

28

12.27%

$33.65

6.39%

The QC (Quantitative Case)

Payout Ratio – EPS, FCF

43.3%, 54.4%

10 Year Revenue CAGR

3.57%

10 Year EPS CAGR (5 Year EPS CAGR)

20.19% (13.76%)

5 Year ave P/E – Current P/E (ttm)

23.7 – 21.4 = +2.3

5 Year ave Yield – Current Yield  

1.6% – 2.1% = 0.5%

10 year mean DGR (dividend growth rate)

16.3%

Debt/Market Cap

$250M / $17.82B (1.4%)

Total Cash

$444.1M

Return on Assets

11.62%

Return on Equity

18.04%

Profit Margin

9.24%

EBITDA/Revenue

$1.37B / $9.17B (14.9%)

Reverse DDM Fair Value DGR at Strike

7.61%

Assumed DGR (DDM valuation 10% disc.)

8% – max by rule ($37.60)

DGR Margin of Safety

0.39%

Dividend Cushion Ratio (X.xx% DGR)

1.047

Cash from Ops “cushion”

-1.98%

Capex “cushion”

+3.20%

DGR “cushion” (delta)

+1.53%

SPL (Strike Price Logic)

Looking at the HRL chart it’s hard to find substantial technical support at $31.50 except that between August and October of last year, the price was range bound between $32.14 and $30.15. So I guess we’re in the middle of that?

As usual the primary driver for the strike price was the maximum amount of downside protection I could get and still earn a 12% annualized return from the premium.

QWaF (Qualitative Warm and Fuzzy)

Did you know that more than 30 of Hormel’s brands enjoy a #1 or #2 market share position in their respective categories? The company’s brand power is one of the strongest in the consumer goods sector.

In addition to the powerful portfolio of brands, I like that the company is focused on meat products. Most of the firm’s future growth is going to come from international markets, and as emerging economies become wealthier, the swelling middle classes are going to be looking for more protein.

Also 49% of shares are held by insiders. That is a good thing. I trust management to continue to raise the dividend as long as they can because that’s how they pay themselves.

CPR (Cold and Prickly Risks)

You don’t go down to the Hormel store to buy a can of spam. The company relies on retailers to distribute their products, and the way retail works, as we all know, is changing in this day and age.

For one thing, grocery stores are getting more and more aggressive about their white label brands which are in direct competition with Hormel’s premium brands. Canned meat isn’t really anything special after all. That kind of competition could compress margins.

Also Hormel’s products aren’t exactly known as being very good for you. Any consumer trends favoring organic foods and healthy options are probably negative for the company on balance.

But that strikes me as an issue fairly easily solved with a few well-placed marketing campaigns, and the white label thing is mainly a domestic concern, which isn’t where we’re looking for the growth.

I’ll take my chances with a stellar balance sheet, dominant market position and management tightly aligned with my interests as fellow shareholders.

 

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