Wednesday, November 25, 2009

Establish Rock-Tenn Co. Covered Calls

A new covered calls position was established today in the Covered Calls Advisor Portfolio(CCAP) with the purchase of Rock-Tenn Co. (RKT) covered calls as follows:

Established Rock-Tenn Co. (RKT) Covered Calls for Dec09:
11/25/09 Bought 300 RKT @ $46.49
11/25/09 Sold 3 RKT Dec09 $50.00 Calls @ $.40

Rock-Tenn Company manufactures and sells packaging products, recycled paperboard, containerboard, bleached paperboard, and merchandising displays worldwide. The Consumer Packaging segment manufactures folding cartons for packaging applications; express mail envelopes for the overnight courier industry; coated recycled and bleached paperboard for manufacturers of folding cartons and other paperboard products; and market pulp. The Corrugated Packaging segment produces linerboard and corrugated medium, corrugated sheets and packaging, and preprinted linerboard for industrial and consumer products manufacturers and corrugated box manufacturers; converts corrugated sheets into corrugated products; and provides structural design and engineering services. The Merchandising Displays segment designs, manufactures, and pre-assembles temporary and permanent promotional point-of-purchase displays for consumer products companies; provides contract packing services, such as multi-product promotional packing and product manipulation; and produces lithographic laminated packaging. The Specialty Paperboard Products segment sells specialty recycled paperboard to manufacturers of solid fiber interior packaging, tubes and cores, and other paperboard products; produces gypsum paperboard liner; converts specialty paperboard into book cover and laminated paperboard products for use in furniture, automotive components, storage, and other industrial products; designs and manufactures fiber partitions, including solid fiber partitions for glass container manufacturers and producers of beer, food, wine, spirits, cosmetics, and pharmaceuticals, and die-cut paperboard components; and manufactures specialty agricultural packaging for certain fruit and vegetable markets and sheeted separation products. It also sells recycled paper to the manufacturers of paperboard, tissue, newsprint, roofing products, and insulation. The company was founded in 1936 and is headquartered in Norcross, Georgia.

Credit Suisse recently issued a very bullish analysis of containerboard stocks in which they highlighted the following catalysts: (1) containerboard pricing is poised to increase as the overall economy improves since the industry is already operating at 95% of capacity while current inventories are at 15-year lows; and (2) analysts' current average earnings estimates are low in comparison to likely results for the next several quarters.
More specifically for Rock-Tenn Co., it is in the midst of a dramatic improvement in free cash flow generation which it is using: (1) to pay shareholders (RKT has already announced a 50% increase in dividends to $.60 annually); and (2) to aggressively pay down the large debt from its 2008 acquisition of Southern Container. Despite its relatively high enterprise value resulting from its current high debt, its stock is now value-priced with a EBIT/EV (Earnings Before Interest and Taxes divided by Enterprise Value) of only 10.0. As such, this advisor believes that there is minimal downside risk for this stock -- so a moderately deep-out-of-the-money covered calls position was established in RKT.

Some possible overall performance results(including commissions) for the RKT transactions would be as follows:
Stock Purchase Cost: $13,955.95
= ($46.49*300+$8.95 commission)

Net Profit:
(a) Options Income: +$108.80
= (300*$.40 - $11.20 commissions)
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If stock price unchanged at $46.49):
-$8.95 = ($46.49-$46.49)*300 - $8.95 commissions
(c) Capital Appreciation (If exercised at $50.00): +$1,044.05
= ($50.00-$46.49)*300 - $8.95 commissions

Total Net Profit(If stock price unchanged at $46.49): +$99.85
= (+$108.80 +$0.00 -$8.95)
Total Net Profit(If stock price exercised at $50.00): +$1,152.85
= (+$108.80 +$0.00 +$1,044.05)

Absolute Return if Unchanged at $46.49: +0.7%
= +$99.85/$13,995.95
Annualized Return If Unchanged (ARIU) +10.8%
= (+$99.85/$13,995.95)*(365/24 days)

Absolute Return if Exercised at $50.00: +8.2%
= +$1,152.85/$13,995.95
Annualized Return If Exercised (ARIE) +125.3%
= (+$1,152.85/$13,995.95)*(365/24 days)