ITM Covered calls - HSY and XOM

I am planning to enter naked puts for Hershey and Exxon with intentions to take ownership of the stocks and convert it to a ITM Covered calls.

Both stocks are good candidates for ITM covered call as they have great fundamentals. They are great company with great managements, good brand recognition, steady and increasing dividends, buying back stocks every year and plenty of cash.

Both stocks have been driven down recently because of pending acquisitions. Hershey is in a bidding war with Kraft for ownership of Cadbury and Exxon is buying XTO for $32 billions dollars in stock. Together with the debts of $10 billion, it will cost XOM a total of $42 billion. This is a very big acquisition.

Exxon is a $360 billion company. It earned nearly $60 billion in CASH last year. It can borrow money cheaply because of its AAA credit rating.

Normally, during an acquisition, the acquirer’s stock will be driven down because they have to pay a premium for the company to be acquired. But we have to examine whether the acquisition makes sense in the longer term. If it does, it is a great time to acquire the stock.

HSY is a long term performer. If you examine HSY performance from 1980 until today, it is better than 15% per year assuming you re-invested the dividends. Since 2005, HSY has repurchased more than $1 billion worth of its stock. It continues to pay and increase dividends. In 2008, the company produced >$500m in cash from operations. It spent $300m on dividends and share buyback plus repaid $138 m in debt. The company continues to pay out $500m per year to shareholders and I expect this to continue.

Hershey has tremendous amount of “economic goodwill”. The company is capital efficient, which means that in an inflationary climate, when chocolate prices go up, more money ends up in the price of shareholders. It has proven over the years, it can produce more without proportional increase in capital investments. During its best year in 2007, the company annual capital budget only increase 9.8% or $189 m,


The business model is similar to Coca-Cola. Between 1989-1999, Coke’s market cap rose nearly 12X. The company raised its dividend consistently each year. We know the success story of Warren Buffet with Coke.

What makes the company so successful? It is simply branding. Coke is the no. 1 brand in the world for soft drink. Hershey is the number one brand for chocolate in US. It will become the number one brand for chocolate if the bid is successful.

Hershey is in a biding war with Kraft to take over Cadbury. It will cost $20billion. But Hershey’s market cap today is only $8billion. So it must take on some huge debt to finance the deal. This is one of the reasons why the stock is trending down.

I am speculating that if Hershey were to take over Cadbury, the money will have to come from someone who knows the business. This person is Warren Buffet.

Warren Buffet is cash rich. He likes this kind of business. He has invested in See’s Candies and Coke. He helped to provide financing for the Mars takeover by Wrigley. Hershey has retained investment banker, Byron Trott for the deal. This is the same guy who did the Mars / Wrigley deal for Buffet.

The deal will probably be announced in 1-2 weeks.

If the deal does not go through, I expect the shares to go up.

If the deal goes through, share may go down temporarily as the market may worry about the debt. In that case, I will double the stake when it stabilized.

Longer term, this is a very good deal for Hershey if it goes through.

As for Exon, it is a very well run company. The stock will find support at 66. It is now very oversold.

But my indicators have not gone bullish yet. Naked put are bullish trade. So I will place the trades when the technicals give me the bullish signal.