Food for Thought on Kraft
By KOPIN TAN
Barrons, Jan 29th
AT ABOUT 34.50, KRAFT FOODS' SHARES haven't strayed far from the 31 at which they went public in 2001. But that hasn't stopped option traders from anticipating bigger moves ahead.
That's because the coming weeks will give Kraft (ticker: KFT) investors much food for thought. The world's second-largest seller of packaged calories will report earnings Wednesday, and its parent company, Altria (MO), probably will detail plans to spin off the 88% stake it holds in the maker of Oreo cookies, Jell-O snacks, Oscar Mayer meats and Post cereal. And come Feb. 20, in her first investor conference, Irene Rosenfeld, who took the helm as CEO last summer, will discuss her blueprint for turning around Kraft.
Traders have begun bidding up short-term options, driving the annualized implied volatility of Kraft shares to nearly 24% -- up from 18% just two weeks ago. Expectations for Kraft to bust out of its persistent trading range aren't entirely far-fetched. Bulls believe, for instance, that Kraft's odds will improve once it shakes off Altria's tobacco taint. Full autonomy will also let Kraft more nimbly navigate the crowded competition in the food aisle.
Still, the discharge of so many Kraft shares into the market probably will blunt the fervor of any short-term rallies -- presenting an opportunity for call sellers to earn rich premiums for agreeing to relinquish short-term stock upside.
Spinoff details and the impact on Altria are examined by my colleague Andrew Bary in "A Long-Awaited Breakup1," but investors will receive 0.7 Kraft shares for every Altria share they own. This releases more than 1.45 billion Kraft shares into the hands of Altria investors -- dwarfing the float of nearly 200 million now available for trading. As such, Altria stockholders probably will seize upon Kraft rallies to lighten their load.
In a Jan. 24 note to clients, Citigroup's derivative strategists suggested selling Kraft calls against stock, or "collaring" -- essentially selling calls to finance the purchase of puts, since downside risk will be exacerbated by the increased crop of Kraft shares available for sale. Selling June 37.5 calls trading near 75 cents, for example, could substantially pay for June 32.50 puts trading around 80 cents.
By the strategists' reckoning, out-of-the-money Kraft puts recently were trading at fairly normal levels, relative to out-of-the-money calls -- when one would expect this differential, or "skew," to be far wider, given the potential for aggravated selloffs. So another suggestion was for sophisticated volatility traders to buy the Kraft skew.
What could propel Kraft higher and thwart call sellers? Besides any restructuring buzz, the addition of Kraft to the Standard & Poor's 500, which many investors anticipate, would require index funds to buy roughly 20 million shares, Citigroup estimates. And any scramble to cover short bets involving more than 30 million shares could spur more buying. But these amounts are small, compared to the vast stock overhang.
Kraft bulls lick their lips at the prospect of a turnaround. But rising commodity and other raw-material costs continue to threaten the packaged-food world's treacherously thin margins. And supermarkets' push to hawk their own private labels -- the quality of which continue to improve -- also means that any Kraft revival will take time. |
