We’re Laughing About This Now

Franchise Group

Market momentum is green. We continue to look for strong opportunities in S&P 500 stocks in the energy, materials, and industrial space. However, be very cautious with technology stocks.

On May 19, I made a controversial trade recommendation in Haven Investment Letter.  A bullish put spread on Kohl’s Corp. (KSS). Shares were off more than 30% in a few weeks after the board of directors rejected several offers from prominent private equity and retail companies. 

Its leadership somehow turned down an offer for more than $64 from the retail specialty giant Sycamore Partners. But then, the shareholders somehow decided to ignore an activist investor aiming to sell the retail giant and then reelect the entire board of directors. 

The market didn’t take that news too well. The stock collapsed from the low $60s to the low $40s. While there was blood in the streets and sellers were panicking…

I saw a unique opportunity. But it all started with one simple question. What is a company like Kohl’s actually worth? 

Determining a Liquidation Value

I’ve discussed that I love the film Other People’s Money with Danny DeVito a few times. In the film, the takeover artist looks for companies trading for less than the sum of their parts. This is a strategy used by activist hedge funds today like Jana Partners, Starboard Value, and Third Point. 

I examined the story behind Kohl’s. I examined its real estate. Then I looked at the potential liquidation value of its inventory. I asked what all of the “stuff” they owned if a credit implosion happened tomorrow. 

I determined that the worst case was roughly $33.20. That price is just below its tangible book value ($34.50). That figure is considerably lower than its future projected free cash flow and comparative value to other competition. 

Now, I knew that companies would come back with offers. The arbitrage traders ran away and sank the stock after the first rejection of its offers by the board of directors. But insiders suggested that a deal was coming… That offers would come in the next few weeks. 

If the stock reversed and went higher, the value of my credit spread would decline, and I’d make money. And if the time decay picked up toward July 15, the credit spread’s value would decline, and I’d make money.

If the stock just stayed above the breakeven price of $33.85, I’d make money. And in the worst-case scenario – if the stock fell under $35, I’d purchase a stock that I want to own near the value of the sum of its parts. 

While the stock continued to decline due to selling among the arbitrage crowd – represented by people trying to buy and hold while waiting for a deal – it never dropped below my liquidation price. 

Good News For Franchise Group

On Monday, Kohl’s announced that it would enter an exclusive negotiation period with Franchise Group (FRG), a retail holding company that owns The Vitamin Shoppe. Target price: $60 per share. 

The next three weeks will allow Franchise Group to conduct its due diligence around Kohls. This includes a deep dive into the value of its real estate, operations, and other assets. Kohls operates about 1,110 stores and generates about $19 billion in annual sales. 

The news pushed shares more than 8% on Tuesday. I don’t care if Kohl’s is bought in the next three weeks. I care that the stock went higher, allowing the puts in my credit spread to decline in value. As the stock rises, out-of-the-money puts decline in value. 

In addition, I now have three weeks that will allow the time decay in my options to decay. As the time decay continues, those put contracts’ value also declines. As the value of the put spread declines, I can purchase it back for less than the credit I bought it for. What a great trade. 

Where Am I Looking Now?

To identify a list of stocks trading in this environment, I’m looking for stocks trading under a tangible book value of 1x and in line with their net asset value. Here are the nine stocks that trade over $9 that fit the bill. 

The primary stocks on this list are in the housing industries: Meritage Homes (MTH), M/I Homes (MHO), KB Homes (KBH), and Beazer Homes USA (BZH). All of these homebuilders are trading like we are already in a recession.

I’m eyeing these stocks based on their massive pullback to start the year. In addition, Hurco Companies (HURC) is a producer of machinery. All of these companies are real companies with real assets. 

They prevent an opportunity to sell puts or credit spreads lower that allows you to generate income off your margin requirements. Remember, the worst case is that you will buy a stock with real assets for less than the sum of its parts.

Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.
Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.

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