Stop me if you have heard this before, but inflation data and the moves in the bond market continue to be the major drivers of the market’s direction. And last week traders weren’t thrilled with these inputs as the S&P 500 fell by 1%, the Dow gained 0.5% and the Nasdaq continued its recent weakness with a further decline of 2%.
This week we are adding a recent earnings winner to the portfolio, though because the market has been weak, we are again doing so defensively.
The Stock – Freshpet (FRPT)
Why the Strength
Nobody is going to argue pet food is revolutionary, but Freshpet’s fresher, healthier food (almost all for dogs) plays into the mega-theme of pets becoming more part of the family, and this company’s offerings lead to longer lives and better quality of life for Fido.
Frankly, demand here has never been an issue—sales have grown at least 25% for 20 consecutive quarters (!)—but some company mishaps, the pandemic itself and heavy investments caused costs to ramp, while a series of price hikes (more than 25% total) also caused a few convulsions. But now it’s looking like most of that is in the past: Not only did Q2’s top line rise nicely (up 26%), but it wasn’t just from price hikes, with volume growth accelerating of late (up 18% in the latest quarter), while household penetration is doing the same thing. (All in all, Freshpet has just 15% of U.S. pet households as customers.) Moreover, gross margins are picking up nicely as a new production plant ramps up and all sorts of costs (inputs, G&A, etc.) fall back to Earth. Because of that, EBITDA, while small, is positive, growing and topping estimates ($55 million or so estimated for this year, vs. $20 million last), and the top brass has some bullish longer-term goals, thinking sales can grow 25%-ish annually through 2027 while margins leap a few percentage points, which of course will have EBITDA and earnings doing very well.
Granted, after the last couple of years, there are fears management will lose control of things again, but with the industry growing nicely and with Freshpet being the leader, it’s more likely that big investors will start looking ahead to sustained good vibes.
Technical Analysis
FRPT was destroyed during the bear market, falling from 187 in early 2021 to a low of 36 (!) before staging a solid off-the-bottom rally into November of last year. And then shares went mostly dead—there were some encouraging signs (a huge shakeout-and-recovery in March; some excellent tightness in July), but net-net, the stock did nothing for eight-plus months. Now it’s looking like FRPT is leaving that behind, breaking out on earnings and holding up since. Stop — 68.5
The Covered Call Trade
Buy Freshpet (FRPT) Stock at 80, Sell to Open September 75 Strike Calls (exp. 9/15) for $6.50, or a Net Price of 73.5 or less
Static Return: $150 per covered call (2.04%)
Breakeven: 73.5
Covered Call Return (if assigned): $150 per covered call (2.04%)
Please note, the stock and options prices will be moving throughout the day, so these prices are simply an approximation of prices that you should be able to achieve.
However, the important component of this equation is that the stock price paid, minus the premium received via the call sale, equals the Net Price, or 73.5 or less. (In this case 80 minus 6.50 = 73.5. Or another example is you could pay 79.50 for the stock and sell the call for 6, which also equals 73.50)
For every 100 shares of stock you buy, you can sell 1 call. For every 200 shares of stock you buy, you can sell 2 calls. And so on …
Open Positions
If our stop is hit, I will send an alert giving detailed instructions on how to exit the trade. But don’t get too worried about setting the stop. I will manage that for you.
The next Cabot Profit Booster issue will be published on August 22, 2023.
