New Trade GMCR – Buying A Stock in Foreclosure

by Enis June 14, 2012 2:28 pm • Commentary

Before I say anything, look at the incredible chart of GMCR over the last 3 years:

The stock is down more than 80% in the last 9 months, with the market actually up almost 20% in that period.  The background story to GMCR is a fascinating one.  It has all the elements of a finance thriller.  A former hippie founder-turned billionaire, but now at risk of bankruptcy.  A high-profile hedge fund short seller.  Bank margin calls in GMCR, but also Krispy Kreme.  And what a stock chart.

Here is the full Bloomberg story from last month about the founder of GMCR, Robert Stiller, with background on the other players (like hedge fund manager David Einhorn, an outspoken short seller in GMCR).  So the huge volume down day in early May was obviously the margin call that forced Stiller to sell the stock.  Incredibly, the stock is down an additional 20% from the lows of that forced selling day, which makes me think Mr. Stiller might be getting more margin calls from his bankers to sell more stock.

In a volatile situation like this, it pays to look at the fundamentals of the business, beyond the short-term moves, because the stock has come down so far that I am sure some value-based fund managers are looking through the books.  GMCR trades at 8.5x forward EPS, with analysts expected 15-20% growth for the next 2 years.  However, even if those growth rates are far too optimistic, the stock has plenty of room for error now, as again, it trades at 8.5x.  It is at the same stock price level as it was 3 years ago in 2009, but is on pace to earn 2.40 per share this year vs. 0.43 per share in 2009.  Mr. Einhorn was right in shorting the stock due to the accounting discrepancies and excess inventory, but he was short the stock at a much higher level.

The contrarian in me can’t help but think that the stock at $20 reflects the bad news, and more importantly, we’ve had a very large forced seller push this stock down in the past 6 weeks.  To me, this is a distressed situation where I’m willing to stick my neck out with a defined risk/reward options trade, as I think GMCR has gotten cheap enough that other fund managers will sell their other holdings and start buying GMCR as a value play.  On the flip side, the stock has 17% open interest, and those fat and happy short sellers are likely to be a source of demand as they cover their shorts and move on to the next name.

Finally, implied volatility in GMCR is quite high (mid-70’s), making options expensive.  Given my view of limited downside, and the high volatility, I can sell a 3 month put spread for a nice credit:

TRADE: GMCR ($20.25) Sold the Sept 18/16 put spread for $0.73
  • Sold the Sept 18 put at 2.28
  • Bought the Sept 16 put for 1.55

Break-Even on September expiration:

  • Profit between 17.27 and 18, max profit of 0.73 above 18
  • Losses between 17.27 and 16, max losses of 1.27 at 16 or below
Trade Rationale:  The stock has not been below $17 since May 2009, when the broader stock market was obviously in much more dire straits.  Given my broader short risk posture, I wanted to find a bullish bet where I felt like I got a good entry, and with the stock down 5% today, I feel comfortable initiating the trade here.  This trade has a long time to expiry, and I don’t expect GMCR to necessarily rally substantially from here, but I think it’s downside should be limited over the next 3 months,  even if we see market weakness.  My break-even level is down about 15% in the stock, which is a risk I’m willing to take.