(By Philip Guziec) We use Morningstar's proprietary
industry-level data to find sectors and industries that are attractive
for option-based investment strategies.
The charts below show how much the average implied volatility
for each sector differs from its trailing-three-month and
trailing-one-year averages for U.S.-listed equity options (vertical
bars, indexed on the right-hand scale), the change in implied volatility
from week to week (dark blue line, indexed on the left-hand scale), the
implied correlations of small- and large-cap stocks, and the
relationship of implied volatility across size and value stocks.
Implied volatility of consumer defensive equities has spiked
recently, justifying the sale of overvalued downside on a few
undervalued names.
Source: Morningstar Option Research
Avon Products (AVP)
Avon Products is a multilevel marketing company, selling products
through its 6.4 million active representatives in more than 60 countries
and territories. Avon's product mix consists of beauty (cosmetics,
fragrances, and skin care), fashion (accessories and apparel), and home
(home products and gifts). The firm received the first direct-selling
license in China in February 2006. International sales account for about
80% of the firm's consolidated total. Although it appears that Coty has
stepped aside (at least for the time being), interest in the struggling
Avon business has yet to subside. Rumors occasionally resurface that
Richmont Holdings (which led the management buyout of Mary Kay cosmetics
in the mid-1980s and was once Avon's largest shareholder), may make an
investment in or consider acquiring the troubled direct-selling
beauty-care firm. While a tie-up of Avon and Richmont would make
strategic sense, in our view, numerous hurdles could ultimately prevent a
deal from coming to fruition, including the fact that we believe it
would be difficult for Richmont to acquire the full company without the
help of at least one and possibly multiple financial sponsors. Despite
this latest rumor, we still think the more likely path for Avon at this
point is to go it alone; however, its turnaround could take several
years to drive material improvement in its results.
Molson Coors Brewing (TAP)
Molson Coors is one of the
largest brewers in the world. Major brands include Coors Light, Molson
Canadian, Carling, Miller Lite, Keystone, Blue Moon and Leinenkugel's.
Its largest markets include Canada, the United States, and the United
Kingdom. Molson Coors retains 40% share of the Canadian beer market, 29%
of the U.S. beer market (via its MillerCoors joint venture with SABMiller (SBMRY)),
and 19% of the U.K. beer market. We believe that a rebound in the
economic conditions in North America and the United Kingdom will serve
as a catalyst for Molson Coors' stock price. The ongoing economic
malaise has resulted in elevated levels of unemployment for young men
who are key beer drinkers. We believe that once the job environment
improves in Molson Coors' key developed markets the company's beer
volumes should start increasing, thereby spilling-over into improved
earnings per share. Molson Coors also has been a cost-cutting success
story, with its MillerCoors joint venture generating $750 million of
annual cost savings and synergies, of which Molson Coors' share is $315
million. Molson Coors has built a narrow economic moat in the highly
mature North American beer market; and we believe that the brewer's
offerings such as Miller Lite, Coors Light, and Molson Canadian will
continue to be profitable, high volume brands for years to come.
Kroger (KR)
Kroger was founded in 1883 and
is headquartered in Cincinnati. The company is one of the largest food,
prescription drug, and convenience store retailers in the United
States. With the exception of the Northeast, Florida, and a few Midwest
states, Kroger operates stores throughout the U.S. We are raising our
fair value estimate to $30 per share for Kroger. This is in contrast to
the reductions for
Safeway (SWY) and Supervalu (SVU).
Near term, we believe Kroger is best equipped to deal with the risk to
sales, earnings, and cash flows from the rising food and fuel inflation
likely to materialize as the year progresses. Kroger, to a greater
degree than others, deploys gas as a loss leader to maintain customer
traffic. Long term, Kroger is a proven share gainer, its cash flows have
the lowest volatility in the space, and there are some signs of an
emerging moat. Therefore, our fair value estimate requires a lower
relative margin of safety. Our intrinsic value implies a forward
multiple of 13.7 times and 5.0 times on a price/earnings and enterprise
value/EBITDA basis, respectively. The multiples our fair value price
assumes for both P/E and EV/EBITDA are roughly in line with five-year
historical averages.
The rising implied volatility was unevenly mixed across sectors, with the biggest increase in consumer defensive names.
Implied volatility levels did not move materially across
sectors, with the exception of the increase in consumer defensive names.
Other than consumer defensive, real estate, and communication services,
implied volatility is at or below trailing-quarter and trailing-year
levels. Our sector standout chart below shows how much the average
implied volatility for each sector differs from its average during the
last year and last quarter. Vertical bars (indexed on right-hand scale)
show present sector volatilities with respect to historical
averages. The dark blue line (indexed on the left-hand scale) shows
change relative to the previous week.
Source: Morningstar Option Research
PhilipGuziec is co-author of the Morningstar
Investor Training course on Option Investing. For more about
Morningstar's fundamental approach to investing in options, please click on this link to download our free guide to option investing.