Unusual Trading in Kraft Heinz Call Options After CEO Interview - Is KHC Stock a Buy?

Heavy, unusual trading in Kraft Heinz Inc (KHC) call options occurred today after a Reuters interview with the company's new CEO, Steve Cahillane. He outlined his turnaround plan, but so far, KHC stock has faltered since its Q1 earnings release.

KHC is at $23.14 in midday trading on Wednesday, June 3. That's down from a recent peak of $24.47 on May 28, but well up from its trough prices at the end of March and in April, as shown in the Barchart chart below.

The chart shows that KHC has been very volatile, but it has generally trended higher since its May 6 earnings release for the quarter ending March 28. The release showed that Kraft Heinz had lower sales and lower operating income, although its free cash flow (FCF) was significantly higher than last year.

Will Kraft Heinz Turn Around This Year?

In its May 6 release, the CEO, Mr. Cahillane, emphasized that he expects to turn around its U.S. business and accelerate its international growth. 

The only problem is that Kraft Heinz has been losing market share. The CEO didn't really show how it would do this, other than to say they are expanding their marketing and R&D budget by $600 million.

Today's Reuters article, as republished by CNBC, provides more specifics about how this will work. For example, expect to see more higher-protein and low-sugar products, like sugar-free Heinz Zero ketchup and protein-infused Mac & Cheese, etc.

Will this work? Maybe, but free cash flow (FCF) could take a hit until it does.

For example, in the last 12 months (TTM), KHC has produced $3.945 billion in FCF, according to Stock Analysis, representing a FCF margin of 15.79% on $24.99 billion in TTM revenue.

But, if it spends $600 million on higher expenses, hoping to reap some benefits down the road, that margin could sink to 13.38% if sales stay flat:

  ($3.945b - $-.6)/ $24.99b = $3.345b / $24.99b = 0.1338

That is a 15.3% decline in its FCF margin, assuming it takes a while for that investment to pay off. That won't help KHC stock.

For example, analysts don't see much happening with revenue growth. For next year, they are forecasting $24.55 billion in sales, compared to $24.44 billion expected this year, according to Seeking Alpha. 

That represents just a 0.45% growth rate, but would still be below the $24.99 billion in sales it made over the trailing 12 months.

A more optimistic analysis would argue that the $600 million in extra spending would yield a 3-5% increase in sales. That could raise revenue to $25.3 billion to $25.8 billion. And using an average 15.5% FCF margin would produce FCF of up to $4.0 billion (i.e., 0.155 x $24.77b sales).

But that would still be only slightly higher than Kraft's Q1 trailing 12-month FCF of $3.945 billion (see above).

This could be why there is so much heavy trading in today's KHC options.

Heavy Unusual KHC Call Options

This can be seen in today's Barchart Unusual Stock Options Activity Report. Over 15,000 call options have traded at the $23.00 strike price for expiry on June 12, in 9 days.

That strike price is an “at-the-market” or ATM call option with a midpoint premium of 33 cents, or 1.426% of its stock price (i.e., $0.33/$23.14).

That's how much a covered call seller of this call option would make.

Buyers of these calls hope to see KHC rise to over $23.33 ($23.00+.$0.33), or just 0.82% higher than the trading price. So, that likely implies the initiators of these trades are buyers.

After all, it is not much higher than today's price, and the call options could provide good upside, especially if KHC rises to its former peak.

The only issue is that 9 days is a very short time period. This is not long enough for any intrinsic value to emerge from what the CEO just talked about the future of the company.

In essence, it is a speculative play, and investors should be careful of the downside risks of this kind of short-term option. Buyers stand to lose 100% of their investment if KHC falls below $23.00 by June 9.