Options traders have not been this bullish in seven years about Kellogg Co., but speculation is currently increasing that Berkshire Hathaway and Warren Buffett are going to make the company an offer.
Last month alone options volume jumped tremendously, and bullish contracts have not been this high since 2007 in relation to bearish ones, according to information and data that was compiled by Bloomberg. Among the 10 options that had the highest ownership, seven of them were bullish. Kellogg shares have climbed 18% since the beginning of February as traders are betting that the creator of Pop Tarts and Cornflakes is going to be acquired.
Buffett mentioned to shareholders this month that Berkshire Hathaway is going to look for another large takeover with 3G Capital, the same company that he teamed up with last year when acquiring H.J. Heinz Co., the ketchup maker. According to Edward Jones & Co’s Brian Yarbrough, Kellogg is an excellent candidate for an Omaha, Nebraska-based Berkshire Hathaway takeover.
“The reason there would be interest for Buffett is that it’s a basic business,” said the analyst, Yarbrough, who covers the consumer stocks for Edward Jones, in an interview over the phone. “It’s a very consistent business. It’s decent in bad times, it’s decent in good times. It generates a lot of cash flow, and they like that.”
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Just recently, earlier this month, Buffett said that he is on the lookout for purchases in order to put the $48.9 billion of Berkshire Hathaway’s cash to work. He also mentioned that he would gladly welcome more deals with 3G. The 83-year-old Buffett has mentioned over the years that he prefers simple businesses that are easy to understand and that have consistent earnings and good returns on equity.
A Kellogg spokeswoman, Kris Charles, said the company does not make any commentary on stock activity. Buffett chose not to return a message left with his assistant about making a comment.
According to three-month data compiled by Bloomberg, put options protecting against a decline of 10% in Kellogg shares actually cost 0.95 points more than call options that are betting on a gain of 10%. Last week, the price relationship reached 0.27, which is the lowest level since May 2007.
At this time, traders currently own more bullish options as opposed to bearish options of Kellogg. The amount of outstanding calls has more than doubled since the end of March to reach 64,450 contracts on May 9. You can compare that with a 62% increase to 40,494 for puts, according to data compiled by Bloomberg.
The CBOE volatility index, which gauges S&P 500 options prices known as the VIX, dropped by 5.3% today to hit 12.23, which is the lowest level since January of this year. The European counterpart called the VStoxx, also slipped by 2.5% to 16.25.
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Along with General Mills and Kraft Foods Group, Kellogg could very well match the criteria that Buffett specifically targets when and he is evaluating a potential acquisition, according to data that was compiled by Bloomberg. The companies are all valued by over $20 billion before debt and require a takeover premium. Kellogg is currently valued at $24.6 billion.
It is unlikely that Kraft will offer 3G and Berkshire Hathaway the presence that both companies found appealing with Heinz, since most of its revenue comes from North America, said Yarbrough. As far General Mills goes, there is more speculation of Nestlé SA making a bid, which it already has a joint venture with, said Yarbrough.
As a way to counter the drop in sales of cereal as consumers begin looking for more protein laden breakfasts, Kellogg plans to invest money to educate buyers to teach them about the protein already present in cereal and milk, said John Bryant, CEO, in a May 1 conference call. This past November, he started a four-year plan that is designed to save the company $475 million each year by 2018.
While the company’s new strategy is definitely a step in the right direction, Kellogg does continue to face challenges, according to a BMO Capital Markets Corp. analyst named Kenneth Zaslow.
The company’s “execution, including innovation, has been far from consistent,” wrote Zaslow in a note on may second. His current stock rating is market perform, which is very similar to neutral. “Reenergizing the cereal category may prove more challenging in light of the potential breakfast substitutes.”
The entire food industry is seeing quite a few acquisitions. Hillshire Brands Co., the sausage maker, said that it is going to buy Pinnacle Foods Inc. for roughly $4.3 billion. This offer is roughly 20% higher than the previous closing price of Pinnacle.
In 2013, Kellogg’s profit margin was 12%. This beat the 9.5% of the S&P 500 companies, according to Bloomberg data.
“This is a cash cow kind of company,” said Christopher Rich, the head options strategist at Jones Trading Institutional Services LLC based out of Chicago. “Berkshire looks in this direction for cash cow kind of companies they understand and they think they can grow.”