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M&A Continues to Fuel Market

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The stock market has been dealing with many variables over the last week or so but the one constant over the past 7-8 years inserted itself into the US Stock market narrative once again over the last 24 hours, takeovers!

General Dynamics announced a deal to buy CSRA and Walgreen's approaching Amerisource about the purchase of the 76% of ABC stock that it doesn't already own.  ABC is up about 9% today on the rumors of the deal and CSRA was positive about 32% yesterday on the announced nearly $10b offer from GD including about $2.6b of debt.  

One of the best kept secrets of this US stock market is the shrinking share count available to investors to purchase.  Over the last half dozen years or so nearly $7T, yes, that's TRILLION, has been taken out of the market due to 2 factors: mergers and acquisitions (takeovers included) and stock buybacks.  Stock buybacks make up about $4.5-5T of that number with the remaining due to M&A.  You may ask "why is that important?" well, namely Earnings Per Share or EPS.

As shares decrease over time, the amount of attributable earnings which are spread over those shares can either rise, stay the same or fall. In two of those cases, staying the same or rising earnings means greater EPS.  Even in a falling earnings environment, depending on the rate (the ratio between the two) at which shares are being retired, EPS does not necessarily have to fall. 

Some would argue that share repurchases by themselves are not indicative of future positive stock performance and in certain cases, like IBM, they might be correct.  But in general, share repurchase programs are but a function of an overall capital return program to shareholders and not the strategic blueprint for a company's success.  Point being, IBM's lagging performance over the last decade is about operational and management miscues, not a buyback.  

With this as a backdrop I looked at both of the above deals and searched out possible investing set-ups, taking into account: competitors, sector, option volatility levels and other possible external catalysts. 

In either case, neither provides for a clear cut "we should buy XYZ because it's very clearly the next target" but in looking at both sectors, Defense/Aerospace and Drug Distribution Supply Chain, I did find two exceptional Zacks Rank #2 stocks in Defense and one Zacks Rank #2 stock in Drug Distribution.  I'll begin with the two Defense stocks.

Lockheed Martin (LMT - Free Report) : a defense stock darling and a Zacks Rank #2, sports a 2.31% dividend yield and sits squarely in what may be one of the strongest defense spending cycles we have seen in decades.  This is part of my "external catalyst" thinking and along with the current elevated option environment, owning the stock here, $350ish, and selling the June 370 calls for $8.00 is a nice 22.5% annualized yield if taken out of the position above $378.  

Along the way, you also pick up one quarter of the annual $8 dividend so an extra $2 of return to tack on.  Zacks has earnings estimates for LMT increasing 15.71% for the current FY and although LMT trades at a peer and market multiple, its cash flows are prodigious dwarfing the industry average and are approximately 50% greater than GD.

Lockheed Martin Corporation Price and Consensus

Lockheed Martin Corporation Price and Consensus | Lockheed Martin Corporation Quote

Raytheon (RTN - Free Report) : another defense stalwart, Raytheon's business mix, mainly combat ready defense products to buyers globally including the US Defense Department apparatus, positions the company to build on its already strong cash generating capabilities.  A Zacks Rank #2 stock that pays a dividend yielding 1.54%, RTN is enjoying earnings estimates that are increasing 16.99% this current FY.  Buying RTN here and selling the MAY 230 calls for $2.70 sets up an investor to realize an approximate 39% annualized yield if taken out of the position above $232.70, while also collecting a quarter of that yearly $3.19 dividend.

Raytheon Company Price and Consensus

Raytheon Company Price and Consensus | Raytheon Company Quote

Cardinal Health (CAH - Free Report) : this drug distribution, Zacks Rank #2 stock is a bit more complicated. Three things are happening to this company and none are overly bullish on a very short term basis: 1) Possibility of losing a major customer 2) the threat of Amazon 3) not being the company bought by WBA today.  Parceling out each of these, #'s 2 and 3 could actually work to CAH's favor, Amazon could buy CAH!  CAH has a market cap of only $18b and Amazon paid $13.5b for Whole Foods, if you think about supply chain and delivery mechanisms, it's certainly not a reach to think of Amazon buying its way quickly into the drug distribution pipeline using an expert like CAH as the conduit. Customer retention is not easy, cutthroat competition is driving prices lower but CAH continues to acquire great companies, has a pristine balance sheet and enjoys long term contracts. 

For investors looking to add a bit more speculative "punch" to their portfolio, buying the stock around $66 and selling the JUNE 72.5 calls for $2.00, producing an annualized yield of 34.5% if taken out above $74.5, could be a great trade set up. You also pick up a dividend at the end of March which is a healthy 2.72% annual dividend yield.

Cardinal Health, Inc. Price and Consensus

Cardinal Health, Inc. Price and Consensus | Cardinal Health, Inc. Quote

These 3 companies, all Zacks Rank #2 stocks, provide solid portfolio additions or could be added to if already owned.  The elevated nature of macro volatility should be captured by the individual investor!  Owning these stocks and selling upside calls at these volatility levels makes tremendous investing sense.  And maybe best of all, all 3 companies are in the middle of multi billion dollar share repurchase programs.

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Raytheon Company (RTN) - free report >>

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