Two of the top 20 call options in Wednesday’s trading exhibiting unusual options activity were beverage stocks Coca-Cola (KO) and Keurig Dr Pepper (KDP). As of today, both of them have 29 days to expiration. Only one of them is a buy.
Here are my two cents on which call to buy to accomplish this task.
Keurig Dr Pepper Is the Underdog in This Fight
I’ll get into the call options of both stocks at the end. In the meantime, I want to consider both companies as if I were buying the entire business in the same way Warren Buffett would.
Buffett first brought up the idea of owner earnings in his 1986 letter to Berkshire Hathaway (BRK.B) shareholders. It is defined as follows:
Reported Earnings + Depreciation/Amortization +/- Other Non-Cash Charges - Capital Expenditures +/- Changes in Working Capital.
These can be found in the annual earnings and balance sheet statements. Here’s Keurig’s:
An easier way to compare the two companies would be to use their annual EBITDA (earnings before interest, taxes, depreciation and amortization). In 2021, it was $3.80 billion, $1.57 billion more than owner earnings. EBITDA excludes interest expense and taxes from its calculation.
So, if you use owner earnings, they were 17.6% of its 2021 revenue of $12.68 billion. If you use EBITDA, the margin rises to 30.0%. Both are very healthy.
Based on its current share price of $34.77, it’s trading at 22.3x its owner earnings per share of $1.56.
The 11 analysts that cover Keurig, according to Barchart.com, rate it a Moderate Buy (3.73 out of 5) with a mean target price of $39.64, 14% higher than its current share price.
Analysts Prefer Coca-Cola
The 11 analysts that cover Coca-Cola rate it a Strong Buy (4.45 out of 5) with a mean target price of $68.19, 13% higher than its current share price. So while analysts might rate KO higher, the potential upside based on target prices is the same.
Anyone following Warren Buffett knows Coca-Cola is one of Berkshire’s longest-held positions. He started to buy KO stock in 1988. The holding company owned $632.4 million of its stock at the end of that year, making Coke Berkshire’s second-largest equity position.
Today, Berkshire’s fourth-largest position is worth $24.1 billion, good for a 9.2% ownership stake and accounting for 7.4% of its $326 billion equity portfolio. At the end of 2021, Berkshire’s cost for Coke stock was $1.3 billion, so today, it’s sitting on an unrealized gain of $22.1 billion.
That’s a tax problem we all should have.
Anyway, here’s my calculation of Coca-Cola’s 2021 owner earnings.
In 2021, Coca-Cola’s EBITDA was $12.89 billion, about one-third higher than owner earnings. So, if you use owner earnings, they were 24.8% of its 2021 revenue of $38.66 billion. If you use EBITDA, the margin rises to 33.3%. These are even healthier than Keurig’s.
Based on its current share price of $60.20, it’s expensive, trading at 27.2x its owner earnings per share of $2.21. Its multiple is considerably higher than Keurig’s. Investors generally are willing to pay more for quality.
The 11 analysts that cover Keurig, according to Barchart.com, rate it a Moderate Buy (3.73 out of 5) with a mean target price of $39.64, 14% higher than its current share price.
From a valuation perspective, not to mention the analyst’s take on the two companies, Coca-Cola appears to be the better buy.
What About the Call Options?
This is where it gets interesting.
In Thursday trading, the Keurig Feb. 17 $35 call option had a volume of 3,014, 26.44x the open interest. With an ask price of $0.85 and a 0.50884 delta, KDP stock has to increase by $1.67 or 4.8% to double your money on the call option.
As for Coca-Cola, its Feb. 17 $47.50 call option had a volume of 7,501, 23.3x its open interest. With a slightly lower volume-to-open-interest ratio than Keurig, its $12.60 ask price is 26.5% of its strike price, compared to 2.4% for Keurig. So to double your money on the call, KO stock will have to appreciate by $13.27 (22.0%) in the next month.
Of the two options, Keurig’s upside was so much more attractive, in my opinion. Not only does it have to appreciate far less to make money, but the upfront cost of $85 is much better than $1,260. In addition, you could have bought almost 15 KDP call contracts for the same down payment.
As I write this midday on Thursday, the Keurig $35 call expiring on Feb. 17, has an ask price of $0.65, 20 cents less than yesterday’s close, with a volume of just two contracts. Coca-Cola’s $47.50 call, which expires on Feb. 17, has an ask price of $13.00, 40 cents higher than yesterday, with zero volume.
Coke might be the better company, but Keurig Dr Pepper’s stock and call option are both better buys with 29 days left until expiry.
I guess we’ll see by mid-February if I am right.
More Food & Beverage News from Barchart
- Arabica Coffee Slips on the Outlook for Stronger Brazil Output
- Wheat Holding in Black through Midday
- Soy Losses through Thursday Midday
- Thursday Corn Trading Both directions
On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
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