Buying Calls of the Future on Pilgrim’s Pride

One of today’s major movers is Hillshire Brands Co. (NYSE:HSH), a $5.53 billion a manufacturer and marketer of food products. The company’s portfolio includes brands, such as Jimmy Dean, Ball Park, Hillshire Farm, State Fair, Sara Lee frozen bakery and Chef Pierre pies, as well as artisanal brands Aidells and Gallo Salame. Shares of Hillshire are currently surging with a 21.91% gain to trade around $45.13 as at 11:27AM EST.

Why Shares of Hillshire Brands Gained Today?

The company gained on the strength of news that it is now the target of an acquisition offer from Pilgrim’s Pride Corp (NASDAQ:PPC). Pilgrim’s Pride is a chicken producer with operations in the United States, Mexico and Puerto Rico. The company is engaged in the production, processing, marketing and distribution of fresh, frozen and value-added chicken products to retailers, distributors and foodservice operators. Pilgrim’s Pride will purchase Hillshire at $45 per share to value the whole deal at $5.2 billion.

Going Against the Impulsive Reaction

As I have mentioned earlier, traders and investors are buying up shares of Hillshire. Hence, the most logical step would be to buy HSH Call options if we expect the rally to continue or to buy HSH Puts if we can see a pullback on the horizon. However, recent events in the news about the players in today’s acquisition-backed rally show a different unique opportunity to profit with options.

Firstly, Hillshire Brand last Friday had announced an agreement to buyout Pinnacle Foods for $4.3 billion. The takeover bid will cause the two mid-cap food companies to emerge into a major player in the food industry. Hillshire Brands and Pinnacle have both built great brands names that will ensure that the emerging entity stands its ground in the face of bigger competitors.

More so, the fact that Pilgrim’s Pride has offered to buy Hillshire at a 22% premium to its last close in addition to paying the $163 million that will terminate Hillshire’s agreement with Pinnacle Foods suggests that Hillshire is inherently worth much more than what its current valuation suggests.

The second point to note is that the deal comes with the hefty price tag of an additional debt of $4.8 billion that Hillshire will assume after the deal is completed. Two problems with the potential debt situation is that Hillshire Brands currently has long-term debt of $840 million and a BBB credit rating, which could go down even lower when additional debt of $4.8 billion is added to the equation.

The more important point is that traders and investors are buying up shares of Hillshire with the presumption that Hillshire has agreed to Pilgrim’s buyout offer. However, the fact remains that Hillshire is yet to make a comment and the company might end up rejecting the offer because of the reasons provided in 1 above.

Thirdly, Pilgrim’s Pride proposed acquisition of Hillshire Brands makes more business sense for Hillshire’s shareholders than Hillshire’s plan to double its size by taking over Pinnacle. I maintain this position because Pilgrim (the second-largest chicken producer) has the wherewithal to absorb Hillshire and still wax stronger. On the other hand, if Hillshire continues with its plan to acquire Pinnacle, the emerging business may be in for a rough road ahead.

What is the Best Option to Trade Now?

The pendulum could swing in either direction and we may not know what will happen for sure until Hillshire accepts or rejects the offer or until another company makes a counteroffer. In the meantime, Pilgrim’s Pride is the only company that has the best chances of an uptrend irrespective of how Hillshire responds to its offer. Shares of Hillshire are seriously overbought with an RSI of 83.89 compared to Pilgrim’s Pride RSI of 76.70. I recommend PPC calls and the PPC Jan 2015 30.000 call (PPC150117C00030000) the looks very attractive at an ask of $1.55.

— Daily Option Alerts

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