Just in Case There’s no Bread in Wheat

Richard Croft
March 19, 2012
4 minutes read

Clearly, there’s a consolidation of sorts underway in the global agribusiness sector. Reports circulated last week of a possible takeover of Canada’s largest grain handler, Viterra Inc. (TSX: VT, Friday’s close $16.21) by a consortium consisting of Agrium Inc. (TSX: AGU, $85.22), closely-held Canadian grain handler Richardson International, and privately held international commodity conglomerate Glencore International AG. Other global agri-giants are also reportedly interested, including privately-held Cargill Inc.

Viterra’s business segments include not only grain handling ($526 million of latest 12-month earning EBITDA), but also agri-business products ($222 million in earnings) and food processing ($129 million). Each partner in the consortium is said to be interested in a separate part of the business.

Viterra shares climbed to an all-time high of $16.21 from around $11 on the news last week. Agrium shares popped to over $86 from about $82. The interesting thing is that while confidentiality agreements have been signed, no deal has been tabled. And the wild card is whether a takeover deal would get federal approval. BHP Billiton’s attempt to take over Potash Corp. of Saskatchewan last year was scotched when Premier Brad Wall of Saskatchewan applied pressure on the feds to deny BHP ownership of what he insisted was a precious Canadian natural resource company. He is already again making noises about Viterra and where its headquarters will be and so on. With Saskatchewan’s wheat farmers owning a large chunk of Viterra, populist political sentiment, never far from the surface in Saskatchewan, could easily once again derail a major takeover.

In addition to that Viterra seems to have become fully priced, with consensus 12-month price targets between $14 and $16. Agrium, on the other hand, has a mean price target of about $110.

Given the prices spikes in both stocks over the past week, investors might consider puts as straight insurance to hedge against a sudden downdraft in share prices should the potential takeover deal fall apart for some reason (odds of that about 50/50). Speculative traders might establish bearish trades on Agrium and Viterra, levering a sudden short-term slide in the event that Agrium loses out to another bidder or the political risk ramps up and a deal is blocked.

When you look at VT options, traders are making some sizeable with the 15-strike calls and puts. According to data from the Montreal Exchange website, I noted that 8014 VT April 15 puts changed hands on Friday. At the same time 3104 VT April 15 calls were traded. Assuming these numbers are correct there is serious money flowing into a sell-off scenario. For those who think the VT run up may have overshot the potential on this deal, consider buying VT April 15 calls at 45 cents.

With Agrium you might be better off with a bear call spread. In this case, sell the AGU April 86 calls at 2.10 while at the same time buying the AGU April 92 calls at 35 cents. This trade nets a credit of $1.75 which is the difference in the premium received from the April 86 calls versus the premium paid to buy the April 92 calls.

If AGU closes below $86 in April you will pocket the net credit as both options will expire worthless. The maximum risk occurs if AGU closes above $92 per share. Above that price any loss on the short AGU April 86 call will be offset by gains on the April 92 calls.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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