EastGroup Properties (EGP) is an industrial REIT, and it has posted incredible performance in recent years (its price is up 138% since the start of 2016, and that is excluding its big dividend payments). And considering its performance, the options market is currently offering attractive premium income on the shares thanks to some perhaps over-confident “herd-following” investors.
We currently own shares of EGP (we have since 2016), and this report explains why we like a specific income-generating EGP options trade. More specifically, we believe this is an attractive trade to place today, and potentially Tuesday and/or Wednesday, so long as the share price doesn’t move too dramatically before then.
The Trade:
Sell Covered CALL Options on EastGroup Properties (EGP) with a strike price of $135.00 (1.4% out of the money), and expiration date of November 15, 2019, and for a premium of $0.50. That’s an extra 4.4% income for us on an annualized basis (0.50 / 135.00) x 12 months). If the shares get called away from us before the options contract expires then we're happy to sell the shares at the higher price of $135.00 (another 1.4% gain in less than 1 month). And if the shares don't get called away, we’re happy to hang on to them for the long-term, plus we still get to keep the extra premium income we generated no matter what.
Your Opportunity:
We believe this is an attractive trade to place today and potentially Tuesday (and even Wednesday) as long as the price of EGP doesn't move too dramatically before then, and as long as you’re able to generate annualized premium (income for selling, divided by strike price, annualized) of approximately 3-5%, or greater.
Our Thesis:
We had a lot of positive things to say about EGP several months ago in our previous full report on EGP. For example:
“EastGroup’s differentiated strategy of operating and developing well-connected, smaller sized multi-tenant warehouses in clusters, catering to the specific needs of tenants, is primarily responsible for the company’s current enviable market position. While critics may argue that catering to relatively smaller tenants on shorter leases is a risky operational strategy, the company has proven them wrong with its stellar statistic of recording 23 consecutive quarters where occupancy has been 95% or better. When it comes to growth, instead of expanding by acquiring other properties, EGP focuses its attention on increasing development in areas where it already has a presence. EastGroup’s simple yet-effective capital allocation strategy has helped the company achieve continuous FFO growth. We believe EGP’s operational strategy and judicious capital allocation leaves the shares well-positioned to benefit from a longer cycle of industrial demand.”
And since that time, the price has moved dramatically higher, the valuation is getting a little bit ahead of itself, and therein lies the opportunity that make selling covered calls attractive.
Specifically, we still like EGP as a long-term investment (i.e. we don’t believe this business is in any trouble), however (considering the valuation metrics in the table above) we don’t expect the shares to continue increasing in value at the same rapid pace in the near-term. Specifically, Price to Funds From Operations (FFO) and P/Adjusted FFO are near all-time highs (the shares are expensive), and the dividend yield is near all-time lows (a signal from management that they believe the shares are expensive). To be clear, we expect the shares to go higher in the long-term (perhaps significantly higher), but in the near-term it seems less likely they’ll keep climbing so rapidly, and that’s why we like this income-generating trade.
If the shares climb to $135 and get called away from us, then that’s still a 1.4% price gain (in less than 1-month), plus we get to get the premium income we generated for selling the calls, no matter what. Between the potential price gain and the premium income, that’s a nice gain for an income-focused investor in less than one month when this options contract expires.
The big risk is that we get caught holding shares of EGP and they fall dramatically in price (which we do NOT believe is going to happen), and even if they do fall in price, that’ll make us like them even more given the strong long-term business this company has built.
Important Trade Considerations:
Two important considerations when placing options trades are upcoming earnings announcements and dividend dates because they can increase volatility and can impact the value of your options contract in unexpected ways. And in the case of EGP, they are both largely non-issues because the company just announced earnings last week (and therefore won’t announce again until after this options contract expires), and EGP isn’t expected to go ex-dividend again until the end of December (also after this options contract expires).
The “Covered” Part of this Covered Call Sale
Because we currently own shares of EGP, that makes this trade dramatically less risky. Specifically, if we did NOT own shares, and we were forced to deliver the shares if the options contract got executed, then we’d be forced to first buy them in the open market at the prevailing price. Theoretically, if the shares rise dramatically in price, we don’t have to go out and buy them in the open market because we already own the shares, and that dramatically reduces the risk of this trade. Covered Calls (and cash secured puts) are generally the simplest and least risky types of income-generating options trades.
Conclusion:
We continue to like EGP as a long-term investment, but the price may be getting ahead of itself and its valuation metrics are getting frothy (for example, see the valuation metrics we presented earlier in this report). We have no problem continuing to hold EGP for the long-term, but we’re also happy if the shares get called away from us because if they do it will be at a premium to the current price (i.e. we make money), and we get to keep the additional premium income we generated for selling the puts in the first place, no matter what.
As a reminder, you can view all of our current holdings (via our monthly update) HERE.