On Wednesday, Credit Suisse came out with a report laying out the case for discount chain Family Dollar Stores (FDO) to be a potential acquisition target by Walmart (WMT), on the back of which FDO stock rallied on the day but closed off the day’s highs.
More specifically, in the research note, Credit Suisse discussed upside toward $80-$100 for the stock price of Family Dollar as the result of either improvements within the company or a buyout by either Dollar General (DG) or Walmart. The media was rather quick to spin the research note into some sort of imminent buyout by Walmart, even though that wasn’t the base case of the report.
According to the report, what makes WMT a potential candidate to buy FDO is Walmart’s ongoing plans to open more small-format stores. In that regard, Credit Suisse points out that Walmart and Family Dollar have little overlap in store locations, and that furthermore speaks to the potential attraction in FDO stock.
Either way, the research note got my attention. But rather than theorize about ifs and whens, I began to map out a plan on how I would take advantage of a potential FDO stock buyout.
I first took a look at the multiyear chart and noted that FDO stock fell in 2007, but actually rose rather sharply in 2008 when the rest of the stock market tanked into the abyss. The reasons for this are obvious, as cash-strapped shoppers flocked to the discount and dollar stores. More impressively, however, is the stock’s ongoing massive rally since then, which from the lows to the September 2012 peak represented a roughly 400% jump in Family Dollar. All the while, FDO stock has held on to its uptrend line, as marked by the green arrows on the below weekly chart.
During the past couple of weeks, FDO stock again bounced off the multiyear trendline, and with Wednesday’s rally bumped into an important medium-term area of resistance. The confluence resistance area around the $67 mark is made up of the September 2013 downtrending diagonal line, as well as the 200-day (red) and 100-day (blue) simple moving averages.
Although it is important to note that technical levels matter marginally less when it comes to price action around merger and acquisition plays, in this case, a break above the $67 area could really juice FDO stock higher.
So, I am currently considering building up a long position in FDO stock, made up of a mix of stock as well as out-of-the-money calls, using options at least three months out where the bid/ask spread is acceptable and volume is present. This will allow me to have defined risk if nothing comes to pass in terms of a deal, and also gives me plenty of upside potential should a deal come through.
The position will need to be monitored and the options position will need to be adjusted as time passes.
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Learn more about the strategies Serge Berger uses to create profits in the market every day. Download his trading plan in the Essence of Swing Trading e-book by clicking here. As of this writing, he did not hold a position in any of the aforementioned securities.