JPMorgan’s contingent interest autocalls on CVS, Walgreens offer high yield, value-like play

By Emma Trincal

New York, April 15 – JPMorgan Chase Financial Co. LLC’s autocallable contingent interest notes due April 21, 2022 linked to the least performing of the common stocks of CVS Health Corp. and Walgreens Boots Alliance, Inc. offer a double-digit return based on two blue-chip stocks trading at deep discounts.

Rather than choosing highly volatile names to generate a nearly 12% contingent coupon, the issuer brought together two beaten up retail pharmacy stocks deemed to attract value investors.

The notes will pay a contingent quarterly coupon at an annual rate of at least 11.65% if each stock closes at or above its 60% coupon barrier on the review date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if each stock closes at or above its initial level on any quarterly review date other than the first, second, third and final ones.

The payout at maturity will be par unless either underlying stock finishes below its 60% trigger level, in which case investors will be fully exposed to any losses of the worst performing stock.

Sector-specific

“The structure is very attractive,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“But I would need to know the probability of one of these two stocks breaching because only one needs to breach and you lose your income or even your investment.

“It requires a level of knowledge in this sector that I simply lack.”

Unchartered territory

Kunhardt however was aware of the fast-changing landscape in the sector and cautious about potential headwinds.

“CVS dropped Blue Cross Blue Shield from their network. It didn’t help. If you’re one of the millions of Americans who get your health care from Blue Cross Blue Shield, you’re not on their network anymore.”

CVS terminated its contract with the Blue Cross and Blue Shield Federal Employee Program for specialty pharmacy at the end of 2017.

Current debates on Capitol Hill over regulation of drug prices add uncertainty to the sector, which are weighing on the performance of the stocks as well.

Earnings

Recent earnings announcements in February for CVS and earlier this month for Walgreens have pushed the share prices of those companies much lower.

After CVS reported poor performance and lowered its profit guidance for fiscal 2019 on Feb. 20, the stock in a little more than two weeks fell by 26%.

CVS also faced strong reactions from the market after it decided to freeze its dividend to pay for the $40 billion acquisition of Aetna.

On April 2, Walgreen’s results and guidance disappointed too, pushing the share price 15% lower.

“This is probably why the issuer chose those two stocks. Normally their volatility would be too low to generate a decent coupon; but, because there’s been a recent volatility spike, they were able to get a higher premium,” said Jerry Verseput, president of Veripax Financial Management.

“Both stocks are down significantly. That’s how you get the 12% return.”

For the year, CVS has lost 17%. Walgreens has dropped 22%.

Tight correlation

Kunhardt was not comfortable with the sector play.

“It may be a very good note. But it’s such a narrow slice of the market. You really have to know the sector,” said Kunhardt.

In any worst-of, the source of premium, and therefore of added risk, is when the correlation between the underliers is weak or negative. This is not the case with this note, he observed.

“That’s a good thing,” he said.

“The correlation is probably close to one. Across the streets of America, there’s always in a corner either a CVS or a Walgreens. They’re virtually mirrors of each other,” he said.

Busy playing field

But Kunhardt remained skeptical about the bet.

“There is a lot of competition in the retail pharmacy sector. Any supermarket chain has a pharmacy in it. A CVS or a Walgreens has to compete with Wal-Mart, Target and so on.

“It seems like a very attractive note, something like an easy way to pick up 12% in one year.

“But I would stay clear of it. We just don’t follow stocks and sectors.”

Tactical bet

For Verseput the structure was appealing and the underlying stocks added value to the mix given their recent pullback.

“It seems like a decent income play to me,” he said.

“These are high-dividend stocks. But you can boost the dividend from 3% to almost 12%.

“And you have a 40% margin of safety after a significant pullback.

“I wouldn’t have a problem with that.”

Income generation

The dividend yields of CVS and Walgreens are 3.7% and 3.25%, respectively.

Verseput saw the notes as a substitute to a long-only position designed for income.

“You might find stocks in your dividend portfolio paying 3% to 4% but you hold the shares with no downside protection.

“This note jumps you up to 11% with a 40% downside protection.”

Unlike the equity investment, the notes however cap the return at the coupon level.

“But it’s an income play. You’re swapping the unlimited upside for a much more reliable income. And you’re getting a double-digit yield.”

Another attractive aspect of the deal was the call protection.

“I like the one-year no call. Sometimes it’s only six-months but one-year over a three-year term is not unheard of.

“In any case, it’s nice because you’re guaranteed at least 11.65% when you get called,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes will settle on April 18.

The Cusip number is 48132CBU6.

© 2015 Prospect News.
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