Marvel Technology (MRVRChip design company MRVL is scheduled to report its earnings after the close of trading on Thursday, May 30. MRVL stock could see further gains despite its recent surge. The market will be watching to see if the company's free cash flow (FCF) margins can remain high.
One way to do this is to short out-of-the-money (OTM) put options that are expiring within the next few weeks, with a strike price lower than today's price. This allows you to earn additional income while potentially buying the stock at a lower price.
I have discussed this in two previous Barchart articles, including this one from Monday, April 29th.Marvel Technology put options remain high — a good source of profit for short sellers.” Additionally, an April 5 Barchart article discussed Marvell Technology's strong fourth-quarter free cash flow (FCF) and improving FCF margins.
Free cash flow boosts stock prices
For example, in the quarter ended February 3 (fiscal Q4), Marvell generated FCF of $475.6 million, which represents a high FCF margin of 33.3% on quarterly sales of $1,426.5 million.
Additionally, for the trailing twelve months (TTM) period, FCF was strong at $1.034 billion on revenue of $5.5 billion, equating to an FCF margin of 18.8%, meaning FCF margins expanded significantly in the fourth quarter.
We expect this trend to continue in the company's first quarter, which ends April 30. For example, analysts currently expect revenue to reach $1.16 billion for the quarter. If FCF margins remain strong at 33.3%, FCF could reach $366 million. This is lower than last quarter, but could be due to seasonal effects. It's better to forecast the next 12 months (NTM).
For example, analysts currently forecast revenues of $5.32 billion in the year ending Jan. 31, 2025, and $7.05 billion next year. This implies an average NTM run rate of $6.185 billion.
If FCF margins remain high at 33.3%, the company can generate over $2 billion in FCF (i.e., $6.185 billion x 0.333 = $2.06 billion FCF).
This is what is driving the stock price higher: the target price for MRVL stock using the FCF yield metric could be significantly higher than the current price.
Price target rises by more than 51%
For example, if Marvell Technology paid out 100% of its FCF as dividends (it currently pays out only 20%, giving a dividend yield of 0.31%), that would likely result in a dividend yield of at least 1.5% (i.e., 1/0.2 x 0.31%).
Therefore, if we divide the estimated NTM FCF of $2.05 billion by 1.5%, Marvell Technology's market cap could be $136.6 billion, more than double its current market cap of $66.36 billion.
Let's look at this from another perspective: there are currently 879.3M shares outstanding, which means FCF per share over the next 12 months is projected to be $2.33 (i.e., $2.05B / 879.3M shares).
Therefore, if the company paid out 100% of its FCF of $2.33 per share as dividends, at today's stock price the dividend yield would be $2.33/$76.88, or 3.0%. The market would be unlikely to hold onto the stock at this price because it would perceive the dividend yield as too high.
There will soon be pressure to push the stock to a dividend yield of at least 2.0%. That means $2.33/0.02 is $116.50 per shareThat's 51.5% higher than today's price of $76.88.
Short and buy OTM puts to earn extra income
One way to do this is to short the OTM puts and buy at a lower price (if the stock price falls) while earning additional income. This works well for existing shareholders who have benefited from the stock price appreciation but don't want to sell now or sell covered calls.
For example, let's look at the expiration date on June 7th, 13 days from now. We can see that a $70 put option strike price contract has a $1.00 on the bid side. This strike price is 8.71% lower than today's price, so it's completely out of the money.
This means that short sellers of these puts can earn an instant yield of 1.43% (i.e., $1.00/$70.00). All they have to do is set aside $7,000 in cash or margin with their brokerage firm. Then they enter an order to “sell open” one put contract at this strike price and expiration period. Their account instantly receives $100.00.
MRVL Put Expiring June 7 – Barchart – as of May 24, 2024
As a result, the breakeven point is actually $69.00 (i.e., $70.00 – $1.00 in revenue received), which is 10.2% lower than the closing price of $76.88 on May 24. In other words, this provides excellent downside protection.
Furthermore, if an investor is already a shareholder, they will receive not only the income but also any appreciation in the stock price after the earnings are generated.
The bottom line is that MRVL stock looks undervalued here, and one way to take advantage of this is to go short and sell OTM puts close to expiration.
More stock market news from Barchart
On the date of publication, Mark R. Hake, CFA did not hold (either directly or indirectly) any positions in any of the securities mentioned in this article. All information and data in this article is for informational purposes only. For more information, please see Barchart's disclosure policy here.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
