Marvell Technology (MRVL), chip designer company, is expected to release results on Thursday, May 30, after the closing bell. MRVL shares could end up rising despite the stock’s recent rally. The market will be watching to see if the company’s free cash flow (FCF) margins remain high.
One way to play this is to sell out-of-the-money (OTM) put options on close expiration periods. This means selling puts expiring in the coming weeks at strike prices below today’s price. This is a way to earn extra income as well as potentially purchase shares at a lower price.
I discussed this in my last two Barchart articles, including this one on Monday, April 29, “Marvell Technology puts remain elevated – good for short sellers as an income play.” Additionally, in my April 5 Barchart article, I discussed Marvell Technology’s strong fiscal fourth quarter free cash flow (FCF) and elevated FCF margins.
Free cash flow driving up inventory
For example, in the most recent quarter ended February 3 (fiscal fourth quarter), Marvell generated $475.6 million in FCF. This represents a high FCF margin of 33.3%, as its sales were $1,426.5 million in the quarter.
Furthermore, in the last 12 months (TTM) period, its FCF registered a strong value of $1.034 billion, with revenues of $5.5 billion. This represented an FCF margin of 18.8%. In other words, its FCF margin expanded significantly in the fourth quarter.
I expect this to continue in the company’s fiscal first quarter ending April 30. For example, analysts now project revenue to reach $1.16 billion for the quarter. If FCF margins remain strong at 33.3%, FCF could reach $366 million. Although this is lower than the previous quarter, it may be due to seasonal effects. It is best to project for the next 12 months (NTM).
For example, analysts now forecast revenue of $5.32 billion for the year ending January 31, 2025, and $7.05 billion for next year. This results in an average NTM run rate of $6.185 billion.
If its FCF margin remains strong at 33.3%, the company could generate over $2 billion in FCF (i.e. $6.185 billion x 0.333 = $2.06 billion FCF).
This is what has pushed the shares higher. MRVL’s stock target price using an FCF yield metric could be significantly above today’s price.
Target price is over 51% higher
For example, if Marvell Technology paid out 100% of its FCF in dividends (right now it only pays 20% and its dividend yield is 0.31%), it could end up with a dividend yield of at least 1.5% (i.e. 1/0.2 x 0.31%).
Therefore, if we divide NTM’s FCF estimate of $2.05 billion by 1.5%, Marvell Technology could end up with a market cap of $136.6 billion. This represents more than double its current market value of 66.36 billion.
Here’s another way to look at it. There are currently 879.3 million shares outstanding. This implies that the projected FCF per share for the next 12 months is $2.33 per share (i.e. $2,050 million/Shs879.3 million).
Therefore, if the company paid 100% of that $2.33 in FCF per share as a dividend, at today’s price the dividend yield would be $2.33/$76.88, or 3.0%. The market would probably not hold the shares at this price as they would consider this too high a dividend yield.
There would be instant pressure to get the stock to a dividend yield of at least 2.0%. So $2.33/0.02 results in $116.50 per share. This is 51.5% higher than the current price of $76.88.
Go short on OTM as a way to buy and generate extra income
One way to play the game is to sell short OTM puts as a way to buy at a lower price (if the stock falls) as well as to generate extra income. This works well for existing shareholders who have enjoyed share price gains but don’t want to sell now, or even sell covered calls.
For example, look at the expiration period of June 7th, 13 days from now. This shows that the $70 put option strike price contracts are at $1.00 on the supply side. This strike price is 8.71% below today’s price, so it is deeply out of the money.
This means that a short seller of these puts can earn an immediate yield of 1.43% (i.e. $1.00/$70.00). All they need to do is secure $7,000 in cash and/or margin with their broker. Then they enter an order to “Sell to Open” 1 put contract with that strike price and expiration period. The account will immediately receive $100.00
MRVL Puts Expire on June 7th – Bar Chart – on May 24th, 2024
As a result, your break-even point is actually $69.00 (i.e. $70.00 to $1.00 in income received). This is 10.2% below the May 24 closing price of $76.88. In other words, it provides good downside protection.
Additionally, if the investor is already a shareholder, they can not only keep the income but also any upside on the stock after the earnings are released.
The bottom line is that MRVL stock looks cheap here. One way to play this is to sell short OTM puts on upcoming expiration periods.
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As of the date of publication, Mark R. Hake, CFA did not hold (directly or indirectly) 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, see the Bar Chart 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.
