/Dell%20Technologies%20by%20Poetra_RH%20via%20Shutterstock.jpg)
Dell Technologies (DELL) reported higher Q3 revenue and earnings but lower free cash flow margins. DELL stock tumbled 12% today but unusual call options volume indicates investor's bullish outlook.
DELL is trading at $123.70 mid-morning, off over 12% from its prior price of $141.74 and a recent peak of $144.21 on Nov. 22.
But is this sustainable? Maybe not - as indicated by the large call options volume today. Moreover, DELL could be worth more, as seen in my Oct. 28 Barchart article: “Dell Technologies Stock Keeps Treading Water - Good for Short-Put Investors.”
This has led to a huge unusual volume in near-term call options in the stock. Barchart's Unusual Stock Options Activity Report shows that 5 different tranches traded in heavy call volume.
For example, as the table below shows almost 15,000 calls have traded at various strike prices all higher than today's trading price. Moreover, the expiry periods range from this Friday to 9 days from now.
That implies that many investors expect there could be a rebound in the near term. Let's look at why this could lead to an upside in DELL stock.
Strong Earnings - Mixed Cash Flow Results
Dell's revenue rose 10% and operating earnings were up 12% YoY, along with a 16% rise in dilute earnings per share (EPS). The latter was due to its strong share buyback program, effectively lowering the number of shares outstanding over the past year.
Those buybacks were funded by the company's strong free cash flow (FCF). However, in Q3, although positive, its Q3 FCF was 17% lower than last year and the FCF margin ratio fell.
This can be seen in the table below, showing that adj. FCF margins were significantly lower (i.e., FCF/ revenue):
Note that the operating cash flow (OCF) and FCF margins have been dipped, despite the operating earnings increase the company reported. A cursory look at the Q3 earnings call transcript did not show that management had adequately explained this.
I suspect it has to do with net changes in working capital requirements. This is a particularly volatile portion of all fast-growing company's cash flow statements. For example, when revenue and earnings rise quickly it requires a large drain on the company's working capital for inventory and raw materials. That lowers cash flow.
In fact, GuruFocus pointed out that the Dell Technologies AI-related pipeline remained strong with significant increases in backlog. That could eventually lead to higher operating earnings and cash flow.
Setting a Price Target
The company's adj. FCF margin was significantly lower than last year. In my prior article I projected that the company could make a 5% FCF margin. Now I suspect we should use a 4.5% FCF margin going forward.
For example, analysts now forecast $104.98 billion in sales for the year ending Jan. 2026. That implies that adj. FCF could reach $4.725 billion:
$105 b sales x 0.045 adj. FCF margin = $4.725 billion adj. FCF
Therefore, using a 5.0% FCF yield metric, the market might give DELL stock a $94.5 billion market capitalization:
$4.725 / 0.05 = $94.5 billion mkt cap
That is still about 9% higher than today's market cap:
$94.5 b/ $86.74 b mkt cap today = 1.089 -1 = +8.9% higher
In other words, DELL stock is worth at least $135 per share:
$123.70 price today x 1.089 = $134.71 target price
Analysts Still See DELL Stock as Undervalued
Analysts still have higher price targets for DELL stock. For example, the average price target from Yahoo! Finance's survey of 25 analysts is $149.05 per share. Similarly, Barchart's survey shows a mean price target of $151.31.
Moreover, AnaChart, which tracks analysts' price targets over time (to see how well analysts perform) reports that the average of 18 analysts who've recently written on the stock is $156.49. That is over 26.5% higher than today's price.
The bottom line is that analysts still like DELL stock. So, no wonder there is a huge volume today in the DELL call options.
Take Caution
Nevertheless, investors should take caution that these higher price targets could take a year to work out. There could be a good deal of volatility in the stock before that occurs.
In addition, copying these call options trades could come with a huge amount of risk. There is certainly no guarantee that the stock will rise to a price that makes these call options worth investing in, especially given the short expiry periods.
In effect, these are speculative plays. There is no real fundamental reason why investors should copy these highly risky call option trades.
Moreover, this article is not effective advice to any investor to copy these huge unusual call options trades. All I wanted to point out is that there is a correlation between the higher value of the stock long-term and the fact that these calls indicate a bullish outlook on the stock.
