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Dell Technologies Inc (DELL) disappointed investors on Aug. 29 with significantly lower adj. free flow (FCF) for its quarter ending Aug. 2. As a result, the stock has been falling. Nevertheless, its underlying value still looks strong. That could make DELL a bargain here.
DELL stock is at $111.26 in midday trading on Tuesday, Sept. 3. That is down from a peak of $149.15 on June 18, but up from a trough of $87.89 on Aug. 7.
Moreover, DELL stock could keep floating lower over the next week or so as investors digest the company's earnings. Nevertheless, value investors should carefully review this profitable company's stock, as it may be a bargain.
Free Cash Flow Lower But Still Strong
It could be worth over 28% more at $143 per share. Dell Technologies is still producing strong free cash flow, albeit at a lower margin than before. That could propel the stock higher. Let's look into how that works out.
Last quarter the company's revenue rose 9% to $25.026 billion in the quarter ending Aug. 2. However, its adj. free cash flow (FCF) fell from over $3 billion ($3.05b) to $1.284 billion from a year ago. That's a decline of 58%. In addition, the first half adj. FCF results were similar, falling 49% YoY to $1.9 billion.
This also means that its FCF margin dropped significantly. For example, last year its Q2 adj. FCF was over 13% of revenue, but now it's down to just over 5%. This can be seen in the table below.
The point is that the company's cash flow has taken a hit. This was not the result of higher capex spending. It has to do with lower margins on the company's fundamental products and services.
Nevertheless, management said during the earnings call they expect growth in the second half of the year. For the full year, they forecasted revenue of $97 billion, 10% higher than last year.
Moreover, analysts now project $105.14 billion in sales next year, representing 8.4% top-line growth. Therefore, if its adj. FCF margin stays level at 5%, the company could produce $5.26 billion in adj. FCF (i.e., 0.05 x $105.14b).
That implies that DELL could still be a bargain.
What DELL Stock Could Be Worth
For example, the market might eventually value the stock with a 5.0% free cash flow yield. Here is what that means. Let's say the company decided to pay out 100% of its adj. FCF in dividends. The market would respond positively to this. It would likely value the stock with at least a 5.0% dividend yield.
Therefore, DELL stock can be valued using this 5.0% FCF yield metric. Taking the forecast $5.26 billion in adj. FCF for next year and dividing it by 5.0% results in a market capitalization forecast of $105.2 billion (i.e., $5.26b/0.05 = $105.2b).
That is 28.7% higher than its existing market value of $81.72 billion (i.e., $105.2/$81.72-1 = +0.287). In other words, DELL stock is worth at least $143.19 per share (i.e., 1.287 x $111.26 price today).
Analysts tend to agree that DELL stock is a bargain. For example, Yahoo! Finance reports that 18 analysts have an average price target of $152.10 and Barchart's mean survey is $154.33. These two surveys average $153.22 per share, or 37.7% higher than today's price.
Moreover, AnaChart.com, a site that tracks analysts who've recently written on the stock, shows an average price target of $130.37 from 17 sell-side analysts. That is still 17% higher than today's price.
The bottom line is that DELL stock could still be a bargain here, despite its disappointing free cash flow results.
Shorting OTM Puts
One way to play this is to sell short out-of-the-money (OTM) put options in nearby expiry periods. For example, look at the Sept. 27 put option expiration period, a little over 3 weeks from now.
It shows that the $105 strike put option strike price, which is 6% below today's spot price, still has a high premium of $2.33 per put contract. That means that a short seller of these puts can make an immediate yield of 2.219% over the next three weeks.
This means the investor must buy shares if DELL stock falls to this strike price. But in return, they get to keep the premium income.
For example, to do this trade the investor secures $10,500 with their brokerage firm. That is enough to buy 100 shares (per put contract) at $105.00, should the stock fall to this price on or before Sept. 27.
Then, immediately after entering an order to “Sell to Open” 1 put contract at that strike price, the account will receive $233.00. That is why the return on investment is 2.219% (i.e., $233/$10,500). Moreover, over the next quarter, if this play can be repeated, the expected return (ER) is $932 (i.e., $233 x 4), or 8.876% of the $10,500 invested each time.
That is a very good return. It could help pay for any unrealized losses the investor may have since the stock has declined. Moreover, existing investors in DELL stock can gain all the upside in the stock price, along with this income. In addition, even if DELL stock falls to $105, the investor has a lower breakeven of $105-$2.33, or $102.67 per share, or 7.7% lower than today's price.
The bottom line is that DELL stock could be a bargain here. One way to play this, especially for existing investors, is to short OTM puts as an income play.
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