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Infosys Ltd (INFY), the Indian consulting and software company, is becoming a free cash flow (FCF) producer based on its generative AI software services. INFY stock looks cheap based on a reasonable FCF yield metric.
INFY stock is trading at $21.67 in mid-day trading on Monday, July 22. The stock is up over 29% in the last 3 months, although it's off a recent high of $22.29 on July 19.
Nevertheless, INFY stock could still be worth as much as 48% more, or $32.00 per share. This article will describe why.
Strong FCF Margins
On July 18, Infosys reported robust earnings and free cash flow (FCF) for its fiscal Q1 ended June 30. The company produced $1.1 billion in FCF on $4.7 billion in sales, up 3.6% on a quarter-over-quarter (QoQ) basis. Its FCF was up an astounding 56% on a YoY basis.
As a result, Infosys's FCF margin was over 23,2% (i.e., $1.094 b FCF / $4.714 b sales = 23.21%). Much of this came from the company's efforts to monetize its AI-generative software tools and solutions. That has huge implications for the value of the stock going forward.
For example, analysts now project that sales will range between $19.3 billion for the year ending March 2025 and $20.94 billion for March 2026. That implies that the next 12 months (NTM) run rate is $20.12 billion in sales.
So, if we multiply a 23% FCF margin by this $20 billion NTM sales forecast we get $4.6 billion in projected FCF over the next 12 months. That is likely to push INFY stock much higher. Here's why.
INFY Stock Price Targets
Right now INFY stock is trading on a FCF multiple of just 19.3x. That can be seen by taking the stock's market cap of $88.71 billion and dividing it by the $4.6 billion FCF NTM forecast (i.e., $88.71b/$4.6b = 19.28x).
This is the same as saying the stock has a 5.19% FCF yield. This is because the inverse of 19.28x is 5.18% (i.e., 1/19.28 = 0.0519). That is too high an FCF yield. It menas if Infosys were to pay out 100% of its FCF in dividends, the market would give the stock a greater than 5.0% dividend yield.
The truth is that many tech stocks have dividend yields much lower: between 1.5% and 2.5%. So, even if we were to lower the FCF yield for INFY stock to 3.5%, it would still be very attractive.
For example, dividing $4.6 billion (the FCF estimate) by 3.5% results in a market cap estimate of $131.4 billion. That is still over 48% higher than its existing market cap of $88.7 billion. In other words, INFY stock is worth 48% more than $21.67, or $32.00 per share.
Shorting OTM Puts in INFY Stock
One way to play this is to sell short out-of-the-money (OTM) put options in INFY stock. For example, the August 16 expiration period shows that the $19.00 strike price put trades at a 38 cents premium.
That means that the short seller, assuming a price of 35 cents on the bid side, can make an immediate yield of 1.84% (i.e., $0.35/$19.00). Moreover, the strike price is over 12% below today's spot price, providing good downside protection.
Here is how that works. The investor first secures $1,900 in cash and/or margin with their brokerage firm. Then they can enter an order to “Sell to Open” 1 put contract at $19.00 for expiration on Aug. 16. The account will immediately receive $35.00.
The same is true for 10 puts. The investor secures $19,000 and then shorts 10 put contracts. The account will receive $350. That works out to 1.84% of the $19,000 invested.
As long as INFY stock stays over $19.00 for the next 25 days, the cash in the account won't be used to buy 100 shares per contract shorted. But even if this occurs, the breakeven price is $19.00 - $0.35, or $18.65 per share. That is over $2.00 below today's price, or 14% below today's price.
This shows that shorting OTM puts is a good way to buy into the stock. It also provides additional income for existing investors in INFY stock.
The bottom line is that INFY looks cheap here. One way to play this is to sell short OTM puts in nearby expiry periods.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
