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Marvel Technology (MRVL) stock is off over 15% since earnings came out on March 7, although it's up 9% from the bottom. Put option premiums are now high and bullish investors can short them as an income play.
I discussed the chip designer company's outlook in a recent Barchart article on March 20, “Marvell Technology Has Unusual Call Options Activity - Highlighting Its Underlying Value.” In that article, I pointed out that going long MRVL calls might be worthwhile for bullish investors in the stock.
However, since then, put options have increased their premium levels, given the stock's volatility. As a result, it makes sense to short out-of-the-money (OTM) put options which now have very high premiums. More on this below.
But first, let's review why MRVL stock could be worth significantly more.
Recent Earnings and Outlook
The company reported a 1% increase in Q4 sales for the quarter ending Feb. 3 and a decrease of 6.96% in sales for its fiscal year.
However, free cash flow (FCF) was very high at $475.6 million, since it works an FCF margin of 33.3% on sales of $1,426.5 million for the quarter. That implies that the stock could be worth significantly more if this keeps up.
Much of this positive outlook is based on the implications of the chip designer's high FCF margins on the stock's valuation.
Upside in MRVL Stock Based on Free Cash Flow
For example, analysts project $5.32 billion in sales for the year ending Jan. 2025 and $7.01 billion for the following year. That means sales could average $6.165 billion over the next 12 months (NTM). We can use that to set a price target for MRVL stock.
Here's how. If we assume that the company will keep making a 33.3% FCF margin, it implies that its NTM FCF could rise to $2.052 billion. That represents a gain of 101% over its adj. FCF last year of $1.02 billion in FCF. (This is based on the 2023 operating cash flow of $1.37 billion less $336.3 million in capex and also deducting $13.9 in licenses).
In other words, its FCF is set to explode. Moreover, if we theoretically assume Marvell Technology was to pay out 100% of this FCF in dividends, the market would likely give the stock a 3.00% dividend yield valuation.
Therefore, after dividing the NTM FCF estimate of $2.05 billion by 0.03 we get a valuation estimate of $68.4 billion. That represents a potential upside of 10% more in the stock from its existing $62.18 billion market capitalization.
And using a 2.5% FCF yield metric implies that it would be worth over $82 billion, or 32% higher. So, you can see that MRVL stock is worth between 10% and 32% more, or about 21% more. That gives us a price target of $87.43 per share compared to today's price of $72.26.
One way existing investors in MRVL stock can play this is to short out-of-the-money (OTM) puts, to gain extra income and potentially also buy in at a cheaper price.
Shorting OTM Puts in MRVL Stock
For example, look at the April 26 put option expiration period in MRVL, which is three weeks away from today (21 days). It shows that the $68.00 strike price, over 5% below today's price, trades for $1.72 on the bid side.
That represents a short-put yield of over 2.52% (i.e., $1.72/$68.00) for the short seller of these puts. Here is how that works.
The investors first must secure $6,800 in cash and/or margin with their brokerage firm. Then, after gaining permission to do short put trades, they can enter an order to “Sell to Open” 1 put contract at $68.00 for expiry on April 26. The account will then immediately receive $172.00.
That works out to an immediate yield 2.52% yield on the $6,800 investment. Moreover, if this is repeated every 3 weeks for a quarter, the investor stands to make an expected return (ER) of $688. That represents an ER yield of over 10.11% in just 90 days doing these short put plays.
You can also see that shorting the $69.00 put option, which entails taking on more risk since the OTM level is only 3.75% below the spot price, provides a higher return. The $2.08 premium received represents a put option yield of 4.058% (i.e., $2.08/$69.00).
Similarly, by shorting the $67.00 strike price, the investor has less risk since it is 6.54% OTM. But the yield is still very high at $1.39/$67.00 or 2.07%. In other words, over 90 days, if this can be repeated, the investor could make an ER yield of 8.29%. That is not much lower than the 10.11% ER yield at the $68.00 strike price.
This will work well for existing shareholders who hold on to MRVL stock. That way they gain all the upside in the stock due to its higher price target, along with the short-put yield income gains.
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.
