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Salesforce Inc (CRM) stock is rising based on investors' anticipation that its Q3 earnings for the quarter ending Nov. 30 will show strong operating and free cash flow (FCF). CRM stock could be worth much more - up to 30% more at $448 per share.
CRM is trading at $343.31 midday on Nov. 12, up from a recent low of $243.97 on Sept 6. However, based on its strong FCF outlook, it could have substantially more to go.
For example, last quarter ending July 31, 2024, Salesforce generated $890 million in operating cash flow (OCF) and $760 million in free cash flow (FCF). FCF is equal to OCF less capex spending.
Salesforce reported that its FCF rose 20% YoY, representing a strong 8.14% FCF margin on $9.33 billion in Q2 sales (i.e., FCF/sales). However, over the last 12 months (LTM), its free cash flow was $11.46 billion on $36.465 billion in sales. That means its LTM FCF margin was very high at 31.4%.
This has huge implications for the company's ongoing FCF projections and the value of CRM stock.
Projecting FCF Going Forward
For example, in the Q2 results release management said it expects 2024 operating cash flow (OCF) will rise 23% to 25% over last year. Based on data from Seeking Alpha, Salesforce generated $10.234 billion in OCF for the year ending Jan. 31, 2024. That implies that 2024 OCF will be $12.69 billion
Therefore, after deducting the forecast capex spending of $1.2 billion, its FCF could be about $11.49 billion (i.e., $12.69b OCF - $1.2b capex). That represents 30.3% of projected sales of $37.87 billion this year, on par with the 31.4% FCF margin it made in Q2.
Moreover, next year analysts are now forecasting $41.29 billion in sales, up+9% YoY from 2024. Assuming its FCF margin rises to 31% due to operating leverage, FCF could hit $12.8 billion in 2025 (i.e., 0.31 x $41.29b).
That could push the value of CRM stock significantly higher.
Target Price for CRM Stock
For example, let's assume the market eventually gives the stock a 3.33% FCF yield valuation (i.e., the same as multiplying it by 30x). As a result, Salesforce's market cap could rise to $284.4 billion (i.e., 30 x $12.8b = $426.7 b).
That is 30.6% higher than Saleforce's existing market value of $326.69 billion. In other words, CRM could be worth $448.36 per share, or 1.306 x $343.31 p/sh today.
That is why CRM stock may have much more to go, especially if management's outlook on forecasted operating cash flow comes to pass.
One way to play this is to sell short out-of-the-money (OTM) put options expiration periods. That way investors can set a lower buy-in target price and get paid to wait for this to happen.
Shorting OTM Puts
For example, the Dec. 6 expiry period, a little more than 3 weeks away, shows that the $325 strike price put options contract has a bid side premium of $6.85 per contract.
That is a very high short-put yield for the short-seller of these puts. That means that one put contract can provide a 2.108% yield for the short seller of these puts (i.e., $6.85/$325.00).
This means that an investor who secures $32,500 in cash or buying power can enter an order to “Sell to Open” 1 put contract $325.00. That way the account will immediately receive $685 in income and hence achieve a 2.1% yield.
Moreover, even if the stock falls in the next three weeks, the short-put investor still has a lower breakeven price of just $325-$6.85, or $318.25. That is over 7% below today's price, giving the investor good downside protection.
Nevertheless, given the huge upside in CRM stock, this also provides a lower buy-in price target for the investor. If CRM stock stays flat over the next several months and if this play can be repeated, the expected return (ER) could be as high as 8.4% (i.e., 2.1% x 4 over the next 3 months).
The bottom line is that CRM stock looks like it still has good upside. One way to play it in the near term is to short OTM puts in nearby expiration 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.
