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Shopify Inc (SHOP) reported strong Q3 free cash flow and higher FCF margins on Nov 12; management said this will continue in Q4. As a result, FCF should explode to $2 billion next year. Buying SHOP LEAPs (long-term call options) and shorting out-of-the-money SHOP puts in nearby expiry periods are good ways to play the stock.
SHOP closed at $108.49 on Friday, Nov. 15, up over 20% from the day before its Q3 earnings release on Nov. 11 ($89.99). Moreover, SHOP stock has been up over 100% in the last 4 months, when it bottomed at $52.66 on Aug. 6.
But is it at a peak? On Aug. 16, I wrote in a Barchart article that SHOP was worth $95.00 per share ("Shopify's Huge FCF Margins Imply SHOP Stock Could Still Have Upside").
It doesn't look like it based on its latest FCF margins and the company's outlook. My new target price is $157 per share, up +45 % from today's price. This article will discuss why and how to best play SHOP stock.
Strong FCF and FCF Margins
Shopify is one of the very few companies that highlights its free cash flow (FCF) and FCF margins. Its Q3 earnings title is almost unrivaled:
“Shopify Q3 2024 Revenue Growth Accelerates to 26%, Free Cash Flow Margin Expands to 19%”
Shopify notes that in the last three quarters, this competitor to Amazon's shipping business has raised its FCF margins in each of the last 3 quarters. In Q1, it achieved a 12% FCF margin on sales, in Q2 it made 16%, and now in Q3, it has produced a 19% FCF margin on even higher sales.
Moreover, so far this year Shopify has made more FCF than all of 2023:
FCF: $986 million YTD 2024 vs. $905 million in 2023 - i.e., +9%
In addition, Shopify expects to see a 19% FCF margin in Q4. So, its total Q4 FCF could hit $516.8 million based on analysts' forecasts of $2.7 billion in Q4 sales. This implies a 66% gain over 2023:
FCF: $1.502.8b 2024 / $905m 2023-1 = 0.66, i.e., +66% gain over 2023.
Nevertheless, markets are forward-thinking. The recent stock gains already have priced this in. We need to project out further to see where the stock will be in the next 6 to 9 months.
For example, analysts forecast 2025 sales of $10.7 billion, up +21.7% over 2024. Therefore, if we assume that Shopify produces at least an average 19% FCF margin in 2025, it could generate over $2.0 billion in FCF.
FCF: $10.70b sales x 0.19 FCF margin = $2.033 billion FCF
This means FCF will have risen 35%+ over 2024's $1.5 billion FCF. That means SHOP stock could be worth much more. Let's look at that.
Price Target for SHOP Stock
One way to value a fast-growing company like Shopify is to use an FCF yield metric. This assumes that all a company's FCF will be paid out to shareholders - either in dividends or buybacks. What yield will the markets give SHOP stock then?
In this case, we can assume, based on its historical FCF yield and comparables, that Shopify could end up with a 1.0% yield. So, let's reverse-engineer the future estimated market cap:
$2.033 billion est. FCF (2025) / 0.01 = $203.3 billion projected market cap
That is 45% higher than its present market cap of $140.18 billion as of Friday, Nov. 15. In other words, SHOP stock is worth 45% more, or $157.31:
$108.49 per share x 1.45 = $157.31 per share Target Price
Analysts Agree - SHOP Stock Undervalued
Analysts on Wall Street agree now that SHOP stock is too cheap. For example, AnaChart.com, which tracks analysts' recommendations as if they are stocks, notes that 34 analysts are covering SHOP and the average target is $114.88 per share. That is 6% higher than Friday's close.
But looking more closely at AnaChart's review shows that several analysts have hiked their targets after writing on the stock since Q3 earnings were released.
The table above shows that many analysts have raised their price targets much higher in the last 3 days - between $125 and $135 per share. Moreover, note that they all have very high Price Targets Met Ratio numbers - in other words, they have good track records with their price targets.
This underlines my argument - SHOP stock looks cheap for the long term. Shorting out-of-the-money (OTM) puts in nearby expiry periods and buying long-term calls are two ways to play this.
Shorting OTM Puts and Buying Long-Term Calls (LEAPs)
For example, look at the Dec. 13 expiration period for put options. It shows that the $105.00 put strike price has a $2.35 bid-side premium.
That provides an immediate 2.23% yield to the short-seller of these puts (i.e., $2.35/$105.00).
Moreover, the investor can use this income to pay for long-term calls known as LEAPs (long-term anticipation securities) - generally over 1 year in expiry periods. For example, look at the Jan. 16, 2026, call option period (1 year and 2 months away).
It shows that the $100 call price (i.e., $8.49 in the money) has a mid-price premium of $28.03 per call.
The investor can use the $2.35 short-put play received to pay for some of this. So the net break even is $125.68, or just 15.3% higher:
$28.03 call price - $2.35 = $25.68 net call price
$100 call strike price + $25.58 net call price = $125.58 breakeven
$125.58 - $108.98 SHOP price today = $16.70 breakeven hurdle rise
$16.70 / $109.98 = 1.153 = +15.3% hurdle rise
Repeating Short-Put Plays to Lower Risk
Moreover, the investor can repeat the out-of-the-money short-put strategy to lower risk. If they can average over $2.09 per month for 8 months, the $16.70 hurdle could be met (assuming SHOP stays flat). This seems very doable.
As a result, the investor could end up with a very low breakeven price at the $100 call strike price. If SHOP ends up with a $157 price in the next year, the investor stands to make much more than the 45% projected. For example, the intrinsic value of the call at a trading price of $157 would be:
$157 - $100 = $57.00 per call = $57.00/$25.58 net call price paid - 1 = +122.8% return potential - i.e., much higher than +45% upside owning SHOP stock
Moreover, the call price will always have some level of extrinsic value making it worth more than $25.58, so the return could be much higher. In addition, buying an in-the-money (ITM) call also protects on the downside since there is still some intrinsic value left in ITM call prices.
The bottom line is that SHOP stock looks deeply undervalued here. Shorting OTM puts and buying long-term calls is one way to play this very profitably.
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