Marvell Technology (MRVL), the chip designer company, is set to release results on Thursday, May 30, after the close. MRVL stock could end up moving higher, despite the stock's recent runup.  The market will be looking to see if the company's free cash flow (FCF) margins remain high.

One way to play this is to short out-of-the-money (OTM) put options in nearby expiry periods. That means selling puts for expiration in the next few weeks at strike prices below today's price. This is a way to gain extra income as well as to potentially buy into the stock at a lower price.

I discussed this in my last two Barchart articles, including this one on Monday, April 29, “Marvell Technology Put Options Remain Elevated - Good for Short Sellers as an Income Play.”  In addition, in my April 5 Barchart article, I discussed Marvell Technology's strong fiscal Q4 free cash flow (FCF) and elevated FCF margins.

Free Cash Flow Pushing the Stock Higher

For example, last quarter ending Feb 3 (its fiscal Q4) Marvell generated $475.6 million in FCF. That represents a high FCF margin of 33.3% since its sales were $1,426.5 million for the quarter.

Moreover, in the trailing 12-month (TTM) period, its FCF came in strong at $1.034 billion on $5.5 billion of revenue. That represented an FCF margin of 18.8%. In other words, its FCF margin expanded significantly in Q4. 

I expect this will continue in the company's fiscal Q1 ended April 30. For example, analysts now project revenue will hit $1.16 billion for the quarter. If its FCF margins stay strong at 33.3%, FCF could reach $366 million. Although that would be lower than the prior quarter, it could be due to seasonal effects. It's better to project forward for the next 12 months (NTM).

For example, analysts now forecast $5.32 billion in revenue for the year ending Jan. 31 2025, and $7.05 billion next year. That works out to a run rate NTM average of $6.185 billion. 

If its FCF margin stays strong at 33.3% the company could generate over $2 billion in FCF (i.e., $6.185b x 0.333 = $2.06b FCF).

This is what has been pushing the stock higher. The target price for MRVL stock using an FCF yield metric could be significantly above today's price.

Target Price Is Over 51% Higher

For example, if Marvell Technology were to pay out 100% of its FCF in dividends (right now it only pays out 20% and its dividend yield is 0.31%), it could end up with at least a 1.5% dividend yield (i.e., 1/0.2 x 0.31%).

So, if we divide the NTM FCF estimate of $2.05 billion by 1.5%, Marvell Technology could end up with a market cap of $136.6 billion. That is over double its present market value of 66.36 billion. 

Here is another way of looking at it. There are presently 879.3 million shares outstanding. That implies that the FCF per share projected over the next 12 months is $2.33 per share (i.e., $2,050 million/879.3 m shs).

So, if the company were to pay out 100% of this $2.33 in FCF per share as a dividend, at today's price the dividend yield would be $2.33/$76.88, or 3.0%. The market would likely not keep the stock at this price, since it would perceive this as too high a dividend yield.

There would be instant pressure to push the stock to at least a 2.0% dividend yield. So, $2.33/0.02 works out to $116.50 per share. That is 51.5% higher than today's price of $76.88.

Shorting OTM Puts as a Way to Buy In and Generate Extra Income

One way to play this is to sell short OTM puts as a way to buy in at a lower price (in case the stock falls) as well as to generate extra income. This works well for existing shareholders who have ridden the stock price gains but don't want to sell now, or even to sell covered calls.

For example, look at the June 7 expiration period, 13 days from now. It shows that the $70 put option strike price contracts are at $1.00 on the bid side. This strike price is 8.71% below today's price, so it is deeply out of the money.

This means that a short seller of these puts can make an immediate yield of 1.43% (i.e., $1.00/$70.00). All they have to do is secure $7,000 in cash and/or margin with their brokerage firm. Then they enter an order to “Sell to Open” 1 put contract at this strike price and expiry period. The account will immediately receive $100.00

As a result, their breakeven point is actually $69.00 (i.e., $70.00-$1.00 in income received). That is 10.2% below the closing price on May 24 of $76.88. In other words, it provides good downside protection.

Moreover, if the investor is already a shareholder they get to not only keep the income but also any upside in the stock after the earnings come out.

The bottom line is that MRVL stock looks cheap here. One way to play this is to sell short OTM puts in nearby expiry periods.

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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.