Constellation Brands (STZ), which makes Corona and Modelo beer, reported mediocre results for its fiscal Q2 yesterday. However, management reaffirmed its free cash flow (FCF) target for the year. This makes STZ look cheap to investors based on projections of positive FCF. As a result, out-of-the-money (OTM) short-put and call option plays work here.
STZ is at $247.53 in morning trading on Friday, Oct. 4. The stock has been volatile in the past 3 months, partly reflecting investor's lukewarm attitude towards STZ stock. That is what provides opportunities for OTM options short sale traders.
This is based on a price target of $294 per share. Here's how I derived this.
Free Cash Flow Projections Remain Stable
In my last two Barchart articles I discussed Constellation's value and how to play short options. On July 5, I discussed management's FCF projection of between $1.4 and $1.5 billion in FCF this fiscal year. In the company's recent press release, they reaffirmed this FCF projection. As a result, we can develop a price target for STZ stock.
For example, last quarter analysts projected $10.7 billion in sales for the year. But now they are forecasting $13.7 billion for the year ending Feb. 2025. As a result, Constellation's FCF estimate now represents a little over 10% of sales (i.e., $1.45b/$13.7b = 10.6%).
Moreover, for the coming year ending Feb. 2026, analysts now project $15.19 billion in sales. That means over the next 12 months (NTM) the run rate revenue is $14.445 billion. Therefore, using a 10.6% FCF margin, free cash flow should average $1.53 billion.
Price Targets
As a result, using a 3.0% FCF yield metric Constellation stock could end up with a market cap of $51 billion over the next 12 months. That is 14% higher that today's $44.5 billion market value. In other words, its price target is $280.00 per share.
Moreover, using a 2.75% FCF yield metric, the same as multiplying FCF by 36x, Constellation's market cap estimate is $55.6 billion. That equals a price target 25% higher or $307 per share. So, on average the NTM price target is $293.50.
This is close to other analysts' price targets. For example, Yahoo! Finance says 21 analysts have an average target of $297.44 per share. Similarly, Barchart says the mean price target is $298.65 per share.
Moreover, AnaChart, a sell-side analyst tracking site, shows that 21 analysts have an average $290.01 price target. The bottom line here is that analysts have all converged on this sub-$300 price range. This is still 18% or so higher than today's price.
That makes it profitable to sell short out-of-the-money puts and calls.
Shorting OTM Puts and Calls
I discussed this in my recent July 28 Barchart article about shorting covered calls and cash-secured puts - all in out-of-the-money (OTM) strike price for nearby expiry periods. The article, “Constellation Brands Stock is a Value Investor's Favorite - Especially Shorting Puts and Calls,” suggested shorting the $245.00 strike price put option expiring three weeks later on Aug. 16.
That strike price was 3.35% out-of-the-money (i.e., below the spot price of $253.48) and the $1.45 premium received represented a put-yield of 0.59% for the short seller (i.e., $1.45/$245).
As it turns out, STZ closed at $245.70 on Aug. 16. So the option did not end up in the money and the investor did not have to buy shares at $245.00. This trade can now be repeated for more income, given how STZ stock fluctuates.
I also discussed shorting covered calls which had slightly lower yields but also ended up not being exercised. Let's focus on the OTM put strategy going forward since it makes sense to try and establish a potential buy-in price target below today's price.
For example, look at the Nov. 1 expiration period, 4 weeks away. It shows that the $235 strike price puts, 4.35% below today's price, trade for $1.45 - the same as last time.
However, the yield is slightly higher since the strike price is lower. This is because the $145 in income per contract for an investor who secures $23,500 in cash and/or margin represents 0.617% for the next month.
On an annualized basis, that represents a potential yield of 7.40%. This assumes that the same premium and yield can be made each month. That is highly possible, though, given how much this stock fluctuates.
Moreover, the investor has a lower potential buy-in target price (i.e., $235-$1.45, or $233.55). That is 5.6% below today's price.
In addition, for less-risk-averse investors, the $240 strike price has a premium of $2.65. That represents a yield of 1.10% (i.e., $265/$24,000 invested over the next month). However, this strike price is just 2.60% below today's price, so the downside protection is much less. Nevertheless, it still represents a breakeven of $237.35, or -4.2% below today's price.
The bottom line is that STZ stock still looks cheap, despite its mediocre results today. One way to play this is to short out-of-the-money (OTM) put options 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.
