/code%20on%20computer%20screen%20java%20html.jpg)
Oracle Corp (ORCL) stock is up over 11% since March 11 when its quarterly results showed strong free cash flow (FCF) growth. It still has good upside based on that FCF. Short-put plays are attractive as yield plays.
ORCL stock closed at $124.90 on April 5, up 11.1% from $112.42. That is where it closed on March 8, the day before its fiscal Q3 results for the quarter ending Feb. 29 were released.
I discussed Oracle's strong FCF and FCF margins in my March 12 article, “Oracle Stock Spikes on Earnings and Free Cash Flow Results, But It Could Still Be Worth 26% More.” I argued that ORCL was worth $161.28 based on its FCF.
That thesis still holds today, implying a 29% upside for investors in the stock. More on this below.
Shorting OTM Puts Still Makes Sense
In the meantime, investors can make extra income by shorting out-of-the-money (OTM) put options in near-term expiry periods. For example, in the article I discussed shorting the March 28 expiration puts at the $124 strike price for $1.32 in premium.
That resulted in an immediate yield of over 1% (i.e., $1.32/$124.00 = 1.0645%) for 2 weeks until expiration. Since ORCL closed at $125.61 on March 28 there was no obligation by the short-seller of these puts to buy the stock at $124.00.
It makes sense to do this again now. For example, look at the April 26 expiration period for ORCL put options, which is three weeks away. It shows that the $120 strike price, which is 3.92% below today's price trades for 85 cents on the bid side. That provides an immediate 0.708% yield for short sellers.
Here is what that means exactly. An investor who secures $12,000 in cash and/or margin with their brokerage firm can apply for permission to do this trade. Once approved, they can enter to “Sell to Open” 1 put contract at $120 for expiration on April 26. The account will then immediately receive $85.00 - hence, the 0.708% yield (i.e., $85/$12,000).
Moreover, if the investor can repeat this yield over the next quarter (i.e., 4 times making 0.708% in short-put plays expiring in 3 weeks), they stand to make an expected return (ER) of $340. That works out to be an ER yield of 2.833%.
Keep in mind that the risk is that if ORCL stock falls to $120 or lower on or before April 26, the account will assigned a purchase of 100 shares at $120.00. That is why you must secure $12,000 in cash and/or margin while the trade is on.
But would that be all that bad a situation? Not really, as although it would result in an unrealized loss, it could be a good investment for the long term.
For one, the investor could turn around and then sell OTM covered calls. That would bring in more income that could lower the unrealized loss. In addition, ORCL is a good long-term buy. The reason is that ORCL is very attractive due to its strong FCF. Let's look at that again.
Price Targets for ORCL
As I explained in my prior Barchart article, Oracle produced $12.258 billion in FCF in the trailing 12 months (TTM) ending Feb. 28. That was over 23.3% of its $52.5 billion in TTM revenue, based on data from Seeking Alpha.
Moreover, analysts now project its May 30 FY revenue will be $53.26 billion, and next year's revenue is forecast to rise 8.5% to $57.79 billion. That implies that if its 23% FCF margin holds up Oracle could end up making $13.29 billion in FCF next year (i.e., $57.79b x 0.23).
So, assuming the market gives ORCL stock a 3% FCF yield, the market cap could rise to $443 billion. That is 29% higher than its present $343.3 billion market cap. It implies that the stock is still worth $161.12 per share.
Moreover, even using a more conservative 3.33% FCF yield, which is the same as multiplying FCF by 30x (i.e., 1/0.03333 = 30), the stock's market cap value would be about $400 billion (i.e., $13.29b x 30 = $398.7b). This is still 16.1% over today's market cap and implies a minimum price target of $145 per share.
This is in line with what other analysts are saying. For example, AnaChart.com, a new sell-side analyst tracking service, reports that the average of 28 analysts' price targets is $140.93 per share. That is 12.8% over today's price.
The bottom line is that ORCL still looks cheap here, especially to value investors. In addition, existing shareholders can make extra income by shorting OTM puts as a yield play.
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.
