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Salesforce Inc (CRM) stock is still over 25% below its three-month highs even after rebounding from lows. It still looks cheap here based on its strong free cash flow (FCF). One way to play this is to short out-of-the-money puts.
In morning trading on Tuesday, June 18, CRM stock is at $230.38, down from $307.77 on March 22. However, the stock is still worth over $270 per share over the next year based on its strong FCF and FCF margins.
Projected Price Target
I discussed this in my May 31 Barchart article, “Salesforce Overreaction - CRM Stock Looks Deeply Undervalued Based on Its Massive FCF.” I showed that Salesforce could generate $12.7 billion in FCF over the next 12 months (NTM). This is based on a 32% FCF margin on projected NTM sales.
Salesforce could end up with a $266.7 billion market cap. This is the result of using a 4.75% FCF yield metric, which is the same as multiplying FCF by a low 21x multiple. So, multiplying $12.7b in projected NTM FCF by 21 equals a market value of $266.7 billion.
That value is still 19% over the stock's $224 billion market cap today. In other words, it could be worth $274.15 per share using this method.
Analysts Agree
Other analysts also see high price targets for CRM stock. For example, Barchart's survey of 41 analysts has an average price target of $290.81 per share. The average at Yahoo! Finance is $296.04 (42 analysts surveyed) and at AnaChart.com, a new sell-side analyst tracking service, 38 analysts have a $273.09 price target.
All of these surveys imply that analysts believe that Salesforce is still deeply undervalued.
In fact, AnaChart shows that some of the most accurate analysts have price targets at $300 or higher. This can be seen in the table below. For example, Scott Berg, of Needham, has a $345 price target.
The table shows that he has hit his price targets two-thirds of the time. Moreover, Brian Peterson, who has an 85%+ hit target ratio has a $325 price target.
One way to play this, especially for existing investors in the stock, is to sell short out-of-the-money (OTM) put options in nearby expiry periods.
Shorting OTM Puts in CRM Stock
I discussed this in my last Barchart article on May 31. I suggested shorting the June 21 expiration put option that expires this Friday on June 21. At the time, CRM stock was at $220.74 and I pointed out that the $210 strike price puts traded for $2.51.
That provided an immediate 1.20% yield (i.e., $2.51/$210.00) to the short seller, as well as a potential buy-in price that was 3.21% below the existing price. Today those puts are almost worthless - trading at 3 cents. So, now it makes sense to cover that short sale (i.e., enter an order to “Buy to Close”) and do another short sale in a nearby expiry period.
For example, look at the July 5 expiration period, 2 weeks from now. It shows that a similar trade can be done at the $225.00 strike price put options. The premium on the bid side is $1.99 per contract.
That provides an immediate 0.88% yield to the short seller of these puts (i.e., $1.99/$225), for a strike price that is 2.34% out-of-the-money (OTM). That strike price is below today's price, although it is not as far OTM as the prior trade, so there is more risk.
Nevertheless, if the investor believes that CRM continues to be undervalued, it makes sense to do this trade. That means that they may have to buy in at $225, using the secured cash, if the price falls to this strike price on or before July 5.
But it could be worth it since, as I have shown, CRM remains deeply undervalued. Moreover, the short seller has a lower breakeven. This is because the $1.99 income received lowers the overall cost from $225 to $225-$1.99, or $223.01 per share. That is 3.2% below today's price.
The bottom line is that investors in CRM stock can make extra income by shorting these puts. After all the stock's dividend yield is very low at just 0.17% annually. Moreover, for investors looking for a cheaper way to buy into the stock, this provides a disciplined way to play the entry point.
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.
