Meta Platforms (META) stock is too cheap here based on its stellar free cash flow (FCF) margins after its recent drop. As a result, its out-of-the-money (OTM) put option premiums are very high, making them attractive to short sellers for income and good entry points.

META stock fell dramatically after its April 24 Q1 earnings release to $443.29 on Friday, April 26. This was down from a recent peak of $527.34 on April 4 and $493.50 the day before the earnings came out.

Investors are concerned about the company's outlook for revenue and its plans to raise capex spending by 12% according to the WSJ. However, the market may have overdone this.

Concerns About FCF Are Overblown

In Q1 the company made $12.5 billion in adjusted free cash flow (FCF), after spending $6.4 billion in capital expenditure on revenues of $36.455 billion and operating cash flow (OCF) of $19.3 billion. This can be seen on page 15 of its investor deck.

That means that adj. FCF margin was 34.4%, significantly higher than its full-year 2023 adj. FCF margin of just 31.9%. Moreover, its OCF margin was high at 52.8%, comparable to 52.7% in 2023.

I discussed these margins and the company's revenue and adj. FCF margins in my recent April 8 GuruFocus article, “Meta Platforms Is Still Cheap Based on Its Powerful FCF.” In that article, I projected that Meta would have $35 billion in capex spending this year and $38.5 billion next year. The result was a forecast of $48 billion in FCF in 2024 and $55 billion in 2024, implying FCF margins of 30.3% and 30.8% respectively.

Now Meta is saying that it plans on spending higher amounts on capex. However, these are within the ranges that I forecast. Here is what Susan Li, CFO, said about its capex spending plans on the earning call:

"We anticipate our full-year 2024 capital expenditures will be in the range of $35-40 billion, increased from our prior range of $30-37 billion as we continue to accelerate our infrastructure investments to support our AI roadmap"

In other words, the increase in spending could potentially lower FCF estimates. Let's look at this.

FCF Margins Will Lead to a Higher Price Target

Analysts forecast revenue will reach $158.81 billion this year and $178.99 billion in 2025. This is higher than the April 8 GuruFocus article analysts' estimates.

Assuming that OCF margins will stay at 52.8%, operating cash flow will reach $83.85 billion in 2024 and $103.8 billion in 2025. So, assuming capex rises to $37.5 billion in 2024 (i.e., the midpoint of Meta's range) and $42 billion in 2025, adj. FCF will be $45.35 billion (after $1 billion in lease principal payments). For 2025 it will rise to $60.8 billion.

In other words, its FCF margin will still be very high at 28.6% (i.e., $45.35b/$158.81b) and 34% in 2025. In other words, over the next 12 months, the company will be on a run rate for an average of 31.3% FCF margins.

That is at the same level as in my GuruFocus article. That also implies META stock is cheap. For example, using a 3.33% FCF yield, (i.e., the same as multiplying FCF estimates by 30x), the stock will have a market cap of $1.36 trillion in 2024 (i.e., $45.35b x 30) and $1.824 trillion in 2025.

This implies an upside of at least 21% today, as Meta Platforms has a market cap of $1.124 trillion right now. That means its near-term price target is at least $536.88 per share. And next year it could be significantly higher.

Shorting OTM Puts for Income

Given all the negative sentiment now on META stock, its put options have high premiums. That makes them ideal to short for income, especially for existing investors, and as a good entry buy point for new investors in the stock.

For example, look at the May 17 expiry period, 3 weeks away. It shows that the 3% out-of-the-money strike price ($430) has a put option price of $8.05 per put contract. That represents a huge put yield of 1.87% (i.e., $8.05/$430.00) in less than 3 weeks.

Moreover, a strike price that is 5.25% below today's price ($420) has a $5.15 price or a yield of 1.23%. The point is that even if Meta stock keeps falling, these are good entry points and the investor who shorts these puts gets to keep the income from the short sales. That lowers their breakeven prices even further.

The bottom line is that Meta stock looks very cheap here. One way to play this is to short out-of-the-money put options in near-term 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.