McDonald's Corp (MCD) stock has benefited from higher analysts' price targets since its Feb. 11 earnings release. But the stock has been relatively flat. That makes it ideal for short-sellers of out-of-the-money (OTM) MCD puts.
MCD is at $326.82 in midday trading on Monday, March 16, about where it was a month ago ($327.62 on Feb. 17). But it could be worth at least 9% more at $357 per share, based on analysts' price targets as well as its strong free cash flow (FCF).
Free Cash Flow (FCF) Based Price Target (PT)
I discussed this in my last Barchart article on Feb. 15 ("Analysts are Lovin' McDonald's With Higher Price Targets and Estimates - Is MCD Stock a Buy Here?"
I discussed the company's strong FCF and FCF margins. Based on analysts' revenue estimates, I showed that McDonald's could generate $8.16 billion in FCF. Using a 3.0% FCF yield metric, this implies MCD could be worth 16% more:
$8.16b / 0.03 = $272 billion mkt value
$272 / $233.88b mkt cap today = 1.163
That implies a price target of $379.58 per share. That's slightly higher than my previous $374.92 PT.
Other analysts agree. They have raised their price targets since the earnings release.
Other Price Targets Higher
For example, Yahoo! Finance now shows that the average PT of 38 analysts is $344.09. That's up from $340.03 a month ago. Similarly, Barchart's survey price is now $346.82, up from $342.81.
Lastly, AnaChart's survey of 23 analysts is now $370.43, up from $367.16. So, the average survey PT is now $353.78, up from $350 a month ago.
In addition, a historical dividend yield price target, as shown in my last article, works out to $338.57.
As a result, using these three methods, MCD's price target is now $357.31, or 9.1% higher:
FCF-Based PT …… $379.58
Analysts' PT ……… $353.78
Div Yld PT ………… $338.57
Average PT …………$357.31
That's up from $353.83 last month. In other words, MCD's upside is slightly better. Nevertheless, MCD stock has been flat over the last month.
As a result, it makes sense to short out-of-the-money (OTM) puts in a one-month expiry period. That way, an investor can set a lower potential buy-in point, but also get paid while waiting to buy in.
Shorting OTM MCD Puts
For example, look at the April 17 expiration period. It shows that the $315.00 strike price put contract, which is 4% lower than today's price, has a midpoint premium of $3.01.
That means an investor can make $301 after securing $31,500 with the brokerage firm to buy 100 shares at $315.00. This works out to a one-month yield of almost 1%:
$301/$31,500 = 0.00955 = 0.955% for 1 month
In other words, it makes sense to do this if you believe MCD could drift lower over the next month. For one, the breakeven point, even if MCD falls to $315, is lower:
$315.00 - $3.01 = $311.99
That's 4.53% lower than today's price, so it makes a good potential entry point. Note that the delta ratio of -.24 is low, implying less than a 25% chance that MCD will fall to $315 by April 17.
Meanwhile, if the investor repeats this over the next three months, income accumulates, which makes it worthwhile.
The bottom line is that MCD looks cheap here. One way to play it is to short OTM puts each month.
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.
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