DraftKings Inc (DKNG) conveyed a surprising message in its latest earnings release on Feb. 15, anticipations of $310 to $410 million in free cash flow (FCF) this year. If this unfolds, DKNG stock’s value could increase by at least 50%.
What’s the takeaway of this unforeseen revelation? The company’s FCF would represent nearly 8% of its revenue, given analysts’ forecast of $4.71 billion in revenue for the year. The midpoint estimate mentioned by the company, $360 million, translates to 7.64% of the total revenue. Furthermore, a $410 million FCF indicates an impressive FCF margin of 8.70%.
As expected, DKNG stock soared, reaching its highest price in six months, closing at $44.57 on Friday, Feb. 16. But there’s more to this surge which could potentially lead to a 50% appreciation in value. Here’s why.
Implications of Positive FCF on DKNG Stock
Looking into the future, DraftKings’ free cash flow holds significant implications for the DKNG stock. For instance, by 2025, revenue is projected to escalate by 20% to $5.65 billion. Thus, an 8.0% FCF margin could yield a minimum FCF of $452 million. A more optimistic 8.7% FCF margin estimate raises the bar to $491.6 million.
Using a 1.5% FCF yield metric with the $360 million midpoint estimate for this year, current market cap could scale to $24 billion (i.e., $360m/0.015 = $24,000 million), a 13.7% increase from today’s $21.1 billion. Pushing the envelope further and applying this metric to the upper end of $491.6 million in FCF hints at a market cap of $32.8 billion, a significant 55% surge from today’s market cap.
The math suggests a potential 50% increase in DKING stock’s value over the next 12 months, pegging it at $66.86 per share (i.e., 1.50 x $44.57 price today).
For investors, selling short out-of-the-money (OTM) put options in nearby expiry periods might be an ideal approach to partake in this rally while earning extra income.
Shorting DKNG Put Options for Income
The premiums for DraftKings put options are currently soaring, presenting a lucrative opportunity for short sellers of OTM puts in near-term expiration periods.
For instance, take a peek into the March 8 expiry period, just three weeks away. The $41.00 strike price, standing 8% below the current price, boasts a bid side price of 43 cents, equivalent to 1.05% of the strike price. This presents an opportunity for short sellers to attain a 1.05% return with just 3 weeks until expiration.
An investor with $4,100 in cash and/or margin can “Sell to Open” 1 put contract at the $41.00 strike price and receive $43.00. Alternatively, with $20,500, they can sell short 5 put contracts at $41.00 for expiration on March 8 and receive $215.00.
Both strategies offer an immediate yield of 1.05%. When repeated four times in a quarter, it can generate $860 on an investment of $20,500, amounting to an expected return of 4.195% in just 90 days.
In light of this opportunity with DKNG stock, it makes sense to hold the stock and short OTM puts, not just for income but also to help mitigate potential downside action in the stock. The additional income serves as a hedge against any downturn in the price and the resulting unrealized losses.
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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.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
