United Airlines Stock Shows Unusual Call Options Activity - a Bullish Investor Signal

Unusual activity in United Airlines (UAL) call options today highlights investors' bullish outlook on UAL stock. The Barchart Unusual Stock Options Activity Report shows huge numbers of UAL call options bought at an at-the-money strike price.

UAL is at $91.10 today and over 4,000 call options traded at the $92.00 strike price for expiration on Nov. 29, just over 2 weeks away. This was reported in Barchart's Unusual Stock Options Activity Report today.

This volume traded in these calls was 20 times the prior outstanding number of call options contracts, indicating heavy buying initiation activity.

The mid-price paid for these calls is $3.01. That means the breakeven for the investor in these call options is $92.00 strike price + $3.01, or $95.01. That is $3.91 higher than today's price, but that represents +4.29% (i.e., $95.01/$91.10 -1) over the existing price.

In other words, investors in these UAL calls believe that UAL stock may rise 5% over the next weeks. Can that happen? Maybe. One thing is true - UAL stock looks cheap here.

United Airlines Strong Free Cash Flow (FCF)

On Oct. 15, United Airlines reported strong free cash flow (FCF) for Q3. The airline reported that its pre-tax profits were $1.3 billion, with an 8.7% pretax margin on sales.

Moreover, the company said its operating revenue was up 2.5% YoY. UAL implied that going forward revenues would be strong as unprofitable capacity had exited the industry.

That has huge implications for the company's ongoing free cash flow (FCF). Last quarter its FCF was positive at $41 million, compared to a huge negative $1.08 billion outflow last year. Moreover, year-to-date (YTD), it has made $3.44 billion in FCF compared to just $2.2 billion last year.

This optimism about forecast FCF going forward was why UAL's board approved a new $1.5 billion share repurchase program. Management indicated that it expects to see its profitability improve as an inflection point has been passed.

What does this mean for investors?

Forecasting FCF

In the last 12 months, UAL generated just $305 million in FCF. So, its $3.44 billion in FCF YTD is a huge increase. Moreover, this YTD figure represents an 8.1% FCF margin on $42.4 billion in YTD operating revenue.

Analysts now forecast revenues in 2024 will rise to $56.64 billion this year (up 12% from $50.54 billion in 2023), and +6.55% to $60.35 billion in 2025. 

Therefore, if its FCF margin improves to 10% over the next year, it's likely that UAL could generate $6 billion in FCF. But just to be conservative, let's assume it stays flat at 8.5%, or $5.13 billion (i.e., 0.085 x $60.35b 2025 revenue).

As a result, its market value could rise significantly from just $29.3 billion today.

Target Prices for UAL Stock

Right now UAL does not pay a dividend. But if it were to pay out half of this $5.13 in forecast FCF next year as a dividend, what would happen to the stock price?

We can assume that the market would give UAL stock at least a 5.0% dividend yield. So, dividing $2.565 billion ($5.14 billion 2025 FCF est. x 50%) by 5% results in a market cap of $51.3 billion. That is 75% higher than its existing market cap of $29.3 billion.

But just to be conservative, let's assume that only ⅓ of that FCF is paid out in dividends. So $1.71 billion (i.e., $5.14 x 0.3333) divided by 5% equals $34.20 billion.

That is still +16.7% higher than today's market cap. In other words, a conservative target price is $106.31 per share (i.e., $91.10 x 1.167), with a possible upside significantly higher.

Analysts tend to agree. For example, AnaChart.com, a new site that tracks sell-side analysts' price targets, reports that the average of 17 analysts' price targets is $106.43 per share. That is very close to my price target of $106.31.

So, no wonder investors are buying at-the-money (ATM) call options today. They believe that UAL stock looks undervalued here.

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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.