Two important questions to ask before you buy Stella-Jones Inc (TSE:SJ) is, how it makes money and how it spends its cash. What is left after investment, determines the value of the stock since this cash flow technically belongs to investors of the company. Today we will examine Stella-Jones’s ability to generate cash flows, as well as the level of capital expenditure it is expected to incur over the next couple of years, which will result in how much money goes to you.
What is Stella-Jones’s cash yield?
Free cash flow (FCF) is the amount of cash Stella-Jones has left after it pays off its expenses, including its net capital expenditures, which is what the company needs to spend each year to maintain or grow its business operations.
There are two methods I will use to evaluate the quality of Stella-Jones’s FCF: firstly, I will measure its FCF yield relative to the market index yield; secondly, I will examine whether its operating cash flow will continue to grow into the future, which will give us a sense of sustainability.
Free Cash Flow = Operating Cash Flows – Net Capital Expenditure
Free Cash Flow Yield = Free Cash Flow / Enterprise Value
where Enterprise Value = Market Capitalisation + Net Debt
Stella-Jones’s yield of 1.84% indicates its sub-standard capacity to generate cash, compared to the stock market index as a whole, accounting for the size differential. This means investors are taking on more concentrated risk on Stella-Jones but are not being adequately rewarded for doing so.
What’s the cash flow outlook for Stella-Jones?Another important consideration is whether this return is likely to be maintained over the next couple of years. We can gauge this by looking at Stella-Jones’s expected operating cash flows. In the next couple of years, Stella-Jones’s operating cash flows is expected to grow by a double-digit 17%, which is encouraging, should capital expenditure levels maintain at an appropriate level. Below is a table of Stella-Jones’s operating cash flow in the past year, as well as the anticipated level going forward.
|Current||+1 year||+2 year|
|Operating Cash Flow (OCF)||CA$197m||CA$176m||CA$231m|
|OCF Growth Year-On-Year||-11%||31%|
|OCF Growth From Current Year||17%|
Given a low free cash flow yield, on the basis of cash, Stella-Jones becomes a less appealing investment. This is because you would be better compensated in terms of cash yield, by investing in the market index, as well as take on lower diversification risk. However, cash is only one aspect of investing. Keep in mind that cash is only one aspect of investment analysis and there are other important fundamentals to assess. I recommend you continue to research Stella-Jones to get a more holistic view of the company by looking at:
- Valuation: What is SJ worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether SJ is currently mispriced by the market.
- Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on Stella-Jones’s board and the CEO’s back ground.
- Other High-Performing Stocks: If you believe you should cushion your portfolio with something less risky, scroll through our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.