Hengan International Group Company Limited (HKG:1044) shareholders, and potential investors, need to understand how much cash the business makes from its core operational activities, as well as how much is invested back into the business. After investment, what’s left over is what belongs to you, the investor. This also determines how much the stock is worth. Today we will examine Hengan International Group’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 free cash flow?
Hengan International Group’s free cash flow (FCF) is the level of cash flow the business generates from its operational activities, after it reinvests in the company as capital expenditure. This type of expense is needed for Hengan International Group to continue to grow, or at least, maintain its current operations.
I will be analysing Hengan International Group’s FCF by looking at its FCF yield and its operating cash flow growth. The yield will tell us whether the stock is generating enough cash to compensate for the risk investors take on by holding a single stock, which I will compare to the market index. The growth will proxy for sustainability levels of this cash generation.
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
Along with a positive operating cash flow, Hengan International Group also generates a positive free cash flow. However, the yield of 3.1% is not sufficient to compensate for the level of risk investors are taking on. This is because Hengan International Group’s yield is well-below the market yield, in addition to serving higher risk compared to the well-diversified market index.
Does Hengan International Group have a favourable cash flow trend?Does Hengan International Group’s future look brighter in terms of its ability to generate higher operating cash flows? This can be estimated by examining the trend of the company’s operating cash flow moving forward. In the next few years, Hengan International Group’s operating cash flows is expected to grow by a double-digit 35%, which is encouraging, should capital expenditure levels maintain at an appropriate level. Below is a table of Hengan International Group’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)||CN¥3.8b||CN¥4.8b||CN¥5.2b|
|OCF Growth Year-On-Year||24%||8.9%|
|OCF Growth From Current Year||35%|
Although its positive operating cash flow, and high future growth, is appealing, the low free cash flow yield is unattractive. 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. Now you know to keep cash flows in mind, I recommend you continue to research Hengan International Group to get a more holistic view of the company by looking at:
- Valuation: What is 1044 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 1044 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 Hengan International Group’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.