Two important questions to ask before you buy Meridian Energy Limited (NZSE:MEL) is, how it makes money and how it spends its cash. This difference directly flows down to how much the stock is worth. Operating in the renewable electricity industry, Meridian Energy is currently valued at NZ$8.03b. I’ve analysed below, the health and outlook of Meridian Energy’s cash flow, which will help you understand the stock from a cash standpoint. Cash is an important concept to grasp as an investor, as it directly impacts the value of your shares and the future growth potential of your portfolio.
What is free cash flow?
Meridian Energy’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 Meridian Energy to continue to grow, or at least, maintain its current operations.
There are two methods I will use to evaluate the quality of Meridian Energy’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
Meridian Energy’s yield of 4.18% 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 Meridian Energy but are not being adequately rewarded for doing so.
Does Meridian Energy have a favourable cash flow trend?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 Meridian Energy’s expected operating cash flows. In the next few years, Meridian Energy’s operating cash flows is expected to grow by a double-digit 25.02%, which is encouraging, should capital expenditure levels maintain at an appropriate level. Below is a table of Meridian Energy’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)||NZ$429.00m||NZ$532.38m||NZ$536.35m|
|OCF Growth Year-On-Year||24.10%||0.75%|
|OCF Growth From Current Year||25.02%|
Given a low free cash flow yield, on the basis of cash, Meridian Energy 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 suggest you continue to research Meridian Energy to get a more holistic view of the company by looking at:
- Valuation: What is MEL 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 MEL 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 Meridian Energy’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.