Meridian Energy Limited (NZSE:MEL) 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. 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.
Is Meridian Energy generating enough cash?
Meridian Energy generates cash through its day-to-day business, which needs to be reinvested into the company in order for it to continue operating. What remains after this expenditure, is known as its free cash flow, or FCF, for short.
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 3.53% 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.
Is Meridian Energy's yield sustainable?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. Over the next three years, Meridian Energy’s operating cash flows is expected to grow by a double-digit 37%, 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||+3 year|
|Operating Cash Flow (OCF)||NZ$427m||NZ$573m||NZ$548m||NZ$587m|
|OCF Growth Year-On-Year||34%||-4.4%||7.2%|
|OCF Growth From Current Year||28%||37%|
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 recommend you continue to research Meridian Energy to get a better picture 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.