If you are currently a shareholder in EBOS Group Limited (NZSE:EBO), or considering investing in the stock, you need to examine how the business generates cash, and how it is reinvested. 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 EBO’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?
Free cash flow (FCF) is the amount of cash EBOS Group 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 EBOS Group’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
EBOS Group’s yield of 3.59% 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 EBOS Group but are not being adequately rewarded for doing so.
What’s the cash flow outlook for EBOS Group?
Can EBO improve its operating cash production in the future? Let’s take a quick look at the cash flow trend the company is expected to deliver over time. In the next few years, expected growth for EBO’s operating cash is negative, with operating cash flows expected to decline from its current level of NZ$197.78m. This is unfavourable to its future outlook, especially if capital expenditure heads the opposite direction. However, breaking down growth into a year on year basis, EBO ‘s negative growth rate improves each year, from -14.05% next year, to -3.02% in the following year.
The company’s low yield relative to the market index means you are taking on more risk holding the single-stock EBOS Group as opposed to the diversified market portfolio, and also being compensated for less. Furthermore, its declining operating cash flow doesn’t seem appealing. 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 EBOS Group to get a more holistic view of the company by looking at:
- Valuation: What is EBO 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 EBO 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 EBOS 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 email@example.com.