If you are currently a shareholder in Associated British Foods plc (LON:ABF), or considering investing in the stock, you need to examine how the business generates cash, and how it is reinvested. This difference directly flows down to how much the stock is worth. Operating in the packaged foods and meats industry, ABF is currently valued at UK£19.3b. Today we will examine ABF’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.
Is Associated British Foods generating enough cash?
Associated British Foods 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.
I will be analysing Associated British Foods’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
Associated British Foods’s yield of 0.34% 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 Associated British Foods but are not being adequately rewarded for doing so.
Is Associated British Foods’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 ABF’s expected operating cash flows. In the next few years, the company is expected to grow its cash from operations at a double-digit rate of 71%, ramping up from its current levels of UK£1.3b to UK£2.3b in three years’ time. Furthermore, breaking down growth into a year on year basis, ABF is able to increase its growth rate each year, from 20% in the upcoming year, to 24% by the end of the third year. The overall picture seems encouraging, should capital expenditure levels maintain at an appropriate level.
Low free cash flow yield means you are not currently well-compensated for the risk you’re taking on by holding onto Associated British Foods relative to a well-diversified market index. However, the high growth in operating cash flow may change the tides in the future. 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 Associated British Foods to get a more holistic view of the company by looking at:
- Valuation: What is ABF 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 ABF 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 Associated British Foods’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.