Two important questions to ask before you buy Waste Connections, Inc. (NYSE:WCN) is, how it makes money and how it spends its cash. What is left after investment, determines the value of the stock since this cash flow technically belongs to investors of the company. I will take you through WCN’s cash flow health and the risk-return concept based on the stock’s cash flow yield, using the most recent financial data. This will help you think about the company from a cash perspective, which is a crucial factor to investing.
Is Waste Connections generating enough cash?
Waste Connections 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 Waste Connections’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
Along with a positive operating cash flow, Waste Connections also generates a positive free cash flow. However, the yield of 3.4% is not sufficient to compensate for the level of risk investors are taking on. This is because Waste Connections’s yield is well-below the market yield, in addition to serving higher risk compared to the well-diversified market index.
Is Waste Connections’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 WCN’s expected operating cash flows. In the next couple of years, the company is expected to grow its cash from operations at a double-digit rate of 13%, ramping up from its current levels of US$1.4b to US$1.6b in two years’ time. Although this seems impressive, breaking down into year-on-year growth rates, WCN’s operating cash flow growth is expected to decline from a rate of 6.9% next year, to 5.8% in the following year. But the overall future outlook seems buoyant if WCN can maintain its levels of capital expenditure as well.
Given a low free cash flow yield, on the basis of cash, Waste Connections 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 Waste Connections to get a more holistic view of the company by looking at:
- Valuation: What is WCN 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 WCN 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 Waste Connections’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.
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