Two important questions to ask before you buy HomeServe plc (LON:HSV) 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 diversified support services industry, HSV is currently valued at UK£3.2b. I will take you through HSV’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 HomeServe generating enough cash?
Free cash flow (FCF) is the amount of cash HomeServe 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.
I will be analysing HomeServe’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
Along with a positive operating cash flow, HomeServe also generates a positive free cash flow. However, the yield of 0.54% is not sufficient to compensate for the level of risk investors are taking on. This is because HomeServe’s yield is well-below the market yield, in addition to serving higher risk compared to the well-diversified market index.
Is HomeServe’s yield sustainable?
Does HSV’s future look brighter in terms of its ability to generate higher operating cash flows? This can be estimated by examining the trend of the company’s operating cash flow moving forward. In the next couple of years, the company is expected to grow its cash from operations at a double-digit rate of 65%, ramping up from its current levels of UK£130m to UK£214m in three years’ time. Although this seems impressive, breaking down into year-on-year growth rates, HSV’s operating cash flow growth is expected to decline from a rate of 26% in the upcoming year, to 11% by the end of the third year. However the overall picture seems encouraging, should capital expenditure levels maintain at an appropriate level.
Given a low free cash flow yield, on the basis of cash, HomeServe 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. 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 HomeServe to get a better picture of the company by looking at:
- Valuation: What is HSV 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 HSV 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 HomeServe’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.