Two important questions to ask before you buy The Timken Company (NYSE:TKR) 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. Today we will examine TKR’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 Timken 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.
The two ways to assess whether Timken’s FCF is sufficient, is to compare the FCF yield to the market index yield, as well as determine whether the top-line operating cash flows will continue to grow.
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, Timken also generates a positive free cash flow. However, the yield of 4.1% is not sufficient to compensate for the level of risk investors are taking on. This is because Timken’s yield is well-below the market yield, in addition to serving higher risk compared to the well-diversified market index.
Does Timken have a favourable cash flow trend?
Does TKR’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 few years, the company is expected to grow its cash from operations at a double-digit rate of 70%, ramping up from its current levels of US$333m to US$564m in three years’ time. Although this seems impressive, breaking down into year-on-year growth rates, TKR’s operating cash flow growth is expected to decline from a rate of 35% in the upcoming year, to 11% by the end of the third year. But the overall future outlook seems buoyant if TKR can maintain its levels of capital expenditure as well.
The company’s low yield relative to the market index means you are taking on more risk holding the single-stock Timken as opposed to the diversified market portfolio, and being compensated for less. Though the high operating cash flow growth in the future could change this. 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 Timken to get a more holistic view of the company by looking at:
- Valuation: What is TKR 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 TKR 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 Timken’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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.