Two important questions to ask before you buy Sonoco Products Company (NYSE:SON) is, how it makes money and how it spends its cash. After investment, what’s left over is what belongs to you, the investor. This also determines how much the stock is worth. I will take you through SON’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.
What is free cash flow?
Sonoco Products’s free cash flow (FCF) is the level of cash flow the business generates from its operational activities, after it reinvests in the company as capital expenditure. This type of expense is needed for Sonoco Products to continue to grow, or at least, maintain its current operations.
There are two methods I will use to evaluate the quality of Sonoco Products’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
Sonoco Products’s yield of 4.74% 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 Sonoco Products but are not being adequately rewarded for doing so.
What’s the cash flow outlook for Sonoco Products?
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 SON’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 12%, ramping up from its current levels of US$520m to US$581m in two years’ time. Although this seems impressive, breaking down into year-on-year growth rates, SON’s operating cash flow growth is expected to decline from a rate of 7.9% next year, to 3.6% in the following year. But the overall future outlook seems buoyant if SON can maintain its levels of capital expenditure as well.
Low free cash flow yield means you are not currently well-compensated for the risk you’re taking on by holding onto Sonoco Products 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. You should continue to research Sonoco Products to get a better picture of the company by looking at:
- Valuation: What is SON 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 SON 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 Sonoco Products’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.