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Two important questions to ask before you buy Ansell Limited (ASX:ANN) 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 ANN’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.
View our latest analysis for Ansell
What is free cash flow?
Ansell 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.
The two ways to assess whether Ansell’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, Ansell also generates a positive free cash flow. However, the yield of 3.41% is not sufficient to compensate for the level of risk investors are taking on. This is because Ansell’s yield is well-below the market yield, in addition to serving higher risk compared to the well-diversified market index.
Is Ansell’s yield sustainable?
Does ANN’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 26%, ramping up from its current levels of US$172m to US$217m in three years’ time. Although this seems impressive, breaking down into year-on-year growth rates, ANN’s operating cash flow growth is expected to decline from a rate of 12% in the upcoming year, to 6.6% by the end of the third year. However the overall picture seems encouraging, should capital expenditure levels maintain at an appropriate level.
Next Steps:
Although its positive operating cash flow, and high future growth, is appealing, the low free cash flow yield is unattractive. 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. You should continue to research Ansell to get a better picture of the company by looking at: