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AP Eagers Limited (ASX:APE) shareholders, and potential investors, need to understand how much cash the business makes from its core operational activities, as well as how much is invested back into the business. After investment, what’s left over is what belongs to you, the investor. This also determines how much the stock is worth. Today we will examine APE’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.
Check out our latest analysis for A.P. Eagers
What is free cash flow?
A.P. Eagers’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 A.P. Eagers to continue to grow, or at least, maintain its current operations.
I will be analysing A.P. Eagers’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
A.P. Eagers’s yield of 1.29% 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 A.P. Eagers but are not being adequately rewarded for doing so.
Is A.P. Eagers’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 APE’s expected operating cash flows. Over the next few years, expected growth for APE’s operating cash is negative, with operating cash flows expected to decline from its current level of AU$131m. This is unfavourable to its future outlook, especially if capital expenditure heads the opposite direction. Breaking down operating cash growth into a year-on-year basis, it seems like APE will face a continued decline in growth rates, from 0.5% next year, to -4.5% in the following year.
Next Steps:
The company’s low yield relative to the market index means you are taking on more risk holding the single-stock A.P. Eagers as opposed to the diversified market portfolio, and also being compensated for less. Furthermore, its declining operating cash flow doesn’t seem appealing. 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 A.P. Eagers to get a better picture of the company by looking at: