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If you are currently a shareholder in Air New Zealand Limited (NZSE:AIR), or considering investing in the stock, you need to examine how the business generates cash, and how it is reinvested. 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 AIR’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 Air New Zealand
Is Air New Zealand generating enough cash?
Air New Zealand 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.
I will be analysing Air New Zealand’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
Air New Zealand’s yield of 3.38% 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 Air New Zealand but are not being adequately rewarded for doing so.
Is Air New Zealand'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 AIR’s expected operating cash flows. Over the next few years, AIR is expected to deliver a decline in operating cash flow compared to the most recent level of NZ$1.0b, which is not an encouraging sign. However, breaking down growth into a year on year basis, AIR 's negative growth rate improves each year, from -10% next year, to 0.3% in the following year.
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The company’s low yield relative to the market index means you are taking on more risk holding the single-stock Air New Zealand as opposed to the diversified market portfolio, and also being compensated for less. Furthermore, its declining operating cash flow doesn’t seem appealing. Now you know to keep cash flows in mind, You should continue to research Air New Zealand to get a better picture of the company by looking at: