Companies require capital expenses in purchasing and upgrading plant and equipment for growth. The money is not gone. It is carried on the balance sheet as an asset. The end goal is for the company to generate a return on the asset. Free cash flow (FCF) is what is left after those expenses.
Free cash flow is like the end all goal of companies. The point is to do so well that you make so much money that even after all the checks written to expand the business you still have a lot of cash. Cash is pretty much the most important thing, and FCF is the most flexible kind of cash there is. With this internally generated FCF, a company can pay out dividend consistently, buy back its shares when they are selling cheap, pare down loans, or invest in other profitable ventures, all done without assuming more debts which makes the business more risky in times of the down turn in economy, or asking more money from shareholders, or issuing more shares to private investors, often at a discount, and hence diluting the earnings per share of the existing shareholders.
There are some companies doing so well that even after heavy expansion they have a lot of cash left over. Scientex Berhad is one of them, and it has been using this FCF to do most of the above.
Scientex Berhad
Scientex Berhad is engaged in two operating segments: property segment, which is in the business of constructing and developing residential and commercial properties, and manufacturing segment, which is mainly in the business of manufacturing various packaging products and manufacturing materials for automotive interior. Included in this segment is also the marketing and sales of laminating polyurethane adhesives. The packaging business unit manufactures various packaging products, which caters for packaging for logistics purposes, general purpose packaging and packaging for bulk handling. The polymer business unit manufactures polyvinyl chloride (PVC) leather cloth, PVC/polypropylene (PP) and PVC/polyethylene (PE) foam and thermoplastic olefin/PP foam sheets for automotive instrument panels, door trims and headlining for car manufacturers in the Asia Pacific region.
I have written a couple of investment thesis on Scientex since 14 months ago when its share price was at RM5.74 apiece as shown in the link below.
http://klse.i3investor.com/blogs/kcchongnz/56316.jsp
Subsequently I wrote another article updating the valuation of Scientex as shown in the link here:
http://klse.i3investor.com/blogs/kcchongnz/60563.jsp
Scientex just announced unaudited earnings results for the year ended July 31, 2015. Revenue for the year improved by 13.3% to RM1.8b and operating income jumped by 18.6% to RM225m. Earnings per share, EPS was 70 sen, against 67 sen a year ago. Net cash from operating activities was RM190m, against RM154m a year ago.
At the close of RM7.40 today, the PE ratio is 10.5; not that cheap compared to its historical PE ratio, and an enterprise value of 8.7 times its operating income. However, it is slowly transforming itself to a big regional PVC/polypropylene and PVC/polyethylene business. The attractiveness of investing in Scientex actually lies in its cash flow.
Cash flows of Scientex
For the latest annual financial results ended July 31st 2015, net income is RM162m while its cash flows from operations (CFFO) is 17% more at RM190m. This signifies the good quality of its earnings. It spent a considerable amount of money in capital expenses of RM116m, and yet there is still abundant free cash flow, FCF of RM74m left. This is 4.1% of revenue and 6.3% of invested capital (IC), in hard cash. It is from this FCF that RM47m was paid out as dividends, and partly paid down its debts.
Figure 1 below shows that the growth of net profit of Scientex at a compounded annual growth rate, CAGR of 30% for the last 12 years.
There is not a single year when it made losses. CFFO grows at tandem and it has been consistently above the CFFO, showing a high quality earnings.
Scientex does use considerable amount of debt of a total of RM254m. However this debt is only 0.24 times its total equity, and its CFFO covers a whopping 23 times its interest payment. Scientex has done a good job utilizing other people’s money to yield a high return on equity of 19%.
Not only CFFO is positive every year, its FCF is also positive every year without fail, except for a single year in 2004 when it spent a relative high capital expenses as shown in Table 1 below.
Table 1: Cash flows of Scientex
Over the last 13 years, it has produced a total FCF of RM689m which it used to invest in profitable investments and paying dividends to shareholders, invest in profitable comanies, and not from your own money (right issues), continued borrowing from banks, or by giving a piece of the business from other private investors (private placement).
Conclusions
Scientex has high revenue and profit growth for the last 12 years. Despite the very high growth, It still have positive and reasonable good FCF every year. It even earns more cash than its accounting profit every year. After spending huge amount of capital expenses and acquiring other companies in the same business, and as a result, it earns more profit and hard cash.
Scientex appears to be the kind of company investors should look out for investing for the long term; A regional and world market leader, high return on capitals, a cash cow, but trading at reasonable price, or may be even cheap price.
For those who wants to learn about investing in cash cows and understand what I have been talking about buying good companies at good price as investment for the long-term, please contact me at
ckc14training@gmail.com
The last train is moving. You still can jump on board now.
K C Chong
No comments:
Post a Comment