Author |
Message |
kumardiwesh
Senior Member
Joined: 26/May/2008
Location: India
Online Status: Offline
Posts: 721
|
Posted: 29/Aug/2008 at 12:15pm |
Yeah...got it
But how would Pantaloon's capex be different from a capital intensive company's capex, say PowerGrid's capex.
|
"History does not tell you the probability of future financial things happening" - Warren Buffett
|
IP Logged |
|
|
|
|
Vivek Sukhani
Senior Member
Joined: 23/Jul/2006
Online Status: Offline
Posts: 6675
|
Posted: 29/Aug/2008 at 9:27am |
Originally posted by praveen
Originally posted by kumardiwesh
But wouldn't companies need cash to grow?
I mean negative cash flow could increase financing costs for the company.
Could you tell me how Pantaloon managed to grow despite negative cash flows? |
I think you are confusing between cash flow from operations and net cash flows.
Let me give you an example.
Company A has a capital base of 200 (100 equity + 100 debt). For a moment lets assume there are no taxes. Cost of debt is 10% and ROIC is 20%.
Year 1
Cash Flow from operations are 40-10=30. Company A has 2 options pay down that debt or invest the same in the business. However company A which is very aggressive and see a bigger opportunity in the market wants to invest more than 40 in the business which is option 3. It goes to its bank and asks for more debt. Bank says as long as your debt is below 1.5 times your equity capital you can borrow at 10% but if it exceeds thats then I would charge you 30%.
Company A calculates that at the end of year 1 equity capital is 130 and debt is 100. So it can borrow another 65 at 10%. However company wants to keep some financial flexibility so only borrows 50 more and invests 80 in business
At the end of year 1
ROIC = 40 Interest = 10 Cash flow from operations = 30 Capex = 80 Incremental Debt = 50 Net Cash Flow = -20 Total capital =280 (130 equity + 150 debt)
Year 2 calculations
ROIC = 56 Interest = 15 Cash flow from operations = 41 Capex (Say) = 85 Incremental Debt = 44 Net cash flow= -3 Total capital = 365 (171 E + 194 D)
So see even though I have -ve net cash flows and an increasing debt value of my equity has increased by 70% in 2 years
I hope this was helpful
|
If you can get the returns according to desired level( as shown by your ROIC) immediately, then it doesnt take rocket science to figure out that you should be aggressive in borrowing. However, in most of the cases, full blown returns can be achieved only after a lag exceeding more than a year's time. Calculations become trickier in such cases, as your finance cost gets capitalised and hence your equity goes up, but capitalised finance cost doesnt offer you any return. So, most of the time we hear people talk of RoIC, its the full-blown return calculated at the original investment level, and even if the gestation lag is for 2 years and rate of borrowing is 10 p.c., your cost on balance sheet goes up to 1.21 timesof the original denominator envisaged.
One interesting thing which I am seeing in most of the mid-level manufacturing companies is that most of them have expanded capacities like anything but what is worrying is that its get entirely finaced on borrowing. D/E has gone through the roof, and if we calculate comfortable debt level using the method of debt service cover, then until and unless significant PBDIT improvement can be made, most of the companies are in for some real tough time.
So, what appears cheap on the book-value and P/E, may be hidden problems which can be disastrous in case return picture deteriorates by any whisker. Sensitivity Anlaysis has to be applied in most of the cases to figure out whether what is cheap is actually cheap.
|
Jai Guru!!!
|
IP Logged |
|
|
kumardiwesh
Senior Member
Joined: 26/May/2008
Location: India
Online Status: Offline
Posts: 721
|
Posted: 31/Aug/2008 at 1:17am |
Just read that Warren Buffett uses maintenance capex in his formula to calculate free cash flow.
FCF = Net income + Depreciation - Maintenance Capex.
If someone could elaborate what maintenance capex means, it would be great.
Also, what i could figure out that capex itself is not bad.
If all capex is just maintenance capex, the company is spending all its money just to survive.
If it's growth capex, it's actually good for the company.
Plz share ur views on this.
|
"History does not tell you the probability of future financial things happening" - Warren Buffett
|
IP Logged |
|
|
somu0915
Senior Member
Joined: 25/Nov/2008
Location: India
Online Status: Offline
Posts: 703
|
Posted: 15/Jul/2009 at 7:09pm |
ICSA is one amazing example of a 1000 bagger with -ve cash flows.
The companies which have opportunity to expand cannot generate good cash flows since they always have the burden of expansion.
Of course there are companies like Titan which have a unique franchisee
business model which lets them expand without taking too much debt. But
otherwise if companies have to expand, they have to take on debt to
expand.
What should matter is over a period of time (long period), there should
be sufficient cash flows from the expanding business to show that the
business is doing properly as expected.
|
IP Logged |
|
|
basant
Admin Group
Joined: 01/Jan/2006
Location: India
Online Status: Offline
Posts: 18403
|
Posted: 15/Jul/2009 at 9:11pm |
As long as there is growth these things do not matter but the moment the external environement stands to get toughthe negative cash flow starts to pinch.
To em if I am buying a non growth stock negative cash flow is something that I would keep in mind but not excessively base my buy decision on.
Originally posted by valuepicks
Originally posted by basant
Cash flow negative does not mean that a company is in a loss. It just shows that expansion is being funded by external borrowings or by fresh
equity. |
I can only infer that by retaining profits as reserves, they* are attaining higher leverage and hence borrow or infuse additional capital at amounts that is otherwise not possible. Not bad economics, i feel, as businesses have benefits of deducing interest before paying taxes.
So, negative cashflow need not be interpreted as 'negative'... did I infer it right?
* refers to companies with negative cashflows. |
|
'The Thoughtful Investor: A Journey to Financial Freedom Through Stock Market Investing' - A Book on Equity Investing especially for Indian Investors. Book your copy now: www.thethoughtfulinvestor.in
|
IP Logged |
|
|
subu76
Senior Member
Joined: 25/Feb/2008
Online Status: Offline
Posts: 5709
|
Posted: 15/Jul/2009 at 11:59pm |
One more observation on Free cash flow...
Generating free cash flow is very very tough.
Recently i studied the 4 year track record of about 140 odd companies in random order and found that less than 1/4 of these generate decent amount of free cash on an aggregate.
As one would expect the companies with the a lot of free cash from operations gave out a lot of dividends and had negligible debts.
Not all of them were hyper growers, they were stable entities and the highest free cash flow generators have some sort of brand or competitive advantage.
And these 4 years were really great years for the industry.
Edited by subu76 - 15/Jul/2009 at 12:02pm
|
IP Logged |
|
|
subu76
Senior Member
Joined: 25/Feb/2008
Online Status: Offline
Posts: 5709
|
Posted: 20/Jul/2009 at 6:18pm |
During a bull market, analysts will come up with all sorts of theories to justify valuations (e.g. Land holding value).
1. One of the strangest ones i came across was for biotech companies in mid 90s.
It was called cash burn. The rate of spending on research projects...the more the better a company's future is.
2. In 2000 we had "eyeba*ls" theory to justify internet valuations.
Edited by subu76 - 20/Jul/2009 at 6:20pm
|
IP Logged |
|
|
Hitesh Shah
Senior Member
Joined: 12/Oct/2008
Online Status: Offline
Posts: 3656
|
Posted: 20/Jul/2009 at 6:33pm |
Originally posted by subu76
During a bull market, analysts will come up with all sorts of theories to justify valuations (e.g. Land holding value).
1. One of the strangest ones i came across was for biotech companies in mid 90s.
It was called cash burn. The rate of spending on research projects...the more the better a company's future is.
2. In 2000 we had "eyeba*ls" theory to justify internet valuations.
|
Subu, the point is that we (meaning I, me, myself and the resident tapeworm) bought into these stories
|
IP Logged |
|
|