Companies With Consistent Growth in Generating Free Cash Flow

Although financial ratios and other factors are often considered to reflect the current earning potential while investing, can they also predict future prospects? This is where free cash flow of a company assumes importance. Mandar Wagh explains the concept of free cash flow, the benefits it delivers to the company, and why it is critical for investors to consider. Also, check out the leading companies that are consistently growing their free cash flow 

Interested in stock investing? If you answered yes and were asked what factors you would examine while investing in stocks, the most typical responses would surely be financial performance, return and valuation ratios, among others. Price-to-earnings (PE) and priceto- book value (PB) ratios are two valuation factors that any investor may consider. While they both reflect current earning potential, neither of these valuation metrics indicates future prospects. And here is where ‘free cash flow’ is important! Free cash flow takes into account the company’s earnings as well as historical (depreciation) and present capital expenditures, capital inflows and working capital investments.  [EasyDNNnews:PaidContentStart]

The following story will help you in comprehending the concept of free cash flows, its method of calculation, the benefits it brings for the company, as well as why it is crucial for investors to take these into account. We will also focus on the top companies that have consistently generated free cash flow year-on-year, demonstrating excellent growth. Let’s start by understanding the concept. The cash a company has, after taking into account the cash payouts required to run its operations and to sustain its capital assets, is known as free cash flow (FCF). 

A portion of a company’s cash flow can be withdrawn and given to creditors and investors without having an adverse effect on operations. The more the free cash flows, the better for the company. It represents the surplus cash that is readily available for value generation, expansion and rewarding stakeholders. The capability of a company to make a healthy profit serves as an asset for presenting an optimistic perspective to its stakeholders. And hence, while evaluating a business’s sustainability and growth potential, analysts and stakeholders always assess the company’s free cash flow position.
 

Calculating the Free Cash Flow

Free cash flows can be calculated by subtracting capital expenditures from cash from operations. The amount of funds that a company makes from its regular and core business operations including the production and sale of goods or the offering of services are known as cash from operations. A company uses capital expenditures as a means of financing the purchase, maintenance and improvement of tangible assets like land, buildings, machinery and other physical assets. Companies make such kinds of financial expenses to strengthen the scope of their operations or to add some potential economic value. The income statement and balancesheet can also be used to calculate it. It is possible to construct the formula as net income plus non-cash expenses minus increase in working capital minus capital expenditures.
 

Advantages of Free Cash Flow

There are certain specific advantages of free cash flow such as:n Evaluation of Financial Health — It offers useful insights into a company’s financial health and its capacity to produce cash from its core business operations. It assists to determine a company’s profitability and liquidity position in addition to serving as an indicator of its financial stability. 

◼ Competitive Advantage — Generation of robust and consistent free cash flow offers a competitive edge by allowing a company to survive economic crises, engage further in research and development and capitalise on strategic opportunities that may come up. 

◼ Flexibility in Decision-Making — A company’s ability to utilise free cash flow for a variety of purposes, including investing in research, expanding operations into new markets, acquiring other businesses or reinvesting, share buybacks and other uses, provides it with flexibility in its strategic decision-making.

◼ Better Control — By self-funding the investments, a company can boost profitability, maintain better control over its operations and lessen its reliance on external financing if it has enough cash on reserve.

◼ Repayment of Debts — A company’s debt burden can be reduced by using free cash flow. A business can strengthen its financial stability, lower interest costs and improve creditworthiness by paying off debts. A reduced cost of capital as well as greater investor optimism can result from lower debt levels.

◼ Payment of dividend — A company is able to pay dividends to its shareholders if it has a positive free cash flow. Dividends offer a direct return on investment and may appeal to income-seeking investors looking for regular cash dividends. 

Overall, free cash flow is a crucial indicator that allows analysts, investors and companies to track financial performance, make well-informed decisions and effectively utilise money. However, a healthy free cash flow doesn’t always indicate compulsory growth or gains for a company’s stock as it is possible for the stock to perform adversely for a variety of reasons. It is simply regarded as one of the most important techniques an investor can utilise to evaluate the company.

Companies with Growth in FCF Generation

We have selected BSE 500 companies in order to identify those companies that have consistently posted growth in free cash flow generation over time. The free cash flows of all companies during the previous five years were initially calculated, and only those companies that had positive year-on-year growth over the five-year period were shortlisted. A number of companies have displayed outstanding year-on-year growth, and five of them have had compound annual growth rates (CAGR) of more than 100 per cent over the past five years. 

Apollo Tyres topped the list with a CAGR of 224 per cent, impressing investors who look for free cash flow as a measure of financial strength. Apollo Tyres has grown to become one of the top tyre manufacturers in the industry. The company is a renowned tyre manufacturer in India and has a strong presence abroad. Through a broad network of more than 7,200 dealers in India and 7,000 dealers in Europe and seven manufacturing facilities spread out over Europe and India, it provides topnotch goods and services in more than 100 countries. In its investor presentation, the company stated that despite a challenging economic and demand environment, operating performance had significantly improved. 

It further stated that despite a reduction in input costs, it was still able to sustain the price advantage in the replacement category gained in the previous few quarters. In the short term, maintaining pricing positioning and promoting mix improvement would be the major priorities. According to reports, the company’s net debt also decreased. Power Grid Corporation of India is a Government of India Schedule ‘A’, Maharatna public sector enterprise. Since 1993-94, it has been continually rated ‘excellent’ under a Memorandum of Understanding with the Ministry of Power. The business dominates national transmission and operates roughly 86 per cent of inter-regional networks. The key business divisions are power transmission, telecom and consulting. The company has a track record of consistently delivering excellent operational performance. 

According to the most recent investor presentation, the company has ₹ 50,000 crore work-in-hands and has ₹ 8,800 crore in capital expenditures planned for FY24. Some of the key drivers of the company’s growth outlook are solar generation, smart metering, the data centre business and international transmission projects in the developer mode. In terms of free cash flow generation, Ircon International, L and T Finance Holdings and Happiest Minds Technologies had a remarkable CAGR rise. Three Tata Group companies including Tata Communications, Tata Elxsi and Tata Consultancy Services managed to rank among the top businesses that have consistently shown growth in free cash flow creation over time. 

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