Hi all,
Currently doing some investment research (personal) and was wondering if I could ask for help understanding something I've read. X company is looking to have extensive FCF yield in X amount of years due to "substantial non-cash costs on the P&L that should cause free cash to exceed net income". Without getting to far into the weeds about this particular company, I was wondering if I could ask what generally these non-cash costs could be?
Thanks for your help in advance
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Generally it is a good thing to have operating cash flow higher than net income, because there's probably minimal manipulation of add-backs of non-cash expenses and/or minimal financial engineering bringing in cash - the cash is all coming straight from the company's operations.
Is X amount of years pretty far down the road? I'd guess this statement probably indicates depreciation or stock-based compensation that will be added back on the CFS to show higher operating cash flow. What industry is this company in?
Thanks for your response -
X amount of years generally refers to ~3 yrs out in the Defense industry, and FCF estimates are expected to be extensive as a result of operational improvements and unrealized gains as I understand it.
The only other large non-cash expenses I'm familiar with are D&A - do Defense companies generally see a large amount of expenditure here? If so, why?
Thanks again!
They definitely do because of the level of heavy manufacturing equipment necessary for production.
Lockheed Martin, according to their 2018 10K, doesn't book depreciation on construction-in-progress until assets are placed into operation, and they use accelerated depreciation for the first half of an asset's useful life and straight-line from there on out.
LMT's capitalized software costs also don't get amortized until the software is ready for use. Heavily depending on the timing of all of these non-cash items, a defense contractor in a similar position could certainly see operational improvements leading to increased FCF in a few years from capex being spent now or over the past few years.
This was very insightful and helpful, and I really appreciate the thought that went into your answer! In the case of a recent merger (L3Harris for example), what are non-cash expenses mostly coming from? I imagine most would be from cost efficiencies being implemented, but wouldn't those costs be cash-based rather than non-cash expenditures?
Non-cash expenses are mostly coming from D&A by a wide margin, followed by SBC, pensions, and stock plan items.
If I had to take a guess from looking at LC3's Feb 2018 10K (pre-merger) and reading a couple articles, I'd say they are working on a couple things: - Co sold several service-based businesses pre-merger and has plans to streamline more, so D&A will possibly play an even larger role by percentage in the overall add-back situation. - Debt retirement, pensions, and employee stock plans look like pretty big chunks on the CFS, and they do mention planning to curtail pension benefits to get leaner. - Milestone payments relating (possibly) to the F-35 program will be larger relative to a "resized" business segment - looks like they have found some inefficiency they are planning to remove there as well.
MD&A on their DoD budget expectations makes for an interesting read.
I can't thank you enough for your help! Definitely will look into MD&A and the milestone payments as well.
Thanks for your time!
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