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If you are currently a shareholder in Sterling Tools Limited (NSE:STERTOOLS), or considering investing in the stock, you need to examine how the business generates cash, and how it is reinvested. This difference directly flows down to how much the stock is worth. Operating in the industry, STERTOOLS is currently valued at ₹10b. Today we will examine STERTOOLS’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.
View our latest analysis for Sterling Tools
What is free cash flow?
Sterling Tools’s free cash flow (FCF) is the level of cash flow the business generates from its operational activities, after it reinvests in the company as capital expenditure. This type of expense is needed for Sterling Tools to continue to grow, or at least, maintain its current operations.
There are two methods I will use to evaluate the quality of Sterling Tools’s FCF: firstly, I will measure its FCF yield relative to the market index yield; secondly, I will examine whether its operating cash flow will continue to grow into the future, which will give us a sense of sustainability.
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
Sterling Tools’s yield of 1.85% 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 Sterling Tools but are not being adequately rewarded for doing so.
What’s the cash flow outlook for Sterling Tools?
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 STERTOOLS’s expected operating cash flows. In the next couple of years, the company is expected to grow its cash from operations at a double-digit rate of 96%, ramping up from its current levels of ₹500m to ₹980m in three years’ time. Although this seems impressive, breaking down into year-on-year growth rates, STERTOOLS’s operating cash flow growth is expected to decline from a rate of 34% in the upcoming year, to 22% by the end of the third year. But the overall future outlook seems buoyant if STERTOOLS can maintain its levels of capital expenditure as well.
Next Steps:
Although its positive operating cash flow, and high future growth, is appealing, the low free cash flow yield is unattractive. This is because you would be better compensated in terms of cash yield, by investing in the market index, as well as take on lower diversification risk. However, cash is only one aspect of investing. Now you know to keep cash flows in mind, I recommend you continue to research Sterling Tools to get a better picture of the company by looking at: