free cash flow, capital expenditures and tax
TRANSCRIPT
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Free Cash Flow, Capital Expenditures and Tax
By Jae Jun
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Foreword
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I wanted to add some additional points on FCF which
I brought up in analysing the Statement of Cash Flows
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before moving onto the future posts on balance and income
statements.
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If a company receives a tax deduction when employees exercise their stock options,
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does this count as cash from operating activities?
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Or if the company defers its income taxes to a later period, does this count as cash from
operations?
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I don’t think so.
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What You Will Learn
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• What is cash flow• The use of FCF• How to use CAPEX• The effect of positive FCF
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Disclosure
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I wanted to add some additional points on FCF which I brought up in the Cash Flow
Statement analysis before moving onto the future posts
on balance and income statements.
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Free Cash Flow Capital Expenditures
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The FCF is supposed to be derived from the operations of
the business.
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In the updated version of the intrinsic value spreadsheet, the
FCF number now subtracts deferred taxes and “others”.
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Capital Expenditure Adjustments
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I would say the most difficult aspect of trying to calculate
FCF is
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determining the amount of capital expenditure used to
maintain operations and
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market position versus the amount used for growth.
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A simple example would be to think of a retailer like Wal-Mart.
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In 2008, Wal-Mart spent $14.9 billion on capital expenditure.
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Of that $14.9 billion, 100% of it did not go to opening new
stores or expanding to new emerging markets.
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A certain percentage was used to maintain its current stores.
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The shelves have to be filled, maybe the plumbing needed to be fixed or the walls had to be
repainted.
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The point is to find (or estimate) how much of the
company’s capex is for maintenance which should
then be subtracted from Cash From Operations,
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whereas the capex used for growth should not be
subtracted.
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Calculating these numbers is much easier said than done.
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If you don’t feel inclined to go through so much data (like
myself),
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simply subtracting the given cap ex is an accepted and
conservative practice.
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The reason people go to such lengths to find maintenance
cap ex is to find value a majority of investors cannot
see.
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Understanding the Industry and
Company
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Positive FCF for every company is not possible. That doesn’t mean a company with
negative FCF is bad.
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Positive FCF for every company is not possible. That doesn’t mean a company with
negative FCF is bad.
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One example is the oil industry and within that industry, take a
look at Transocean (RIG).
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A cyclical industry and high cap ex business, yet it’s able to
throw off huge amounts of FCF.
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Transocean and most oil drilling companies forego FCF
in the short term to create immense shareholder value in
the future.
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Conclusion
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Cash is a fact but there are lots of items which can be left out
or moved to another section of the statements.
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Stick with the cash that comes from operations rather than
one time occurrences.
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Going the full length to find the real maintenance cap ex will
give you more investment opportunities.
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It’s always a good idea to understand the business’s
cash strategy.
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Old School ValueJae Jun ([email protected])
http://www.oldschoolvalue.comOld School Value improves your
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valuation for you. Just like a personal stock analyst.