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3 stocks set for strong cash-flow growth

Nicholas Grove  |  21 Jun 2016Text size  Decrease  Increase  |  
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Cash flow is ultimately what matters to investors, UBS points out in a recent report.

The investment firm believes a focus on free cash flow yield and free cash flow growth is particularly interesting at present given the market's preoccupation with dividend yields against a backdrop of low competing interest rates.

"Companies that can grow their free cash flow and subsequently reward shareholders with higher dividends, buybacks or shareholder-value-creating acquisitions should ultimately perform well," UBS says.

"Companies trading on seemingly attractive dividend yields (that in some cases exceed free cash flow) may not in all cases be able to grow these dividends, or worse still, may not be able to maintain them."

With this in mind, UBS re-examined its equity free cash flow measure as a comparison to both earnings and dividend-based measures of valuation and growth potential for individual stocks.

"In simple terms, the key difference between free cash flow and earnings per share is to replace the standard depreciation charge with capex and also include movements in working capital," the firm says.

"This post-interest cash flow should produce an estimate of the free cash flow available to pay dividends, buy back shares, retire debt principle, or contribute toward acquisitions."

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Among UBS's findings, there are several ASX 100 stocks with Morningstar Moat Ratings that are expected to generate high levels of free cash flow growth from fiscal 2016 through to fiscal 2018.

1) Incitec Pivot

Incitec Pivot (ASX: IPL) is a leading global explosives company, and a manufacturer and distributor of fertiliser in Australia.

Morningstar senior equities analyst Mark Taylor believes the source of Incitec Pivot's narrow economic moat is the efficient scale within its Dyno Nobel explosives business.

"Dyno Nobel is a leading global explosives company and benefits from strong technical expertise, global scale and solid share of a consolidated market," he says.

"We estimate global market share of the commercial explosives market at about 15 per cent."

In Australia, Taylor says Incitec Pivot operates in what is effectively a rational duopoly and that it is the second-largest explosives business behind Orica (ASX: ORI).

2) Iluka Resources

The narrow-moat-rated Iluka Resources (ASX: ILU) is a large player in the relatively small zircon and titanium minerals markets, according to Mathew Hodge, Morningstar's sector lead of basic materials, energy and utilities.

Hodge believes the primary source of competitive advantage for Iluka, like any mining company, is low-cost production.

"Iluka's margins are strong relative to the industry, due to high-grade deposits weighted to higher-value products--zircon and rutile," he says.

"Reserve life is shorter than we would like at around 10 years, but the resource base is significantly larger and sufficient to satisfy several decades of production.

"The company has a history of converting resources to reserves by drilling out, advancing and developing new deposits close to existing processing infrastructure. We expect this to continue."

3) Crown Resorts

Morningstar equities analyst Ravi Reddy describes Crown Resorts (ASX: CWN) as a "distinctive company offering both a defensive earnings quality and an attractive growth profile".

"We believe Crown Resorts benefits from a narrow economic moat. Each of Crown Resorts' properties enjoys a privileged position, with a long-term casino operating licence from the relevant state government (expiring in 2050 for Crown Melbourne and 2060 for Crown Perth)," Reddy says.

"This licensing regime creates an onerous barrier to entry--an intangible quality that underpins its economic moat.

"Furthermore, management has a consistent track record of reinvestment, resulting in a scale that is sufficiently large to deter new entrants in the very unlikely event that governments decide to issue more licences in Crown Resorts' markets."

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Nicholas Grove is a Morningstar journalist.

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© 2022 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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