Spindex Industries

[D123]

Spindex has been churning out solid positive FCF year after year

Can you explain how you calculate your FCF?
I calculate it for Spindex as:

reported net cash flow from operations - purchase of PPE = FCF

So for FY 2012, the number would be

FCF = 9,520 - 4,816 = S$4,704k

By this calculation, Spindex would have had negative FCF in 2011, 2005, 2000, 1999 and 1998. I might be wrong, but I'm curious about how you calculate your FCF.

[dydx]

Can you explain how you calculate your FCF?

Taking a business owner's perspective, I would simply compute FCF on a aftertax basis but before accounting for capex (which I look upon as discretionary by the management in the short-term, and could cover both replacement and/or expansion/up-grading purposes) as: NP (i.e. aftertax income) + depreciation/amortization on fixed and intangible assets +/- other relevant one-off non-cash items +/- forex gain/loss (which is not what the management can really effectively control).

In Spindex's case, based on the above simple formulae, the resultant FCF number is always positive, as the group has recorded a positive NP practically every year plus having a fairly consistent yearly accounting depreciation/amortization charge. And invariably the resultant FCF number every year is bigger than the capex incurred - i.e. the business has been generating enough FCF every year to more than fund its recurrent capex, and with some extra cash left that is added to the net cash reserve balance at the end of the year.

[Musicwhiz]

Taking a business owner's perspective, I would simply compute FCF on a aftertax basis but before accounting for capex (which I look upon as discretionary by the management in the short-term, and could cover both replacement and/or expansion/up-grading purposes) as: NP (i.e. aftertax income) + depreciation/amortization on fixed and intangible assets +/- other relevant one-off non-cash items +/- forex gain/loss (which is not what the management can really effectively control).

I feel the above formula is an over-simplification of the Free Cash Flow formula. What you have stated accounts for the non-cash portions in terms of depreciation/amortization and one-off non cash items such as write-offs, impairments and obsolescence but it does not account for:-

1) Working Capital Changes - While it is true that these tend to reverse themselves out over time, one must also be aware that a consistent build up of receivables, for example, may be a growing sign of potential future provision/impairment. Shortening AP days may also signal tighter credit terms extended by suppliers, so I would not completely ignore working capital changes in computing FCF because they do have a bearing on it and give some indication of the quality of the business.

2) Capital Expenditures - As owners of a business, one has to figure out the baseline maintenance capex required for a business, which is the amount spent to ensure machines are in working order and your vehicles can run properly! Expansionary capex, on the other hand, are one-off by nature and would include M&A activities and capex over and above R&M, it usually includes significant upgrades or replacement of existing assets which are not in the ordinary course of business. Hence, one should less of the maintenance capex to derive the true FCF.

I haven't computed it for Spindex, but just typing out my understanding of FCF and how it should be computed.

Regards.

[dydx]

I haven't computed it for Spindex, but just typing out my understanding of FCF and how it should be computed.

I urge you as someone trained in business analysis and accounting to first size up Spindex's business and risks and then run the group's recent numbers, and add your comments afterwards based on the case and as an investor. I guess general discussions that are too academic-oriented would be better off in a class-room.

[Musicwhiz]

I urge you as someone trained in business analysis and accounting to first size up Spindex's business and risks and then run the group's recent numbers, and add your comments afterwards based on the case and as an investor. I guess general discussions that are too academic-oriented would be better off in a class-room.

Sure thing! I was commenting based on my understanding as an investor, and I've used the FCF formula quite a few times when doing business analysis. To do a thorough analysis of Spindex (or any company, for that matter) would require considerable amounts of time, and it would not only include the numbers/ratios but also qualitative aspects such as industry characteristics, 5-Forces, SWOT, Corporate Governance among other things. Sad to say, I may not have the time for this as I am rather engaged in my job and family.

But I will definitely revisit Spindex again if I have the opportunity and time.

One last point I wish to make is that though such discussions may be "academic" in nature, nevertheless theory and formulae are very important in formulating an opinion of a Company, as by computing such numbers correctly and accurately one can immediately get a sense of whether a Company is worth further research or not.

Regards, and have a great week!

[psolhawk]

I agree that capex should not be disregarded in the computation of FCF. To me, that's kind of like manipulation of solid facts to suit your perception of Spindex as a consistent FCF generating machine. To advise buddies here to "first size up ... business and risks and then run the group's recent numbers" is akin to putting in your opinions first, AND inadvertently those opinions WILL somewhat shape our perception of the numbers. Isn't it? To the extent of leaving out capex consistently.

Because the qualitative part in assessing a company is already subjective, all of us will want to seek a common ground on the quantitative aspect at least. and we then read the numbers in conjunction with the attitude/behaviour of the management.

I suspect the better advice here will be "hey, management is good and capable, company is undervalued, it generates solid FCF BUT in a little bumpy manner which are best seen as glitches'.

[Drizzt]

hmm, why is it that capex is not added in? I thought for all businesses (even reits) there is some form of maintenance ultimately we are looking at it as a lukewarm business environment how should cash flow fare. does that mean eBITDA is always a better measure and since we don't always know how much capex is for maintenance?

[dydx]

If I may just first repeat my earlier post (#52) below in bold -

"Taking a business owner's perspective, I would simply compute FCF on a aftertax basis but before accounting for capex (which I look upon as discretionary by the management in the short-term, and could cover both replacement and/or expansion/up-grading purposes) as: NP (i.e. aftertax income) + depreciation/amortization on fixed and intangible assets +/- other relevant one-off non-cash items +/- forex gain/loss (which is not what the management can really effectively control).

In Spindex's case, based on the above simple formulae, the resultant FCF number is always positive, as the group has recorded a positive NP practically every year plus having a fairly consistent yearly accounting depreciation/amortization charge. And invariably the resultant FCF number every year is bigger than the capex incurred - i.e. the business has been generating enough FCF every year to more than fund its recurrent capex, and with some extra cash left that is added to the net cash reserve balance at the end of the year."

Let me be very clear, I would use the above "Simple Formulae" which allows me to very quickly estimate/compute the "raw" FCF of a company/bsiness in a particular FY - and I prefer to have it on an aftertax basis (because I wish to be conservative as a business-owner and expect the business to pay income taxes even in a year where the accounting profit, as computed by the accountants, may be a negative number), before capex (because capex in a particular FY or even in the short-term can be a discretionary item or decision by the management, and it usually includes both "for maintenance" and "for capacity expansion and technolology up-grading" purposes, and unless the details are provided it is difficult for me to split it between the 2 parts by simply applying an arbitrary judgement), before changes in WC items (because I do not wish the timing differences and related impact of such WC items towards and on the cut-off dates of the FY, to cloud the actual CF generated from the "profit" generated from the business operation), before any other revenue or expense items and accounting adjustments which I consider as "one-off" (because I wish my key focus is to arrive at a close and reliable estimate of the "recurrent" net cash generated by the actual underlying business that is staying, and excluding those parts that are peripheral, or have been or are being sold), and before forex gain/loss and other similar or related accounting adjustments linked to the financial markets (because I look at them and forex impact on the underlying business as something not within the control of the management). To me, such a resultant "raw" FCF estimate is as close to actual amount of cash the business-owner can expect for himself from the actual underlying operating business operation in a FY which goes into his own pocket or bank account. If I choose to compute the same "raw" FCF estimate for a few FYs, I should get a fairly reliable basis for both the strength and quantum of the recurrent cash generation capacity of the underlying business from a business-owner perspective.

As for the capex part, I would look at it after the "raw" FCF, just like what a simple-minded business-owner would normally do after counting his profit and money in the pocket or bank-account. If the recurrent capex - like in Spindex's case - is relatively higher because a portion of the total production machines needs to be replaced every year, I would simply adjust and apply a smaller multiple on the "raw" FCF when I do my actual valuation of the underlying business. And in Spindex's case, I said earlier being ultra-conservative, I would use a multiple of only 4x.

And normally I would only compute the "raw" FCF and run the other numbers if and after I can understand and am happy with the key basics of the underlying business, including its market reputation, the quality aspects of the customer base and top management, the acceptability of the underlying business risks, and staying within my own circle of competence. I find it far better and more effective to do the number crunching only after the qualitative assessment of the business basics!

The above is more or less my own approach as an investment practitioner. And I suppose - and hope - readers should know now why I dislike too much academic-oriented discussions!

[freedom]

I believe what dydx talked about is EBITDA instead of fcf. Why not just use EBITDA instead to avoid the confusion.

[CityFarmer]

Wow, since i am the one started it, let me put up my view here.

Standard definition of FCF is to ensure we have a common language, but it should not restrict individual to twist it to suit his/her own analysis, but he/she should highlighted that in discussion.

Dydx highlighted that "aftertax FCF (before capex)" in his early posting. I had no issue to understand, and i believe there was no mis-understanding in our discussion, although i might not agree with his reason for exclusion of capex, and other items

IMO, the capex for Spindex should be included. Base on the last 5 years record, the capex should be taken as maintenance of biz