Free Cash Flow Yields Are Rising

The 500 largest non-financial companies in America currently have $1.8 trillion in cash sitting on their balance sheets, and it has been debated as to the best way for those companies to spend their treasure chests. Today, we look at free cash flow yield growth between 2005 and 2009. Using five consumer goods companies from a list generated in January 2009 when yields were higher, should be able to determine what these yields tell us about each of the businesses moving forward.

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Company	Free Cash Flow Yield 2005	Free Cash Flow Yield 2009
Tempur-Pedic (NYSE:TPX)	1.5%	6.7%
Knoll (NYSE:KNL)	8.3%	8.4%
Jarden (NYSE:JAH)	11.1%	20.4%
Timberland (NYSE:TBL)	7.0%	11.8%
Revlon (NYSE:REV)	-14.6%	10.7%

Why Yields Increase
The simple answer is free cash flow has risen faster than stock prices. Now let's think about this for a minute. What is free cash flow? The funds a company doesn't need to keep operating. Once ABC Company has paid its bills and made the investments necessary to maintain its business, whatever is left over becomes discretionary spending. It can buy other companies, invest in research and development, reduce debt, repurchase shares or payout dividends.

Two things have happened in the last five years related to the level of cash on balance sheets today. The first is we've been through (and are still in) a weak economy. This has forced CEOs to conserve cash rather than aggressively pursuing any of the five choices mentioned earlier. Most companies in the past two years took major steps to control costs and, as result, profits have continued to rise. Stocks haven't kept pace. The S&P 500 was down 10.7% in the last five calendar years. With market caps dropping and free cash flow rising, yields naturally increase.

A Bad Thing
The stock screen for free cash flow yield referred to in the opening paragraph is based on the investing ideas of Bruce Berkowitz. He believes stocks with double-digit yields are superior to those without. However, there comes a time when businesses have to step off the curb and into traffic. In the January, 2009 screen, all 449 stocks in the sample had yields of 14.5% or higher. More than half were at 20% or better. It's unlikely this number is nearly as high today, but you never know because companies still aren't spending. That's bad for America and, ultimately, bad for investors. It's great to have a margin of safety during tough times, but we'll never get out of the unemployment situation we're in without businesses putting the money to work.

Interpreting the Results
Those companies in the table above that increased free cash flow between 2005-2009 had impressive gains in their yields. No more so than Jarden, the 100-plus brand machine. It continues to generate respectable growth in this economy. With just under $1 billion dollars in cash, my hope is that it reduces its $2.5 billion in debt. It doesn't need to make any more acquisitions, but knowing how it operates, it's likely there'll be more to come. At least it's spending; not everyone is. Revlon is simply righting the ship. With $1.2 billion in long-term debt and a shareholder deficit that'll take 10 years to reverse, it can afford no mistakes moving forward. On the other hand, it is making money, and does have positive free cash flow. If you're a risk taker, remember that its stock traded at $299 in June 1999. It's awfully tempting.

What can be said about Tempur-Pedic, except that it continues to find ways to grow. In its first quarter report, it grew revenues by 43%, to $254 million, and net income almost doubled to $33.1 million, thanks to its new Cloud mattress line. The sky's the limit. Things are coming around for Timberland, the New Hampshire footwear manufacturer. Its first quarter delivered revenue growth in all of its geographic locations (North America, Europe and Asia) and earnings per share were 47 cents, 19 cents better than analyst expectations. With an enterprise value less than five times EBITDA, it may be time to give this company another chance.

Lastly, Knoll has fought the good fight in an industry that's been hit hard by corporate frugality. It should bounce back, but not anytime in the immediate future. The headwinds are still strong.

The Bottom Line
A company's free cash flow yield by itself is just a number. To make use of it, you need to understand the various reasons why it's growing and what that means for the future. When you understand this, evaluating its stock becomes much easier. (Find out how a company spends its money and whether there will be any left over for investors. Check out Analyze Cash Flow The Easy Way.)

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