Cash is king, especially when it comes to investing. Companies that are cash cows have more financial flexibility to create shareholder value through dividends or share repurchase programs, to make ground-shaking acquisitions that fuel long-term growth, and to reinvest in their most promising opportunities.
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Companies with strong cash flow from operations, or CFO, may not be the fastest growing stocks on the market, but they do offer great opportunities for long-term investors to corral the power of compound interest. Investors interested in owning stable businesses with leadership positions in their respective industries should put Ecolab (NYSE: ECL), Petrobras (NYSE: PBR), and American Water Works Company (NYSE: AWK) on their investing radar.
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Slow and steady growth for the long haul
Ecolab is a great case study in the power of compound interest. The nearly $6 billion acquisition of Nalco in December 2011 transformed it into a leading water technologies company overnight. Even today, the acquisition continues to provide ample growth opportunities in industries as diverse as food and beverages, oil and gas drilling, and life sciences. Amazingly, despite relatively tame top-line growth in the years since, investors have enjoyed an explosion in CFO -- which has coincided with impressive stock gains in the past 10 years.
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Consider that in 2012, the first full year after the Nalco acquisition, revenue and cash flow from operations totaled $11.8 billion and $1.2 billion, respectively. Last year those metrics grew to $13.1 billion and $1.9 billion, respectively. While the top line has grown just 11% in that time, admittedly affected by a major slowdown in business from the energy sector, CFO has increased 58%.
How did Ecolab achieve that? By focusing on cost efficiency and high-margin opportunities across various industries. The good news for investors is that the ride should continue for the foreseeable future. Management is guiding for a 10% increase in adjusted EPS (using the midpoint) in 2017 compared with last year, and the energy segment is only just beginning to regain its footing. It may be hard to believe, but barring an economic slowdown, growth and cash generation could accelerate in 2018. That could lead to growth-driving acquisitions in critical sub-segments identified by management, such as the newly created life-sciences unit.
How do you say "cash cow" in Portuguese?
Petrobras, the state-owned oil giant from Brazil, has had a rough few years after being at the center of the political scandal that led to a major recession, the impeachment of a president, and increasing enforcement of austerity measures in South America's leading economy. The stock was rightly sold off en masse as investors worried about political, economic, and industry uncertainty, but through it all the company maintained an amazing level of operating cash flow. In fact, Petrobras now generates more cash from operations than better-known multinationals including BP, ExxonMobil, and Total SA.
The industry-leading cash flow helped the stock gain 137% in 2016, as investors gained confidence in accelerated efforts to refocus the business on core segments and clean up the balance sheet. Strong cash flow will certainly be needed for the latter -- Petrobras ended the first quarter of 2017 with an astonishing $105 billion in debt. The good news is that figure is a major improvement from the even-more-astonishing previous level of debt, which peaked at $162 billion in 2015.
So, Petrobras has high levels of debt, a relatively moderate amount of uncertainty, and is doubling-down on expensive deepwater assets. Why should this cash cow be on your radar? Well, it seems that the market is far from fairly valuing the company assuming debt reduction levels are met. It's worth about half of BP and Total SA, and one-fifth of ExxonMobil.
It also boasts the best price-to-book and EV-to-CFO ratios among the group.
It definitely has a long way to go before it can return to previous levels of profitability -- or profitability at all -- but it's the closest it has been in years. If that's coupled with a long-term focus on maintaining more reasonable debt levels, then Petrobras could become a blue-chip oil stock in due time. Then again, in Brazil, nothing seems certain at the moment.
Keeping the cash (and water) flowing
Similar to Ecolab, American Water Works Company is a poster child for the awesome power of compound interest. The stock has more than doubled the returns of the S&P 500 in the past decade when dividends are included for both, and it's also more than doubled CFO in that span. That's easy to do when your main task is to keep the water flowing to residential and industrial customers, even if year-over-year growth rarely breaks out of the mid-single digits.
The water service provider reported CFO of $1.28 billion last year, a 43% increase from 2013. Better yet, management has determined that one of the best uses of that cash is, simply, increasingly higher dividend payments. Shareholders now collect 41.5 cents per share each quarter, up sharply from quarterly payouts of $0.28 in 2013. The stock has nearly doubled in that time -- before accounting for dividends -- and the business sees no signs of stopping. It may just be one of the steadiest cash cows on the market for long-term investors.
What does it mean for investors?
As these three stocks demonstrate that cash really is king. A strong cash flow from operations can power stock gains even when a major business segment gets stuck in a multi-year rut, as Ecolab has proven by mostly outrunning woes from oil drilling. It can also power the creation of shareholder value, as demonstrated by the rapidly growing dividend from American Water Works. And sometimes, a strong cash flow is enough to buy a heavily indebted company facing political scandals the benefit of the doubt as management executes against long-term strategies.
Long story short, strong cash flows from mature businesses provide plenty of financial flexibility and stability. Knowing that, why shouldn't every portfolio own at least one cash cow?
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Maxx Chatsko has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Ecolab. The Motley Fool owns shares of ExxonMobil. The Motley Fool recommends Total. The Motley Fool has a disclosure policy.