Quiet Compounders and a Hidden Moat at an 18% FCF Yield
A high margin, high ROIC business with a hidden moat for 5.5 P/FCF that is buying back shares.
Consider the following:
A durable, mature company that trades at 5x FCF
The FCF is stable but will never grow (0% growth forever)
The P/FCF never moves higher (it will always stay at 5x)
The result of this stock is it will return 20% annually forever.
This is despite a company that has no growth and will never have multiple expansion.
In effect, this scenario creates a compounder very similar to a classic reinvestment engine, but instead of reinvesting into new stores or in growing organically, it is buying more of itself (via buying back stock). Think about two businesses: one earns 20% ROIC and reinvests all earnings; the other has 0% growth but stable FCF and trades at 5x FCF. As long as these fundamentals remain, both companies will grow earnings per share at the same 20% annual growth rate.
Of course, the latter is only possible if the stock remains at 5x FCF, but if the valuation rises, you are pulling forward returns into a shorter period of time (not a bad result). This potential for multiple expansion is an added bonus that the cheap cash cow has and the classic growth stock often lacks.
But, the real beauty of this 20% FCF yield setup that I think is underappreciated by investors and management teams alike is this: you don’t need to care about what the market thinks about your stock. You control your destiny. The multiple doesn’t need to move higher if the stock is that cheap. The share price will rise at 20% per year if the valuation stays at 5x FCF, the FCF is stable, and the FCF is used to buy back shares.
This is very simple math, but I’ve noticed that many management teams focus too much on how to “get the story out”. The cheap stock is not a problem, but in fact is a gift horse.
Ben Graham said that the market is there to serve us, not to be its master. Fortunately, there are some great businesses with management teams who understand this: Natural Resource Partners (NRP), Medical Facilities (MFCSF) and First Citizens (FCNCA) are three examples that come to mind that briefly traded at this level at points in the last few years.
Today’s post will highlight another current example of a stock with a 18% FCF yield that has a surprisingly strong and underappreciated moat (hence the discount). This business has 25% operating margins, over 30% ROIC and a dominant position in their market.
My pitch to Cinemark in 2023 when they traded at 5x FCF was the following: if you reduce your share count by half and the multiple doubles, the stock returns 4x. And reducing share count in half is possible over 5 years or so when the stock is that cheap.
Cinemark didn’t take full advantage, but today’s subject company has these valuation ingredients with the added bonus that the company is run by a capital allocator that understands this setup and plans to return all the free cash flow to shareholders, mostly via buybacks…