A Cash Flow Analysis of Weatherford International plc Stock

Warren Buffett loves companies that generate cash -- loads and loads of cash. Throughout his entire career as an investor he has consistently sought companies that generated cash that he could then use to buy other cash generating companies. While we can't all be Warren Buffett, we can all use his affinity for finding superior cash generating companies as a model for our own stock buying purposes. So today, let's take a look at Weatherford International (NYSE: WFT) through the lens of its cash flow and see if it's Warren Buffett-worthy.

You can't hide from cash flow
You could argue that the cash flow statement of a company is way more important than the income statement, even though we seem to focus so much attention to the income statement with metrics like earnings and EBITDA. The reason that cash flow is a better indicator is because it tells us much more about what is going on with a company, and accountants can't massage the numbers like they can with net income. Besides, we all know what cash looks like, so it gives us a much more tangible means of understanding a company.

There are three key things to look at when analyzing cash flows: Quality, efficiency, and value. So here is what Weatherford looks like compared to its peers.

Quality
Generating free cash flow is great, but certain kinds of free cash flow are better than others. To generate free cash flow, a company can either get it from continuing operations or selling assets. Obviously, we want to see our investments generating cash from continuing operations instead of juicing numbers with asset sales. A rough gauge of cash flow quality is to divide the company's operational cash flow by its capital expenditures. At a minimum we would like to see 100% operational cash coverage, but the bigger the better. Also, be sure to look at this number on an annualized basis as to not be affected by quarterly discrepancies.

Source: S&P Cap IQ

When compared to its peers, Weatherford doesn't look as promising when it comes to generating organic free cash flow. One of the reasons why Weatherford's management has embarked on a major strategic change is to address this issue. By 2016 the company hopes to have sold off several segments of the business that have been not generating returns in order to boost cash flow.

Efficiency
OK, so we are off to a bad start with Weatherford, but for the sake of understanding cash flow better let's keep going. Not only is the quality of cash generation important, but also the rate at which you generate that cash. These are measured with both unlevered and levered free cash flow margins. They are both very close to each other -- free cash flow divided by total revenue -- but there is one small difference. Unlevered free cash flow margin is calculated before debt payments, so it gives a hint of how the company's assets perform at generating cash. Meanwhile, levered free cash flow includes debt payments, so it more accurately describes the actual performance you see as a shareholder. It's important to know both because the unlevered free cash flow margin can show the potential of the company as it unshackles itself from debt. 

Source: S&P Cap IQ

If a company isn't even generating enough cash from operations to cover capital expenditures, then it shouldn't be surprising that Weatherford's free cash flow margins are negative. The other component that is interesting about these numbers is that the difference between unlevered and levered free cash flow for Weatherford is much higher than its peers, which makes sense because its debt to capital ratio is considerably higher than its peers and will therefore have a higher percentage of debt obligations. 

Value
Now that we have a picture of quality, let's get down to the value of that cash generation by adding in the component of price. Most of us know what a price to earnings ratio is, but remember that earnings numbers can be finagled to look better than they really are. Another -- and potentially better -- way you can look at a company is to look at the price to levered free cash flow ratio. This is the total market capitalization of the company divided by that same levered free cash flow from above.Think of it like the price you pay for one dollar of free cash flow generated annually. 

Source: S&P Cap IQ

Weatherford doesn't actually have a price to levered free cash flow ratio because its cash flow is negative, and just like price to earnings it doesn't make sense to have a negative metric.

What a Fool believes
If there  is anything that we can gather from looking at Weatherford International's cash flow situation, it's that the company has a long way to go before it can catch up to its peers. Someone who has a speculative side may consider investing in Weatherford as a turnaround -- and considering how the company's shares have performed this year there are lots of people who fit that description. However, if you look at some of the other companies in the space, there is plenty of opportunity elsewhere that seems much safer as a long-term investment.