Gushing Cash

With a little perseverance you can get things done
Without a blind adherence that has conquered some
--Corey Hart

In a previous missive we discussed the merits of free cash flow for valuing securities. To get a feel for this concept in motion, let's take a look at a company that has been generating mammoth free cash flow, Exxon Mobil (XOM). Recall that free cash flow (FCF) equals operating cash flow (OCF) minus capital expenditures (capex).

Annual XOM Free Cash Flow ($ Billions)

Year	OCF	Capex	FCF
2002	21.3	11.4	9.8
2003	28.5	12.9	15.6
2004	40.6	12.0	28.6
2005	48.1	13.8	34.3
2006	49.3	15.5	33.8
2007	52.0	15.4	36.6

You can see that XOM's operating cash flow has increased by about 150% over the past few years. During this period, capital expenditures have increased less than 50%. As a result, free cash flow has increased nearly fourfold, reaching nearly $37 billion in 2007.

This is a remarkable level of FCF--even for enterprises in the 'sweet spot' energy space. Indeed, many favorite domestic 'go to' trading names in oil and gas production, such as Apache (APA), Devon Energy (DEV), and XTO Energy (XTO) have not been consistently FCF positive throughout this same period. While operating cash flows have increased significantly for these enterprises, capital expenditures have increased commensurately, leaving less FCF than one might expect given the favorable secular winds blowing at the backs of firms in this sector.

One of the first things that I do when examining an investment idea is to review historical FCF trends (similar to what we've done above). This exercise helps me get a toe hold on the economic value producing potential of an enterprise.

How can we use FCF info to estimate the 'fair value' of a stock? Stay tuned.

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