As all Fools know, mature companies operating in mature markets tend to have strong cash flow.
One reason for this is that, having been around for quite some time, there is not a vast amount of growth on offer, so the company tends to limit how much of its operating cash flow it reinvests back into the business in the form of capital expenditure.
Furthermore, mature companies tend to be highly profitable, since they have generally emerged as a ‘top dog’ after years of industry consolidation.
Indeed, BP (LSE: BP) (NYSE: BP.US) remains a major player in the energy industry and has a free cash flow yield of 5.4%. This is an impressive figure, given the difficulties that the company continues to face after the Deepwater Horizon tragedy of 2010.
In fact, free cash flow has been strong in each of the last three years – highlighting the fact that 2012 was not a one-off. In my view, a free cash flow yield of 5.4% is overly generous and, for instance, if it fell to 4.75% (roughly in-line with BP’s yield) then it could mean shares rise by just over 13%, to around 550p.
Of course, I’m not suggesting this would happen overnight, but it looks to me as though there could still be some value left in BP over the medium to long term.
A reason for this potential value could be the positive steps made by management in recent months. Indeed, they seem to have shifted from being completely on the back foot with regard to compensation for the oil spill and asset sales, to being somewhat on the front foot and, certainly, far more decisive and clear about their strategy.
One facet of this strategy is the potential return to shareholders of more cash in future years. As discussed, it appears as though BP has the free cash flow to do so and such a strategy may have the effect of improving sentiment among market participants too.
So, BP’s shares appear to still offer good value for medium to long term investors, with the company’s free cash flow yield being impressive and management strategy being encouraging.
