Is This Cash Flow Positive Oil and Gas Company A Buy?

“Cash, though, is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent. When bills come due, only cash is legal tender. Don’t leave home without it.”

— Warren Buffett

As we search for positive signs in a new company, the cash flowing through the firm may be one thing worth looking up. In particular, the cash conversion cycle of a company may be of interest to the Foolish investor.

Turning goods into cash

Simply said, the cash conversion cycle is the number of days it takes for a company to 1) convert cash in the bank into inventory, 2) sell that inventory, and 3) receive the cash from the sale. The shorter the cycle goes, the better.

To learn how to calculate the cash conversion cycle, go here.

Let’s run MTQ Corporation Limited (SGX: M05), a player in the oil and gas equipment and services sector, through this calculation today. We will be using figures from the financial year ended 31 March 2014 in this case.

We start with the Days Inventory Outstanding (DIO) metric. DIO is the number of days that it takes for a company to sell its entire inventory. Generally speaking, the lower the number of days, the more effective the company’s inventory management is.

Below is a summary table with all the relevant figures.

2014 MTQ DIO

Source: MTQ Corporation’s earnings report

Next up, we have the Days Sales Outstanding (DSO) figure. DSO represents the amount of time it takes the company, on average, to receive money after it has sold a good or service. Having a lower DSO usually indicates that a company is good at credit management.

2014 MTQ DSO

Source: MTQ Corporation’s earnings report

Finally, we come to the Days Payable Outstanding (DPO), which is the number of days it takes a company to pay its suppliers after their products have arrived. In general, having a longer payment term is better for a company.

2014 MTQ DPO

Source: MTQ Corporation’s earnings report

Pulling it together

The cash conversion cycle can now be put together by adding the DIO with DSO and subtracting the DPO. Doing so would give MTQ a cash conversion cycle of 55 days for the financial year ended 31 March 2014 (51 + 90 – 86 = 55).

In the case of MTQ Corporation, the company maintained a DIO of 51 days. This was due to the sizable inventory position that the oil and gas equipment and services provider maintains on its balance sheet. With the DSO and DPO almost even, the DIO proved to be the main contributor to the 55 days in the cash conversion cycle.

In all, the cash conversion cycle of 55 days would mean that the business of MTQ Corporation would require working capital to finance.

MTQ Corporation had generated $10.9 million in free cash flow for the first nine months of the financial year ending 31 March 2015. The company also had about $44 million in cash and equivalents, and $62 million in borrowings. With a less than promising cash to debt ratio, we may want to keep an eye on the firm’s balance sheet and cash flow, moving forward.

Over time, tracking the changes in the cash conversion cycle of a company may help the Foolish investor understand the business changes that the company makes and whether those changes helps bring in the cash faster.

With that, the Foolish investor would be in a better position to decide if MTQ Corporation’s current share price provides an appropriate margin of safety and whether it fits into his or her portfolio.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.