Amazon free cash flow – an update

Last year we published an article about the calculation of free cash flow and the alternative approaches used by Amazon. That original article is still very relevant; recent accounting changes have prompted us to publish an update.

New accounting rules effective in 2019 change and improve the data available to you when making the adjustments we advocate. We explain these changes, provide updated free cash flow measures for Amazon based upon their 2019 financial statements, and consider the relevance of maintenance and growth capex in the analysis of free cash flow.

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In search of free cash flow – Amazon

Amazon provides investors with three alternative calculations of a free cash flow metric. For 2018 these range from $8.4bn to $19.4bn. In contrast our preferred approach gives a negative free cash flow of $3.4bn. What explains these material differences?

The disclosures by Amazon about its free cash flow measures are good and the calculations go further than many other companies. However, in our view important components are missing. We explain our additional adjustments in respect of leased assets and stock-based compensation.

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DCF valuation models: Have you updated for IFRS 16?

An accounting change, such as the introduction of IFRS 16, does not in itself alter underlying economics. It follows that equity values derived from DCF models should also be unaffected. However, the IFRS 16 lease accounting changes seem to be creating some confusion.

We explain how to correctly adjust your DCF calculations and provide an interactive pre and post lease capitalisation model to illustrate. IFRS 16 makes DCF analysis easier and less prone to error; leaving your model based on pre-IFRS 16 figures is definitely not the best approach.

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Leasing – Are you prepared for IFRS 16?

EBITDA up, EBIT up, EPS? … well it depends. The impact of lease capitalisation under IFRS 16 on key company metrics in 2019 is complex and depends on several variables, including transition options chosen by companies.

We highlight what you should look out for and present a simple interactive model to help you understand the effects of IFRS 16 on profitability, growth rates, return on capital and leverage.

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Leasing and leverage – credit rating agencies disagree

Rating agency Fitch recently announced its approach to dealing with the new lease accounting in its credit metrics. Their approach is at odds with that already published by Moody’s and Standard & Poor’s. Of particular interest is the way the rating agencies deal with the differences between IFRS and US GAAP.

We explain the different approaches of the rating agencies, how we think investors should calculate key metrics, such as leverage and cash flow, and the importance of considering the impact of leasing on operating leverage and business flexibility.

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Beware the IFRS 16 inflation headwind – Tesco

The capitalised lease liability of an inflation-linked lease does not include expected inflation. This results in a lower liability and lower initial expense compared with an equivalent lease with no inflation link. The IFRS 16 figures are updated as the inflation uplift occurs, but these catch-up adjustments create a profit ‘headwind’.

We estimate that Tesco’s inflation-linked leases result in a pre-tax profit headwind of about 2.2 percentage points of growth.  If inflation were included in the measurement of the lease liability instead, we estimate it would increase from the reported £10.3bn to approximately £15.2bn.

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Leasing transition options – Air France KLM

In 2019 you will see a significant change in the financial statements of many companies due to the adoption of IFRS 16 on lease accounting. In addition to understanding the new accounting, it is also important that investors are aware of the transition options selected by companies and their impact.

We explain how IFRS 16 transition works and the impact transition options will have on key metrics. Early adopter Air France KLM has already selected the full retrospective approach; we examine some of the effects on its financial statements.

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When cash flows should include ‘non-cash flows’

The problem with cash flow statements is that they only include cash flows. This may seem odd, given that the purpose of cash flow statements is simply to report cash movements. However, most cash flow analysis is focused on sub-totals and it is here that offsetting flows arising from non-cash transactions become important.

We explain why we believe adjustments to cash flow sub-totals are required and for which transactions you should adjust.

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Operating leases: You may still need to adjust

Do you invest in both IFRS and US GAAP reporters? If so, then in recent financial statements you might have noticed differences in the accounting for leases. This could result in a significant lack of comparability in key metrics.

Both IFRS and US GAAP now better reflect the economics of leasing and so the old adjustments to capitalise operating leases are no longer necessary. Unfortunately, you now need to make other adjustments to get comparability between US and IFRS reporters. We explain the adjustments and provide an interactive model to help.

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