Free Cash Flow Is Key to Business Survival, and It’s Why I Like These 2 Stocks

I have learned many things running my own small business over the last decade and a half. One of the most critical is the importance of these three words — free cash flow — to the success of any endeavor. If your entity consistently can produce free cash flow, it likely will survive. If it can’t, it will join the myriad enterprises that shut down every year.

I have applied this lesson to my foray into real estate investing successfully as well. And outside of the staple of small biotech developmental companies in my portfolio — where, by their very nature, cash flow is going out the door as they develop their pipelines — I try to ensure most of the rest of my portfolio consists of entities that are delivering a decent free cash flow. I believe cash flow is of considerable importance right now given the myriad challenges the economy is facing and with a probable recession on the horizon in 2023.

Let’s look at a couple names that are producing solid cash flow and look undervalued even in this uncertain market.

I’ll start with GXO Logistics (GXO) , the largest pure-play contract logistics provider in the world. It offers warehousing, distribution and order fulfillment across more than 950 facilities encompassing about 200 million square feet.

GXO operates on an asset-light model, owning only seven of its warehouses. The balance either are leased by GXO or owned or leased by its customers, which comprise top companies in verticals such as omnichannel retail, food and beverage, technology and electronics, industrial and manufacturing, and consumer packaged goods. Its leases typically match multi-year (usually five to seven years) customer contracts with inflation pass-throughs and minimum volume guarantees.

Capital outlays are concentrated on technology such as robotics to improve labor productivity, warehouse management, inventory management, demand forecasting and automation. GXO stock has been cut in half over the past year on concerns around Europe, where it derives more than half of its overall revenue and consequently faces foreign exchange challenges. However, GXO has beaten expectations with all three quarterly reports in 2022. GXO had $116 million of cash flow from operations in the third quarter. The stock has a market capitalization of $5.2 billion and currently trades at an enterprise value/fiscal 2023 estimated adjusted EBITDA of 7. I established a new position in GXO this week via covered call orders.

I also added to my core holdings in mid-cap oncology name Exelixis (EXEL) this week. The stock is trading near the bottom of its long-term trading range.

While Exelixis stock has gone nowhere for years, the equity has been a great “rinse, wash, and repeat” covered call candidate at these levels. Of the stock’s $5.3 billion in market cap, just over $2 billion is represented by the net cash on its balance sheet. Equating for that, the shares go for 2x revenue with sales growth in the low teens. Cash flow has increased the company’s cash balance by more than 10% so far in 2022.