Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it’s not always clear whether statutory profits are a good guide, going forward. In this article, we’ll look at how useful this year’s statutory profit is, when analysing Aurelia Metals (ASX:AMI).
It’s good to see that over the last twelve months Aurelia Metals made a profit of AU$25.2m on revenue of AU$294.7m. One positive is that it has grown both its profit and its revenue, over the last few years, though not in the last twelve months.
Not all profits are equal, and we can learn more about the nature of a company’s past profitability by diving deeper into the financial statements. Therefore, we think it’s worth taking a closer look at Aurelia Metals’ cashflow, as well as examining the impact that unusual items have had on its reported profit. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.
Examining Cashflow Against Aurelia Metals’ Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. This ratio tells us how much of a company’s profit is not backed by free cashflow.
That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. While it’s not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That’s because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
Aurelia Metals has an accrual ratio of 0.25 for the year to December 2019. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of AU$6.3m despite its profit of AU$25.2m, mentioned above. We saw that FCF was AU$135m a year ago though, so Aurelia Metals has at least been able to generate positive FCF in the past. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. One positive for Aurelia Metals shareholders is that it’s accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.
How Do Unusual Items Influence Profit?
Aurelia Metals’ profit suffered from unusual items, which reduced profit by AU$6.3m in the last twelve months. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it’s surprising that the accrual ratio tells a different story. It’s never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that’s hardly a surprise given these line items are considered unusual. If Aurelia Metals doesn’t see those unusual expenses repeat, then all else being equal we’d expect its profit to increase over the coming year.
Our Take On Aurelia Metals’ Profit Performance
In conclusion, Aurelia Metals’ accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Given the contrasting considerations, we don’t have a strong view as to whether Aurelia Metals’s profits are an apt reflection of its underlying potential for profit. If you’d like to know more about Aurelia Metals as a business, it’s important to be aware of any risks it’s facing. To help with this, we’ve discovered 4 warning signs (1 is a bit concerning!) that you ought to be aware of before buying any shares in Aurelia Metals.
In this article we’ve looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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