Is There More To The Story Than Localiza Rent a Car's (BVMF:RENT3) Earnings Growth?

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Localiza Rent a Car's (BVMF:RENT3) statutory profits are a good guide to its underlying earnings.

We like the fact that Localiza Rent a Car made a profit of R$854.0m on its revenue of R$10.6b, in the last year. One positive is that it has grown both its profit and its revenue, over the last few years.

Check out our latest analysis for Localiza Rent a Car

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. Today, we'll discuss Localiza Rent a Car's free cashflow relative to its earnings, and consider what that tells us about the company. 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 Localiza Rent a Car's 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to March 2020, Localiza Rent a Car recorded an accrual ratio of 0.37. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of R$3.1b despite its profit of R$854.0m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of R$3.1b, this year, indicates high risk.

Our Take On Localiza Rent a Car's Profit Performance

As we discussed above, we think Localiza Rent a Car's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Localiza Rent a Car's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about Localiza Rent a Car as a business, it's important to be aware of any risks it's facing. For example, Localiza Rent a Car has 3 warning signs (and 2 which are potentially serious) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Localiza Rent a Car's profit. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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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