Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company’s underlying profitability. Today we’ll focus on whether this year’s statutory profits are a good guide to understanding Volga Gas (LON:VGAS).
While Volga Gas was able to generate revenue of US$37.5m in the last twelve months, we think its profit result of US$2.58m was more important. The good news is that the company managed to grow its revenue over the last three years, and also move from loss-making to profitable.
Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we’ll look at what Volga Gas’s cashflow and unusual items tell us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Volga Gas.
A Closer Look At Volga Gas’s Earnings
Many investors haven’t heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company’s profit is backed up by free cash flow (FCF) during a given period. 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.
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. That’s because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
Over the twelve months to June 2019, Volga Gas recorded an accrual ratio of -0.19. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of US$12m in the last year, which was a lot more than its statutory profit of US$2.58m. Volga Gas’s free cash flow improved over the last year, which is generally good to see.
Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.
The Impact Of Unusual Items On Profit
Volga Gas’s profit was reduced by unusual items worth US$1.7m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we’d expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. 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 Volga Gas 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 Volga Gas’s Profit Performance
In conclusion, both Volga Gas’s accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Volga Gas’s underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! While it’s very important to consider the profit and loss statement, you can also learn a lot about a company by looking at its balance sheet. If you’re interestedwe have a graphic representation of Volga Gas’s balance sheet.
After our examination into the nature of Volga Gas’s profit, we’ve come away optimistic for the company. 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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.