We're Not Counting On Novartis India (NSE:NOVARTIND) To Sustain Its Statutory Profitability

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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Novartis India (NSE:NOVARTIND).

While Novartis India was able to generate revenue of ₹3.91b in the last twelve months, we think its profit result of ₹264.2m was more important. Below, you can see that both its revenue and its profit have fallen over the last three years.

View our latest analysis for Novartis India

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. Today, we'll discuss Novartis India's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Novartis India.

A Closer Look At Novartis India's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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.

For the year to September 2020, Novartis India had an accrual ratio of 0.97. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of ₹1.1b, in contrast to the aforementioned profit of ₹264.2m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₹1.1b, this year, indicates high risk.

Our Take On Novartis India's Profit Performance

As we discussed above, we think Novartis India's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Novartis India's underlying earnings power is lower than its statutory profit. Sadly, its EPS was down over the last twelve months. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Every company has risks, and we've spotted 3 warning signs for Novartis India (of which 2 make us uncomfortable!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Novartis India's profit. 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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