National Marine Dredging's (ADX:NMDC) Earnings Are Of Questionable Quality

Last week's profit announcement from National Marine Dredging Company (ADX:NMDC) was underwhelming for investors, despite headline numbers being robust. We did some digging and found some worrying underlying problems.

See our latest analysis for National Marine Dredging

A Closer Look At National Marine Dredging's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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 June 2021, National Marine Dredging recorded an accrual ratio of 0.25. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of د.إ496m, in contrast to the aforementioned profit of د.إ814.9m. We saw that FCF was د.إ149m a year ago though, so National Marine Dredging has at least been able to generate positive FCF in the past. One positive for National Marine Dredging 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of National Marine Dredging.

Our Take On National Marine Dredging's Profit Performance

National Marine Dredging didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that National Marine Dredging's statutory profits are better than its underlying earnings power. On the bright side, the company showed enough improvement to book a profit this year, after losing money last year. 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 National Marine Dredging as a business, it's important to be aware of any risks it's facing. For instance, we've identified 4 warning signs for National Marine Dredging (2 are concerning) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of National Marine Dredging's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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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