Here's Why We Think Monadelphous Group's (ASX:MND) Statutory Earnings Might Be Conservative

As a general rule, we think profitable companies are less risky than companies that lose money. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether Monadelphous Group's (ASX:MND) statutory profits are a good guide to its underlying earnings.

We like the fact that Monadelphous Group made a profit of AU$36.5m on its revenue of AU$1.49b, in the last year. The chart below shows how it has grown revenue over the last three years, but that profit has declined.

See our latest analysis for Monadelphous Group

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. So today we'll look at what Monadelphous Group's cashflow tells us about the quality of its earnings. 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 Monadelphous Group'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. 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. 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. 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 2020, Monadelphous Group recorded an accrual ratio of -0.34. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of AU$106m during the period, dwarfing its reported profit of AU$36.5m. Notably, Monadelphous Group had negative free cash flow last year, so the AU$106m it produced this year was a welcome improvement.

Our Take On Monadelphous Group's Profit Performance

Happily for shareholders, Monadelphous Group produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Monadelphous Group's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! On the other hand, its EPS actually shrunk in 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. At Simply Wall St, we found 2 warning signs for Monadelphous Group and we think they deserve your attention.

This note has only looked at a single factor that sheds light on the nature of Monadelphous Group'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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