Sayona Mining (ASX:SYA) Is Posting Healthy Earnings, But It Is Not All Good News

Strong earnings weren't enough to please Sayona Mining Limited's (ASX:SYA) shareholders over the last week. We did some digging and found some underlying numbers that are worrying.

View our latest analysis for Sayona Mining

A Closer Look At Sayona Mining'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to December 2021, Sayona Mining had an accrual ratio of 0.42. As a general rule, that bodes poorly for future profitability. 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 AU$16m despite its profit of AU$65.0m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of AU$16m, this year, indicates high risk. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Sayona Mining.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Sayona Mining increased the number of shares on issue by 60% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. Check out Sayona Mining's historical EPS growth by clicking on this link.

A Look At The Impact Of Sayona Mining's Dilution on Its Earnings Per Share (EPS).

Three years ago, Sayona Mining lost money. And even focusing only on the last twelve months, we don't have a meaningful growth rate because it made a loss a year ago, too. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

If Sayona Mining's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Sayona Mining's Profit Performance

As it turns out, Sayona Mining couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). On reflection, the above-mentioned factors give us the strong impression that Sayona Mining'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. If you want to do dive deeper into Sayona Mining, you'd also look into what risks it is currently facing. Case in point: We've spotted 4 warning signs for Sayona Mining you should be mindful of and 2 of these make us uncomfortable.

Our examination of Sayona Mining has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.