Zimplats Holdings' (ASX:ZIM) Promising Earnings May Rest On Soft Foundations

Zimplats Holdings Limited (ASX:ZIM) announced strong profits, but the stock was stagnant. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

View our latest analysis for Zimplats Holdings

Zooming In On Zimplats Holdings' 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). The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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 June 2021, Zimplats Holdings had an accrual ratio of 0.21. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In fact, it had free cash flow of US$294m in the last year, which was a lot less than its statutory profit of US$563.1m. We note, however, that Zimplats Holdings grew its free cash flow over the last year.

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

Our Take On Zimplats Holdings' Profit Performance

Zimplats Holdings didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Zimplats Holdings' true underlying earnings power is actually less than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Case in point: We've spotted 2 warning signs for Zimplats Holdings you should be mindful of and 1 of these makes us a bit uncomfortable.

This note has only looked at a single factor that sheds light on the nature of Zimplats Holdings' 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. 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.
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