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 Super Retail Group (ASX:SUL).
It's good to see that over the last twelve months Super Retail Group made a profit of AU$110.2m on revenue of AU$2.83b. Happily, it has grown both its profit and revenue over the last three years (though we note its profit is down over the last year).
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. As a result, we'll today take a look at how dilution and cashflow shape our understanding of Super Retail Group's 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 Super Retail Group's Earnings
Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. The ratio shows us how much a company's profit exceeds its FCF.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".
Over the twelve months to June 2020, Super Retail Group recorded an accrual ratio of -0.40. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of AU$542m in the last year, which was a lot more than its statutory profit of AU$110.2m. Super Retail Group's free cash flow improved over the last year, which is generally good to see. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.
To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. As it happens, Super Retail Group issued 14% more new shares over the last year. As a result, its net income is now split between a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of Super Retail Group's EPS by clicking here.
How Is Dilution Impacting Super Retail Group's Earnings Per Share? (EPS)
Super Retail Group has improved its profit over the last three years, with an annualized gain of 8.4% in that time. Net income was down 21% over the last twelve months. But the EPS result was even worth, with the company recording a decline of 21%. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.
In the long term, if Super Retail Group's earnings per share can increase, then the share price should too. 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 Super Retail Group's Profit Performance
In conclusion, Super Retail Group has a strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share are dropping faster than its profit. Based on these factors, we think that Super Retail Group's profits are a reasonably conservative guide to its underlying profitability. If you'd like to know more about Super Retail Group as a business, it's important to be aware of any risks it's facing. For example, we've discovered 3 warning signs that you should run your eye over to get a better picture of Super Retail Group.
In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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. 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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