Cielo's (BVMF:CIEL3) Earnings Are Of Questionable Quality

By
Simply Wall St
Published
May 10, 2022
BOVESPA:CIEL3
Source: Shutterstock

Cielo S.A.'s (BVMF:CIEL3) robust earnings report didn't manage to move the market for its stock. Our analysis suggests that shareholders have noticed something concerning in the numbers.

See our latest analysis for Cielo

earnings-and-revenue-history
BOVESPA:CIEL3 Earnings and Revenue History May 10th 2022

Examining Cashflow Against Cielo'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2022, Cielo recorded an accrual ratio of 0.25. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In the last twelve months it actually had negative free cash flow, with an outflow of R$3.0b despite its profit of R$923.0m, mentioned above. It's worth noting that Cielo generated positive FCF of R$1.8b a year ago, so at least they've done it in the past. One positive for Cielo 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. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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.

Our Take On Cielo's Profit Performance

Cielo 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 Cielo's statutory profits are better than its underlying earnings power. But at least holders can take some solace from the 66% EPS growth in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it's equally important to consider the risks facing Cielo at this point in time. Our analysis shows 2 warning signs for Cielo (1 shouldn't be ignored!) and we strongly recommend you look at these before investing.

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